Description

Brunswick Corporation (Ticker: BC) manufactures, markets and distributes inboard and outboard engines, marine parts and accessories, such as propellers and electronics, and sport and fishing boats. The company’s diverse products and innovative technologies are deployed across an array of recognizable brands, and sold through a global distribution network. The business currently has high rates of revenue growth and growing margins and market share. Yet it is cheap, with an EBITDA/EV yield of 9.6%, which puts it in the cheapest decile of stocks in our tradeable universe (>~$3bn market cap). We think this is a very reasonable cash flow yield for ownership in such a strong and growing franchise.

While many predicted the pandemic would cause a decline in revenues for the company in 2020, instead it showed steady revenue growth of 5.8% through the year, and today is growing even more rapidly due to sharply inflecting retail demand in the US marine industry. In 2021, an early spring and good weather drove many boaters in northern climates to get out onto the water earlier than usual. The availability of low-cost consumer financing also contributed. US Marine industry retail unit demand, which typically grows at mid-high single-digit rates, grew by 23% in Q1 2021.

And BC handily outperformed the industry. During the Q1 2021 period, BC grew revenues by 48% versus the prior year quarter, while expanding operating margins by > 5% to 19%. And this growth appears to be ongoing. The company reports Q2 is similar, growing at approximately a 50% rate over the prior year’s quarter. The company is manufacturing at high rates, but cannot keep the dealers adequately stocked.

The sale of BC’s products are reported across three operating divisions: Propulsion, Parts & Accessories, and Boats.

Propulsion

The Propulsion segment manufactures, markets and distributes outboard/inboard engines and propulsion-related controls. Mercury Marine is BC’s flagship brand in this segment, and is arguably the crown jewel of the company, with a strong brand and a portfolio of high-quality products.

The company estimates its LTM Propulsion Revenues of ~$2 billion represent approximately a ~45% market share of their core US market for marine engines. The company believes it can approach a 50% share in the current planning cycle.

The market has evolved in recent years, and the company has made heavy R&D investments in Propulsion, and this is now paying off, as BC has gained share in almost every horsepower category. For instance, consumers are hungry for more power, and the company has delivered: in the past 3 years, sales of 300+ horsepower engines have doubled to approximately $700 million. The company has offered a new V-12 600 horsepower engine, its largest ever, with attractive margins.

BC’s strong product set helped the company succeed through the pandemic. In 2020, Propulsion segment revenues grew at 11%, while operating earnings grew 19%. International sales were a significant contributor. International sales made up 36% of 2020 revenues, and grew at a rate of 24% versus 2019 revenues. That’s not bad, even for a non-pandemic year.

Operating margins for the Propulsion segment have steadily increased over the past three years, from 13.9% in 2018, to 14.2% in 2019, to 15.2% in 2020. Q1 2021 margins were 18.9%. The company believes it can increase segment margins another 120 bps in 2021 versus 2021. If Q1 is any guide, this looks achievable.

In Q1 2021, the Propulsion segment, the company’s largest, accounting for 46% of revenues, grew at 47% versus the prior year quarter. Again, the company attributes this growth to both an early spring and flexible work schedules that allow for more leisure time.

Parts & Accessories

The P&A segment manufactures, markets and distributes a variety of parts and accessories, including engine parts, electrical products and advanced systems, and boat parts. P&A products are distributed across a network of > 26,000 retail locations, including in North America, Europe and Australia, and the company offers > 19,000 SKUs, with next-day delivery service to many marine service facilities and dealers. An interesting feature of the P&A segment is that each engine sold by the company results in a 20-year aftermarket sales annuity through dealers and retailers that flows through P&A.

P&A segment revenues grew by 12% in 2019, and 9% in 2020 which, as with the Propulsion segment, was pretty good for a pandemic year. Again, as with the Propulsion segment, Q1 2021 was a fantastic outcome for P&A, with revenues increasing by 52% versus Q1 2020.

P&A Operating margins increased steadily over the past three years, from 15.2% in 2018, to 17.2% in 2018, to 18.3% in 2020. Q1 2021 was also a good quarter for margins, with P&A generating Q1 operating margins of 21.3%, up 350 bps versus the prior year’s quarter.

Last month, BC paid $1 billion to acquire Navico, a business focused on marine electronics, including displays, fish finders, autopilots, and sonar and radar. In 2020, the P&A segment accounted for $1.5 billion of BC’s revenues, and with the acquisition, BC’s P&A revenues should increase to over $2 billion.

Boats

The company is a leader in the design, manufacture, marketing and sale of recreational motorboats, has a network of 1,300 dealers and distributors, and offers recognizable brands, including Boston Whaler, Bayliner and Lund.

The company cannot keep up with surging retail demand. Despite producing 9,400 units in Q1 2021, which is up 16% versus Q4 of 2020, dealer inventories stood at 19 weeks, which is down 41% versus a year earlier. It is a very robust market that does not appear to be slowing at this point.

In Q1 2021, the Boat segment achieved a revenue increase of 44% versus the prior year quarter, and double-digit operating margins for the first time in > 20 years. Demand remains strong. There has been a surge in dealer orders with names already attached to the order, and 95% of production slots have been sold for the year, with many models sold out into 2022. There has also been an increase in first-time boat buyers, among younger buyers, and female buyers. This represents a significant demographic shift versus the industry.

An important dynamic to understand about BC is its successful long-term diversification away from low margin boats to higher margin engines, parts and systems. 15 years ago, the company derived ~60% of its revenues from Boats, but today less than a third of revenues come from the Boat segment. We believe this is one reason why the company remains cheap – the boating segment has been shrinking over time. But a key point is that while 15 years ago the Boat segment represented ~40% of operating earnings, today it represents ~10% of operating earnings. Overall corporate revenues are in fact lower than they were 15 years ago, although profits are way up. We see this in a lot of value situations – a company is pushing into higher growth/margin businesses, but suffers a drag from a legacy business.

The good news is the recent decline is not that steep, with an 11% decline in units over the past 5 years, and today the Boat segment revenues and margins seems to be sharply rebounding. Meanwhile, as with the P&A segment, which generates an aftermarket annuity from Propulsion sales, the company’s Boats segment procures almost all of its outboard engines from the Propulsion segment.

In 2019, the company purchased Freedom Boat Club, the largest boat club operator in the US. Today, this network has > 40k members, comprising > 280 company-owned and franchised locations that give members access to > 3,200 boats, and attracts new entrants and grows the boating community.

Strong Financial Performance

All three of the company’s operating segments are growing revenues at double-digit rates over a multi-year time frame, with Propulsion potentially achieving ~15% YoY growth rates. Multi-year margin expansion also looks achievable, with 100-300 bps gains per segment per year possible.

Conservatively estimated, the company could generate >$425 million in FCF in 2021, which at a current EV of $7.9bn equates to a FCF/EV yield of > 5%. We believe FCFs may grow at double digit rates through 2022. Although the company took on new debt for the Navico acquisition, it has traditionally been disciplined with its debt profile – prior to the acquisition, BC had planned to pay down $100 million of debt in 2021, and through April had already repaid approximately $70 million of that total. We believe the company has the discipline to maintain a healthy balance sheet over the longer term. The company has also been repurchasing shares in recent years, and currently anticipates repurchasing $80-$120 million in shares this year. BC also increased the dividend by 24% this year.

Summary

Given these healthy financial dynamics, we believe BC’s EBITDA/EV yield of 9.6% is quite reasonable. The pandemic appears to have given rise to a new generation of outdoor enthusiasts, and we believe this trend remains in place today, and could represent a permanent shift. While traditionally BC has been a modest single-digit EPS grower, in light of explosive current demand, EPS could grow by as a much as 25% per year for the next few years, and could approach $10/sh in the next 18 months, which equates to a forward P/E of ~10x. That’s cheap. We think BC is a solid franchise, and at today’s price represents good value.

Catalyst

-Strong retail demand

-Revenue growth and margin expansion

-Shareholder friendly return of capital through dividend and share repurchases