|Shares Out. (in M):||88||P/E||9.5x||7.9x|
|Market Cap (in $M):||3,916||P/FCF||12x||9x|
|Net Debt (in $M):||669||EBIT||589||629|
We think Brunswick represents an opportunity to invest in an underappreciated high-quality business at an extremely depressed valuation of less than 8x next year’s earnings. The impending sale of the company’s fitness business will remove a declining business from the company’s consolidated results that has obscured stellar performance in the core marine business. Further, the use of proceeds for accretive buybacks and debt repayment should drive EPS above street estimates in 2020 and we believe the stock could double in the next year or two.
Brunswick is a manufacturer of recreational marine engines and boats. The company has also been the largest supplier of commercial fitness equipment through its Life Fitness business, but will soon complete the sale of the business to private equity for $490 million (expected to close by the end of this month).
Going forward, the newly streamlined Brunswick will operate two boating-related businesses. First is its Marine Engine segment, which sells engines for freshwater and saltwater boats along with the parts and accessories used to maintain them, which will account for about 85% of the company’s operating income. The other 15% of Brunswick’s operating income is generated by its Boat segment, which sells recreational and fishing boats (key brands include Boston Whaler, Sea Ray, and Lund).
Attractive and Concentrated Market Structure for Marine Engines
We think this is a much higher-quality and less competitive business than investors generally appreciate. In fact, the marine engine industry is highly consolidated with two players, Brunswick’s Mercury brand and Yamaha, accounting for a large portion of the engine market. We estimate each company has about 40% of the U.S. market for a combined market share exceeding 80% (the other 20% is a mix of smaller players). Interestingly, we think this market share statistic perhaps even understates how good the market dynamics are as Mercury and Yamaha each dominates a specific submarket, with Brunswick’s Mercury historically strong in freshwater (we estimate a roughly ~55-60% share) and Yamaha maintaining a leading position in saltwater. However, Brunswick has spent the past few years investing heavily in new product development, leading to quieter, lighter and more fuel efficient engines, which we believe has helped drive saltwater market share gains (we estimate Mercury’s share in saltwater has reached the mid- to high 20% range).
Less Cyclical Given Growing Parts & Accessories Business plus Restructured Boat Business
While investors are concerned about owning economically-sensitive stocks like Brunswick, we think they are underappreciating the steps the company has taken in recent years to enhance the stability of the business through increased exposure to parts and accessories and by restructuring its boat manufacturing footprint.
First, the percentage of revenue the company receives from the sale of high-margin parts and accessories has roughly doubled since 2006 to a current level of almost 40% and now accounts for roughly half of total company profit. Parts and accessories sales were fairly stable during the financial crisis (revenue fell low- to mid-single-digits percent), which is consistent with end-market demand that is mainly driven by the installed base and average age of boats, as opposed to boat sales in any given year.
Second, Brunswick has consolidated its boat manufacturing footprint to just eight boat plants in North America today from 29 in 2006. Combined with a higher quality mix of brands today, we think the boat segment is positioned to perform much better in a tougher economic environment.
Industry Volumes Are Still Below Prior Peak and Replacement Analysis Would Argue for Higher Sales Volumes
For some context, U.S. powerboat unit sales last year were 201k units vs. a 2002-2006 average of ~290k so overall industry volume is still 30% below peak. After dropping dramatically during the recession, U.S. boat sales have been slowly climbing back at a mid-single digit annual growth rate. At the same time, there has been a mix shift to higher value boats that has helped drive overall engine sales (higher average horsepower engines with higher ASPs and more engines per boat).
While we are not predicting a return to the prior peak in unit sales, we think replacement demand would imply a normalized sales level of ~300k units and is supportive of continued steady growth in engine sales. There are 9.5 million registered boats in the U.S. and assuming a typical useful life of 30-35 years implies ~270-315k of annual replacement demand. Alternatively, you would have to assume a useful life of 47 years for current volume levels to be “normal.”
As it relates to more recent industry data, a slow start to this year’s boat selling season is likely the main reason for Brunswick’s poor stock performance in recent months. While Q4 and Q1 are seasonally small contributors, first quarter industry sales were down slightly vs. last year. We think much of the slower start has been driven by poor weather in many key boat markets and expect to see improvement going forward. Recent industry data for April showed modest growth and Brunswick’s commentary at a recent conference indicates that May was similar to April with Memorial Day weekend providing some “encouraging signs.”
Strong Marine Performance Masked by Declining Fitness Operations
Over the past few years, the Fitness business has seen a significant decline in profitability with EBIT falling from $130 million in 2016 to just $62 million in 2018 and to roughly breakeven in the first half of 2019. When looking at the consolidated financials of Brunswick, this Fitness business underperformance obscures the strong momentum that Brunswick has demonstrated in the marine/boat business. Based on our analysis of the Marine-only financials since 2013, we estimate that Brunswick (ex-Fitness) has grown sales at a ~7.5% CAGR and EBIT at a ~22.5% CAGR vs U.S. industry boat sales volumes up ~5.5% annually over that period. With the Fitness sale expected to close by the end of this month, investors can now clearly focus on the well-positioned business with strong operating momentum that remains.
Below we have outlined our estimate of the historical and projected standalone Marine-only financials based on assumptions around 1) stranded Fitness costs, 2) Brunswick retaining all below-the-line items, and 3) deployment of Fitness sale proceeds into buybacks and debt repayment. We think the table below highlights the business’s impressive financial characteristics:
Potential for Meaningful Near-Term Capital Return and Corporate Cost Reductions
In February, Brunswick gave 2020 targets for the Marine-only business of $5.00-5.50 in earnings per share. While they expected Fitness to generate ~$0.35 in earnings in 2019, they neither provided nor included any Fitness contribution in their 2020 targets. But they also didn’t assume any benefit from the deployment of proceeds from a potential sale. Predictably, consensus estimates for 2020 are in the middle of management’s marine-only guidance of $5.25 per share. But with the company about to receive $460 million in net proceeds, if they use 50% of the proceeds to repay 4.5% debt, the annualized earnings uplift (2020 impact) is about $0.09 per share and if they use the other 50% to repurchase shares at $46 per share (a 5% premium to the current price), they’d repurchase 5.0 million shares, which would improve earnings by ~$0.30 per share for a total uplift vs their 2020 target of ~$0.39 per share (8% boost to the midpoint/consensus). We hope that the company will be even more aggressive in prioritizing share repurchases considering the current stock price and the strong cash generation expected in 2019 (>$300 million of 2019 FCF with the coming Q2-Q4 periods accounting for >100% of annual cash flow). The company recently disclosed that it has repurchased ~$70 million in stock so far in Q2, so we have every reason to believe they think the stock is too cheap and plan to be aggressive once the Fitness sale closes.
Further, we think the removal of the Fitness business gives Brunswick management a clear opportunity to meaningfully reduce its corporate footprint. The company currently has ~$80 million in annual corporate expenses (a number that we think will grow to ~$85-90 million due to certain stranded Fitness costs). Going forward, the overhead required to run the smaller, Marine-only business should be materially lower. We believe management is aware of the issue and could provide details on the cost opportunity once the Fitness sale closes.
Valuation - Reasonable Assumptions Drive 100%+ Upside
We think Brunswick can earn $5.65 in 2020 earnings (higher than management’s targets due to deployment of the Fitness proceeds). At the current share price of $44, the stock is trading at less than 8x 2020 earnings (6.2x EBITDA and 7.3x EBIT). We think the marine engine business is a really good business that should trade at ~12x EBIT (or more), while we value the boat business at ~8x EBIT. This results in undemanding blended multiples for the business overall of 11.3x EBIT and ~14x earnings, resulting in a target value for the stock of $80 per share or ~80% upside from the current price. Assuming further steady growth in 2021 would generate EPS of roughly $6.50, which at ~14x would result in a stock price of $90 per share or double the current price in the next 18-24 months.
|Subject||Re: ?good use of capital|
|Entry||06/17/2019 02:00 PM|
While it is a cyclical business, we think the company’s buybacks over the past few years were done at reasonable valuations (the stock traded at an average of ~13x earnings during the period). Further, we think their approach of being even more aggressive now when the stock seems quite cheap is reasonable and what we like to see from management teams.
In terms of the company’s general capital allocation skills, we would note that the new CEO just took over in January. However, both he and his recent predecessors have demonstrated a history of simplifying the business, having sold the bowling business in 2014/15 and recently announcing the sale of the Fitness business. In addition, we think restructuring the boat business and building up the parts & accessories business (including last year’s purchase of Power Products) are logical extensions of this effort to create a stronger and more profitable, marine-only business.
|Entry||06/17/2019 06:13 PM|
In a recession, we assume BC's boat and engine sales fall 10% from 2018 levels with a 2% decline in parts and accessories sales. At engine and boat decremental margins of mid-20% and mid-teens, respectively, we estimate that Brunswick would generate about $4 in 2020 EPS. At the current stock price of $45 per share, we think these risks are already being reflected in the stock price to a significant extent.
|Subject||Re: adjustments / add-backs|
|Entry||06/17/2019 06:14 PM|
On the marine engine side, the addbacks are entirely the amortization expense related to the Power Products acquisition in 2018 (along with some transaction costs from the deal).
On the boat side, we think the significant adjustments and restructuring charges are in the past and mostly related to the company’s restructuring after they decided not to sell the Sea Ray business in 2018. At that time, they decided to retain only the profitable parts of the Sea Ray portfolio, discontinuing the loss-making sport yacht and yacht operations. This resulted in restructuring and charges to wind down production. We think the bulk of these adjustments/charges are done, as can be seen in the Q1 2019 results with just $2mm of restructuring and related charges in the segment.
|Subject||Re: Re: Downside|
|Entry||06/18/2019 02:23 AM|
thanks for the writeup. can you elaborate a little on why your downside estimates are so sanguine? surely in a recession people dont' just stop buying new boats, they also probably sell their boat or at least stop going fishing/etc as much - meaning less maintenance revs, etc as people delay servicing boats. do you have any idea of how Power Products performed in 2009 or something? this is a business BC paid 17x pre-synergy EBITDA for and 4.5x sales...
a few other questions:
- why is capex going up so much? looks like capex has been >depreciation for the last 3+ yrs and is guided to double D&A (capex $230mm, D&A $110mm) this year. In BC's latest (June) deck, they say maintenance capex is only 25% of the spend, but that they are also only growing capacity incrementally (in engines, they didn't say much in the deck about boat growth capacity). If you look at the capex intensity of the business capex % sales has been growing over the last few yrs despite ramping sales - kind of the opposite you would expect as recurring maintenance/service business share % of total revs grows, and as revs grow in absolute terms. Why is this?
- boat unit volume vs ASPs: you mentioned that boat unit volumes (around 200k) remain well below the prior peak (300k) while normalized replacement demand based on age of boats is somewhere around 300k. this ignores the fact that ASP has been rising continuously such that BC readily admits gross DOLLARS spent on new boats annually is now 10% ABOVE peak. Clearly in the context of a gradual premiumization and fragmentation of consumer interest (less baby boomers, more millenials, etc), this makes sense (note also that boat registrations, as opposed to units, have actually been declining at a very slow pace over the last 15yrs). But isnt this is at the least problematic for your investment thesis? If or when there is a recession it implies the earnings volatility should be higher from the boat segment (more gross profit dollars at risk per unit); and your contention re operating efficiency (8 boat plants now vs 29 in 2006) makes operational deleverage more likely too (since utilization should be much higher steady-state). You may be right re the increased maintenance portion of the revenue stream now vs last crisis; but the non-maintenance part of the business seems to me to be more volatile now (from a higher base) than before, perhaps worthy of a lower multple today.
I really want to like this but these, along with azia's point re the add-backs, are somewhat holding me back.
|Subject||Engine complexity, aftermarket, China|
|Entry||06/18/2019 02:27 AM|
Thank you hawkeye for the write-up. Some questions on it.
1. What proportion of engine annual sales (units) comes from engines that are incorporated in Brunswick’s own boats vs. engine sales to third-party boat OEMs?
2. What is the engine cost as a % of the total cost of the boat? I guess it varies by model, but if you can give a rough estimate that would be great.
3. Engine aftermarket.
· Complexity of an engine in term of # of parts and relative cost of each of them to the total cost of the engine? Is there any individual part that makes for a significant cost of the engine and gets typically replaced over time?
· Is it possible to use other parts suppliers that perform well for a Mercury or Yamaha engine in the same fashion people use autopart stores rather than relying on OEM dealers once warranty expires?
· Warranty. How many years to expire and other relevant terms?
· Is it the aftermarket typically DIY or DIFY? I absolutely ignore how the boat industry works and I guess this relates to the engine complexity question.
o If it is DIFY and Brunswick also does the fixing-substitution through its network, what is the typical split in the final invoice to the customer of labor costs vs. part cost?
o Even if an engine is a complex thing is this an industry where many boat enthusiasts benefit from a small community where there is somebody they know at the harbor who is able to install a new part for little cost compared to Brunswick? Does this “mechanic friend” exists?
4. I have read in the AR that a proportion of outboard engines come from a Brunswick’s factory in China. What proportion is that? Are those units allocated to non-US markets?
Thanks and all the best.
|Entry||06/18/2019 02:20 PM|
thanks for the idea. couple of questions. 1. what is included in the corp overhead number? Is IT, Finance and HR in there or are these costs allocated to the divisions? Has the company given you a target number? 2. Is there a trends towards less ownership and more fractional ownership or shared ownership? i don't have a good sense but I would think a boat is not used that much and it could be shared so is there a trend towards that? The rise of boat clubs (they just bought a big one) could be evidence of that? Thanks.
|Subject||Re: Re: Re: Downside|
|Entry||06/18/2019 02:42 PM|
Regarding whether the downside scenario is harsh enough, NMMA annual retail sales data for the past 40 years indicates that boat units have typically fallen ~15% from peak to trough during a recession. If you then add BC’s share gains in saltwater and modest inflation, we think dollar sales falling 10% is reasonable. We don’t have data for Power Products specifically but it only accounts for ~15% of their total P&A revenues and as we mentioned in the write-up, revenues declined in the overall P&A business by low to mid-single digits percent during 2008-09. This is based on the company’s commentary and our own research, so we think using ~2% decline is reasonable.
Regarding capex, it’s been increasing mainly due to the company’s new product introductions (more capacity on existing lines, ramping new product lines, integrating manufacturing systems etc.). For certain areas, BC has been capacity constrained with new products being sold out (they have more capacity coming online later this year). They are also increasing their vertical integration, allowing for greater in-sourcing of parts. And some of the capex is going toward integrating Power Products manufacturing operations, which should be margin accretive over time. Given the growth the business has seen in the past few years and the success of their new product lines, we think this has been high ROIC capex. We’d also highlight that capex is expected to fall ~12% in 2020 vs this year.
We acknowledge (and mentioned in our write-up) that ASPs have been moving higher but we also think only focusing on boat dollar sales is unfair -- by that standard, sales in many industries are above their 2006/07 peak. Since 2006, nominal GDP has grown ~48%, the U.S. population has grown ~9% and cumulative inflation has been ~25%, so we think U.S. boat dollar sales being a bit above their nominal peak levels is not an obvious cause for concern. Boat dollar sales per capita are roughly flat vs the last peak and are significantly lower in relation to the size of the U.S. economy today. Further, on an inflation-adjusted basis, boat dollar sales per capita are more than 15% below 2006 levels.
Regarding volatility of the business today vs. last cycle, I’m not sure I completely follow the logic. I would expect that a higher margin, higher utilization manufacturing operation would be preferable to the alternative. We think by taking out fixed costs and improving the overall margin level of the boat business, the boat business is much less likely to see a catastrophic decline in EBIT in a future downturn. This lower sensitivity can be seen by the boat segment incremental margins having actually declined over the past few years from the ~25-30% level to ~10-15% currently. We would also highlight that the boat business represents ~15% of overall EBIT for the company.
|Subject||Re: Engine complexity, aftermarket, China|
|Entry||06/18/2019 02:46 PM|
1) BC’s boat market share (about 15%) is significantly lower than its engine market share. While all of the boats BC manufactures will contain Mercury engines, the majority of engines are placed on non-BC boats.
2) Using 2016 data from NMMA, the average outboard boat cost $32k and the average outboard engine cost $9k, so about 28% of a boat’s cost relates to the engine.
3) In general, only Mercury parts and accessories will work for a Mercury engine and same for Yamaha parts on Yamaha engines. Mercury sells its parts and accessories through a network of dealers. Boat maintenance is a combination of DIY and DIFM, depending on the level of expertise possessed by the boat owner. Individuals at the dealers or other boat technicians can assist with DIFM. Standard warranties for boats last 3-5 years, with the option to purchase warranty extensions.
4) BC hasn’t disclosed exactly what percent of its engines are sourced from China, but our understanding is that the engines manufactured there are mostly low horsepower (40-60 hp) products sold globally, for which the company received an exclusion from tariffs in December 2018. Given the heavy mix of domestic sales for BC’s overall engine business, we estimate that a significant portion of these engines are sold in the US.
|Entry||06/18/2019 04:57 PM|
1) The primary components of corporate overhead for BC are IT, treasury infrastructure, financial reporting, audit, legal costs, and the corporate office in Chicago. While management hasn’t provided a target for what amount of corporate overhead could be cut, their commentary suggests they are aware of the opportunity and are looking at ways to reduce corporate costs.
2) It’s unclear at this point (and probably will be for several years given its small scale) to what extent the boat club market is additive to overall boat demand vs. cannibalizing a potential buyer. Freedom Boat Club, which BC recently purchased and is the largest boat club operator, has a fleet of 2,200 boats compared with an installed base of 9.5 mm in the US. We understand the concern that boat sharing could ultimately reduce boat ownership rates, but boat clubs do have two characteristics that would drive higher sales for BC. First, by lowering the cost of ownership, more individuals could be inclined to become boaters, leading to a demand boost from the boat clubs. Second, boat clubs may increase utilization, leading to more parts and accessories sales and replacement demand.