Description

Investment Viewpoint: While the shares of Griffon Corp. (GFF-NYSE) have been volatile in the last 18 months, bouncing down and up between $20 and $40 with news flow, especially surrounding the company’s strategic process, the underlying value of the company’s crown jewel asset, it’s Home and Building Products (HBP) division, has more than doubled over roughly the same the period. Importantly, we believe the improvement in the company’s HBP business is durable. Our belief is underscored by the combination of the recent strong Q2 (March) results posted in this division, competitor Sanwa recently increasing its financial guidance due to its ability to pass thru price increases in its Overhead Door division as well as comments from expert calls with competitors and distributors. 

With the shares currently valued (x-the special dividend) at the lower end of the company’s historical EV/EBITDA, P/E and P/FCF multiple ranges, we believe the intrinsic value of the company’s HBP asset (which constituted ~70-80% of GFF’s EBITDA, before corporate expenses) is not fully recognized nor appreciated by investors. While the recent actions by an activist investor, including obtaining two Board seats, have begun to produce some positive capital allocation and management compensation changes, we believe the news flow associated with the activist campaign and subsequent sale process, has clouded the durable fundamental improvement in the company’s HBP business. We believe the HBP asset is not appropriately valued and, alone it is worth more than the value currently being accorded the entire company in the market. Additionally, with little to no value accorded the company’s challenged Consumer and Professional Products (CPP) division, is the equivalent of a free call option, and any financial progress made in the recently announced restructuring of the company to an asset light sourcing model and could provide a catalyst to the shares.

With the recent ~25% decline in the share price and the conclusion of the strategic process initiative, investors have now completely written off the possible sale of the company or any assets. However, our belief is that there were multiple acquirers interested in the company’s HBP asset, underscoring its intrinsic value. But the combination of the ~40% increase in HBP’s profitability post the announcement of the strategic review which would bode for an increased valuation conflicted with the desire of buyers for lower valuations due to the rise in interest rates; creating a stumbling block to consummating a deal. Nonetheless, we still believe the final chapter may not have been written and a deal could still be completed sometime in the future. This is underscored by recent comments from the Chairman of the Committee of Strategic Considerations suggesting the door to monetizing certain of the company’s asset is not completely shut. Our analysis of multiples from recent comp transactions shows the value of the HBP business alone is about 50% higher than the current share price of the whole company.

We believe that the focus of GFF’s reconstituted Board, given activist Voss’ direct involvement, will now be to both increase the profitability of the company’s challenged CPP division as well as addressing the outsized corporate overhead levels, tied to its long-standing contention that the $50+ million annual corporate overhead is dramatically too large. Any progress in either of these initiatives will likely translate into a higher overall multiple.

Noteworthy, highlighting the unrecognized improvement in GFF’s profitability is the fact that while the shares are currently selling at a price at or below the levels of the Fall 2021, overall EBITDA in calendar 2023 of ~$470 million will be ~90% greater than the level of calendar 2021 (the prior high-water profitability mark) and EPS of ~$3.90/share, roughly 3x higher than this prior period.  

On various valuation measures, we believe the share are attractively priced. On calendar 2023 profitability and FCF, at the current of $32.50 price, the shares are valued at an EV/EBITDA multiple of 6.7x, a P/E of 8.2x and a FCF multiple of 7.3x. 

Using different valuation metrics, we believe the intrinsic value of the company’s assets is significantly higher than the current share price. Our SOTP analysis suggests that the value of the company’s assets is roughly $50-$60/share. Using a FCF multiple of 12-13x, translates into a share price of $44-$48/share. Using the mid-point of the company’s historical 5-year NTM EBITDA range (7x-12x) of ~9x, translates into a share price of ~$46-50/share. We believe downside protection will be provided by the combination of the company’s $258 million share repurchase program, enabling the company to repurchase ~16% of the outstanding shares at current prices, as well as the valuation of the stock already being at the low end of its historical valuation on various metrics.  

The Strategic Review Has Concluded, But That Does Not Mean The Company Is Not Open To A Sale, In Part Or Whole: In May 2022 Griffon publicly announced that it was undertaking a strategic alternatives review process to evaluate a comprehensive range of strategic alternatives to maximize shareholder value, including a possible sale, merger, divestiture, and recapitalization. Subsequently, we learned that this process had initially begun in January 2022, which we believe was pushed by activist investor Voss Capital, who had been waging a proxy fight and was set to obtain a representative Board seat. The key asset of interest to any buyer would likely be the company’s crown jewel HBP asset, while CPP could offer value to either a PE or strategic buyer in the industry looking to restructure the operations under new management.

On April 20th, the company announced that it had formally concluded its strategic review stating: “After careful consideration, the Board unanimously determined that none of the proposals received reflect the intrinsic value and strong operating performance of the business, and therefore elected to conclude its review.” 

However, within the press release, we believe there are a couple of interesting and tell-tale comments. James W. Sight, Chair of the Committee of Strategic Considerations, is quoted as saying: “Although the process has now concluded, Griffon’s Board will continue to be open to and consider all opportunities to enhance shareholder value.” Additionally, Chairman and CEO Ronald J. Kramer is quoted as saying: “Over the past year, our financial performance has improved despite headwinds in the housing market and the global economy.”

In reviewing the comments juxtaposed with observing the significant amount of transaction activity that has been occurring with the industry along with the changes in the financial and credit markets since the initial process began well over a year ago, one can begin to see a possible storyline as to what lead to the conclusion of the strategic review, and more importantly, that an ultimate sale of the company, if part or full, is not completely dead.  

The facts that we know are: 

• GFF management was open to a sale of either HBP, CPP or the whole company,

• the significant amount of transaction activity in and around the industry suggests this is a target-rich environment and the company’s assets should be attractive to both a strategic or PE buyer,

• during the time from when the initial strategic review had begun and when the company “solicited interest from a wide range of potential counterparties” there has been a rise in interest rates and in general valuations have come down, which has put a pause in the overall M&A environment, and

• post the announcement of the strategic review, the company’s overall profitability has improved, especially within its crown jewel HBP division where FY23 consensus have increased ~40%; highlighted in the release of fiscal Q2 FY23 results and increased full year EBITDA guidance.

So, putting all the pieces together, the picture that appears to develop is that in the last 12+ months since the process began, there was likely a fair amount of potential interest from acquirers. However, the increased profitability from HBP and the overall company, which normally would bode for some step up in price or multiple, likely clashed with the desire of any acquirer to want some discount from earlier prices due to the rise in interest rates and tightening in credit markets. Also, we suspect that it is possible that a possible acquirer may have been unwilling to put a multiple of the increased level of HBP’s profitability until they could assess its sustainability at higher levels. 

Our read of the situation is that there could be a potential buyer(s) that may need some additional time to get comfortable with both the sustainable level of HBP’s profitability and where interest rates will settle out before moving forward. So, with the clock ticking now over a year and management needing to make decisions and provide answers to investors regarding its strategy, they decided for now to close the formal process, and move forward on restructuring its CPP operations and to return additional capital to shareholders via the combination of a significant increase in its share buy-back program and declaring a $2.00 per share special cash dividend.

Thus, if the insights that we received from our calls with industry participants (which are illustrated later in this report) suggesting that demand is still healthy and normalizing back to historical levels and that for the most part recent price and margin increases within the industry are sticking, we would not be surprised to see a possible acquirer of HBP reengage sometime in the not-too-distant future.

As a result, the final chapter in the strategic process may not have already been written; stay tuned. 

Activist Voss Capital Beginning To Make Progress In Improving Corporate Governance: One of the clouds surrounding the shares, which has depressed the multiple, has been some past governance issues and questionable actions taken by management. Stepping in to put pressure on management to address these issues and make necessary changes has been activist Voss Capital. 

In September 2021 Voss built a 2% position in the shares and reached out to management to outline its concerns and propose a number of changes. Voss outlined a number of issues it saw as value destroying governance, compensation and cost structure issues as well as poor decisions made by management in the following document: https://static1.squarespace.com/static/601ae5e60b044d0313307aca/t/62c7362819d83868d0ab8d4c/1657222706402/GFF+-+Voss+Capital+Presentation.pdf

While not successful with all its efforts and recommendations (most notably failing in its opposition to the acquisition of Hunter Fan), in the following months Voss was successful in obtaining a representative Board seat (Michelle L. Taylor), moving forward with the sale of the company’s defense business, initiating a strategic review process and making some changes to executive compensation. In January of this year, Voss’s Chief Investment Officer, Travis W. Cocke joined GFF’s Board, replacing a member who had deceased, in what was described as a Cooperation Agreement. While this move appeared to be associated with an effort to finalize an asset sale, which to date has not been successful, he adds another shareholder aligned voice and vote to the Board. 

While Voss backed Board members only hold 2 of the 14 Board seats (soon to be 3 given they have another nomination), we believe that they will be an advocate for helping to initiate a number of necessary changes and moving the company forward with more shareholder friendly initiatives and improved stewards of capital. While it may take time to address some major structural issues at the company, we suspect where are some basic moves that could be made near-term to improve the valuation disparity in the share price. One example would be improving communications with investors in a more open and friendly manner, with the hiring of a high-level in-house professional, who has a seat at the table with senior management and is not just a barrier to management. In addition, having a current investor presentation available to highlight such things as the internal improvements at HBP post the CornellCookson acquisition, outlining the potential cost savings and new business model targeted from the CPP restructuring and the normalized corporate profitability targets would be helpful to increase investor interest in the company.

The HBP Division Is The Undervalued Crown Jewel Asset Of The Company: Having divested its defense business in April 2022, GFF is comprised of 2 divisions, Home & Building Products (HBP) and Consumer & Professional Products (CPP). The HBP division is the crown jewel asset of the company, contributing 80-90% of EBITDA before corporate expenses. Within this division, GFF is the leading manufacturer of commercial & residential overhead garage doors. The company’s Clopay brand is the leading residential garage door manufacturer, with a market share of ~25%, while its CornellCookson brand is the leading commercial rolling steel door manufacturer with a market share of ~30%.

Beginning in FY 2022 (September), there has been a significant, positive inflection in the growth and profitability of the HBP division. As illustrated in the below charts, beginning in this time period HBP’s growth positively inflected higher. 

The acceleration in volume growth was due to a combination of increased demand from home improvement residential customers, increased growth in commercial warehouses, continued healthy new residential construction and overall higher non-residential spending patterns. Additionally, GFF, like most residential & commercial overhead door manufacturers saw its AUV’s increase significantly as they were able to pass on the increase in steel prices, which is the largest component of manufacturing costs, as well as other inflationary costs like labor and transportation. Also, something we picked up in our calls with industry distributors that has helped increase AUV’s within the residential market has been a secular shift in the last few years to higher priced more decorative garage doors (i.e. carriage doors and doors with windows and trim). Over the last 18 months HBP’s revenue growth from commercial customers (CornellCookson) has outpaced growth from residential customers (Clopay). Management believes that since the acquisition of CornellCookson, they have been able to increase their overall market share, which has contributed to their recent growth. 

The big question is what will the level of growth and profitability be in the future. Currently indications from management and our industry sources indicate that overall growth is moderating back to more normalized levels as some of the pandemic related home improvement spending has gone back to prior levels, while commercial demand continues to be healthy. We suspect that going forward there is a high probability that growth should normalize close to historical levels in the mid-single digits range. 

Noteworthy, GFF has already posted healthy growth over the last two quarters in its HBP division against the tough pandemic assisted inflated sales, with commercial demand still holding up better than residential demand. This shows an underlying healthy industry growth environment and differs from other pandemic aided product growth products and services which have already receded to or below prior levels. 

A couple of points are noteworthy when accessing future revenue trends. First, traditionally roughly 90% of residential demand is from repair/remodel vs new construction. While the percent of business from remodeling during the stay-at-home pandemic period may have risen somewhat and will now recede, this does not bode for a significant decline in overall residential decline as the other sources of demand should be more stable. Also, the trend to higher priced, more decorative residential garage doors appears to be more of an ongoing secular trend, which is likely to continue into the future. Additionally, when backlogs extended out beyond normal times, management put on hold its plan to transition legacy CornellCookson dealers to cross-sell the Coplay product line, which they recently resumed. With this cross-selling opportunity now being open up, this should add to residential sales growth. In the commercial business, non-residential construction spending in general remains robust and management indicates that lead times and backlog have not changed significantly from pandemic levels suggesting no significant slowing in the CornellCookson business.

A Google Trends search for “garage door replacements” appears to continue to show a long-term favorable trend and not showing any recent fall-off:

Concurrent with the acceleration in HBP’s sales has been the increase in profitability in the division. Illustrated below is the trend in EBITDA profitability and margins in the division. 

The increase in HBP’s profitability is due to a combination of mix, various company specific operational efficiencies as well as the ability of all industry manufacturers to pass on and continue to capture the inflationary increases in steel prices, labor and transportation. While price increases have been a key part the improvement in HBP’s margins, what has been somewhat hidden by the pandemic has been the company specific moves post the acquisition of CornellCookson in June 2018, which roughly doubled the size of the division, enabling the company to take advantage of economies of scale and other combined operational efficiencies. Noteworthy, when GFF acquired CornellCookson, its EBITDA margins were ~8-9%. Post the acquisition, GFF took a number of steps to improve CornellCookson margins by integrating back-office operations, removing redundancies and cross-selling product lines. These structural changes were a major reason for the increased HBP margins and are durable.

Also, management believes that the CornellCookson acquisition coincided with the roll-out of prior technology investments, including an e-commerce site, which have improved their selling proposition and translated into efficiency improvements. Finally, it is noteworthy to point out in most commercial new construction installations, the cost of an overhead door is a small piece of a large capital expenditure project. So, for the most part, the recent price increases don’t move the bottom line cost of most construction jobs significantly. 

The point here is that one should not look at the meaningful jump in HBP’s EBITDA margins vs pre-pandemic depressed levels and attribute the improvement to just higher prices. Our understanding is that pre-pandemic, HBP had below industry average EBITDA margins and now, HBP’s margins are somewhat middle of the pack versus other industry competitors. As a result, we do not expect a significant decline in margins from current levels, but suspect some moderation with the new normal being EBITDA margins in the mid-to-upper 20 percent range.

All indications we have from various industry sources is that the industry-wide price increases are sticking, despite the moderation in growth. Noteworthy, we have heard from industry sources is that they don’t expect to see any near-term broad based price reductions and any discounts on certain large orders will be coupled to passing on declines in steel prices with little impact on margins. In addition to GFF, other large competitors are also seeing the price increases sticking. For example, Sanwa Holdings on January 31st, revised its financial forecasts, stating: “We revised the full-year consolidated results forecast for the fiscal year ending March 31, 2023, due to a better than expected effect of price pass-through of raw material price hikes in North America.”

Expert Network Discussions Show Demand Normalizing While Pricing/Margins Being Maintained: During the last few weeks, including a number in the last few days, we have participated in calls with a number of both residential and commercial industry participants and distributors. Overall these calls reveal that: while growth and lead times have moderated back closer to more normalized levels, for the most part, the higher pricing in the industry has and is expected to be maintained, with any discounts, usually on just large deals, are tied to passing on lower steel prices, enabling margins to be maintained. The following highlight some key comments.

Large regional commercial & residential distributor/installer: 

• In general, residential demand is still healthy, but is normalizing and returning to a more seasonal normal cycle, with continued growth, while commercial demand remains strong (i.e. commercial quoting & estimating activity is still healthy).

• This year they are looking for 7-10% growth, with stronger growth in commercial. They don’t see residential as a down market, but more of a flat market as it normalizes. If there is a slowdown due to macro factors, they don’t believe it will be significant.

• Currently, for the most part, lead-times are back to more normal levels (about 3-4 weeks).

• Prices went up significantly during the pandemic, as much as doubling, and while they don’t see prices continuing to go up into next year, they don’t expect them to come down. Manufacturers don’t want prices to come down and they don’t want them to come down. They believe people have come to expect to pay current prices.

• For a large commercial job (i.e. a 30-40 door job) they may see manufacturers discounting somewhat to win the business, but don’t see manufacturers changing everyday prices.

• In their residential business, during the pandemic, they saw people who were retrofitting upgrading to a more expensive higher end (i.e. carriage doors) styles, so sales went up more than volumes. In their commercial business the volumes increased, not the type or ASP of the door.

Large mid-west Coplay/CornellCookson commercial dealer/installer:

• They have seen a pick-up in business volumes the last couple of years from various business expansion and municipality activity. Things have gotten to the point where they are not bidding on all available jobs as they have their hands full and have a problem getting capable labor to work on installations. 

• They have had a very busy bid season over the past 4-5 months. Seeing an increase in requests for bids from their major contractors. They believe the demand is currently outweighing the resources available to fulfill demand. Currently, they have a backlog thru mid-October.

• They believe their business will be up ~10% this year, due mostly to volume, and held back by challenges in hiring technicians and installers. 

• For the most part most manufacturers have gotten back on track relative to lead-times, which are now about 3-4 weeks. Coplay & CornellCookson have done a relatively good job of getting their lead times back, and they said they never really experienced any major lead time issues with the Cornellcookson product line in the past.

• Price increases were more rapid and frequent during the pandemic and in some cases have doubled. 

• They have not gotten any push back from customers from any material and labor price increases.

• They are not seeing any signs of manufacturers reducing price increases, does not expect any forthcoming and said that that has not happened in his 35 years in the industry. He said that manufacturers may offer a discount on a large job saying that with steel prices coming down they have some room to play with now. 

• CornellCookson is viewed as the “Cadillac” in the commercial rolling door industry, have done such a good job of marketing and new product development and are pretty far ahead of second place.

The largest nationwide franchisor of residential garage doors:

• The company has 115 franchise locations nationwide, with system sales of all garage door related products and services across their network of $540 million, of which ~95% are residential. The parent company is owned by KKR.

• Since the company began franchising in 1999, the company has experienced consistent low double digit same store sales growth (excluding the 2008/09 recession). 

• During the pandemic they did see somewhat of an increase in the number of jobs they were doing, but did see a more significant ASP’s increase due to passing on manufacturer's price increases and a shift to more expensive decorative garage doors. They are seeing a trend where many people are retrofitting existing garage doors with more decorative doors (windows, carriage doors, trim, etc.), which is tied to manufacturers making new styles/options available and they believe this trend will continue.

• For new garage doors, they are seeing consumers now pay as much as double pre-pandemic levels due to the combination of manufacturer price increases and a higher ASP mix.

• The pandemic price increases during the pandemic related to steel/lumber prices and labor/transportation rate increases everyone got used to paying more and the consumer mindset has been reset and are now continuing to charge a premium for new garage doors.

• They foresee demand remaining pretty solid, with the number of jobs remaining consistent in the future, with no slowdown expected and are projecting roughly a 6-8% revenue increase this year.

• They have not seen any recent significant price declines from manufacturers and believe ASP’s and prices within their network will remain about consistent from current levels in the near future. 

National Accounts Director at a major competitor:

• “So, I think there's going to be some price reduction. But at the same time, it's not necessarily at the sacrifice of margins or anything like that because as we all know, like you just previously stated, costs are coming down. So, I think your margins can remain relatively healthy.

• So, this year, I don't see a whole lot of movement on the price side of things. You may see some here or there.

• So, I think you're going to see a real slow return to the price decrease discussion basically because I don't think anybody really wants to give away those gains. 

• I don't think in the history of the door business that there has ever been a publicly stated price decrease on anything. So, I think there's some real reluctancy to start any pattern with that across the industry….. So, I would be very surprised to see any deviation off of what has gone on in the past from, hey, this has never really been done in the door industry before, so I don't think they're going to take up any price decreases on national levels or anything like that.

• And then now you're starting to see a little bit of a return to normal where maybe it's your two to four weeks… I mean there's still struggles here and there, but yes, for the most part, it's returning to normal.

• It's [steel as a percent of total manufacturing costs] probably in your 60% range.

• I think one of the big realizations in the overhead door industry over the last two years especially has been, there have been very few jobs canceled or decided not to move forward because of the cost of garage doors. Generally, especially on the commercial side, it's such a small piece of the whole pie….So that's the long and short of it from my standpoint is just building is either happening or it's not happening. Garage doors are not going to stomp any project that's slated to move forward or not for the most part.

• You're seeing some reduction in cost of things, and you have the ability to move your pricing down a little bit if you need to, but you're still not really sacrificing margin at that point in time because you've just given away the extra margin that you realized on some of that stuff. So if you're just incrementally having to take it down a little bit here and there, you're still really, really healthy spot for margin.”

 President at an independent national reseller:

• “I don't think pricing, my personal opinion is going to come down significantly because I think some of the things that happened to drive pricing, were not just COVID, it was structural.

• At one point in time, we waited four months to get a door. In normal times, pre-COVID, it was two weeks. Now we're at about four weeks, and it's improving. 

• I think what we're being told is that there is volume that is still up year-over-year, but that uptick is low single digit versus large expansion. 

• We have not seen anything [price reductions]. We do our standard yelling, screaming, like we always do, but have not seen anything come down….I will say that the responses I'm getting right now don't suggest that something is imminent.”

HPB Is Worth More Than The Current Market Value & CPP Is A Free Call Option: We believe that a SOTP analysis show that the current enterprise value of the shares are below the intrinsic value of just the HBP division (including all the corporate overhead) and that investors are receiving a free call option on any recovery in the CPP division. 

Helpful in analyzing the fair market value of the HBP division is that over the last couple of years there has been a significant amount of private market transactions in the industry and with a direct competitor, which provides a good benchmark for looking at an appropriate multiple for valuation purposes. As illustrated in the below table, the average multiple of these transactions has been ~13x EBITDA. This is also the same multiple that one of HBP’s direct competitors was acquired for a little less than a year ago.

On one hand, as the market leader (with scale of size advantages) and given its diversified position in both the residential and commercial market segments of the overhead door market (providing less volatility to demand shifts from one market), HBP should command some premium valuation to its peers. However, one needs to also consider the rise in interest rates over the last year, which have had a depressing effect on valuations. Our understanding is that across most industries, this has resulted in a decline in M&A valuations of about 15%-20%. So, combining these two factors suggests a current valuation at the lower end of the above range to be a realistic multiple, which translates to a private market multiple of ~11x.

The other important element in looking at HBP’s valuation is the division's profitability; a combination of revenue and margins. On a trailing 12-month basis, and aided by an increase in margins, HBP recorded EBITDA of $536 million. While management believes that the increase in HBP’s margins is sustainable at higher than pre-pandemic levels due to internal structural improvements in the business, it is unclear what the new norm is for margins. Based on our conversations with GFF management and industry participants it appears that the increased pricing instituted during the pandemic period is sticking. Also, as previously discussed GFF has made a number of efficiency and consolidation cost savings measures post the CornellCookson acquisition which have added to the margin improvement. 

However, in an effort to adopt a conservative margin of safety in our analysis, we have assumed some modest reduction in the level of sales and/or margins with the HBP division is possible in the future. The following HBP matrix table looks at the impact of reduced revenues and margins on profitability from this division.

From the current trailing 12-month run rate EBITDA of $536, the table shows the range of possible annual EBITDA based on a 10%/15%/20% reduction in revenues from current levels and various lower margins from 33% to 25%. Our base case scenario suggests given the tough comp’s, growth flattening out a current levels in the 2nd half of FY23 (with some price give-backs) and growing at a low single digit level before returning back to more historical levels, with commercial demand being the backbone of the growth. However, we note that even in the most extreme case (which we would assign a low probability) where both revenues decline 20% and margins decline ~800 bsp’s, EBITDA would decline ~40% from the current run rate level of profitability, but still be well above pre-pandemic levels.

Using the above analysis, we then combined the various ranges of HBP profitability to a range of valuation multiples, from our base case of 11x to other more conservative multiples. The following table is a matrix table analysis of the potential value of the HBP division using various estimates for EBITDA and a range of multiples. In the table, we assumed all the debt and the full GFF corporate overhead would be respectively attributed to the division’s enterprise value and profitability. Using the trailing 12-month EBITDA profitability and the 11x multiple we outlined previously as reasonable; we get a valuation of ~$78/share. 

Using the trailing 12-month EBITDA profitability and the 11x multiple we outlined previously as reasonable; we get a valuation of ~$78/share. However, to be conservative, if you were to assume a normalized reduction of about 10% in revenues, a high 20’s EBITDA margin of ~28% (resulting in an EBITDA run rate of $409 million) and apply a 10x multiple to the profitability stream, you get an intrinsic value of roughly $50/share, or ~50% above the current share price. Also, remember, this analysis does not assign any value to GFF’s CPP division.

CPP Turnaround Offers Investors A Free Call Option: While not the central part of the GFF investment thesis, any progress in the company’s restructuring efforts within its Consumer & Professional Products (CPP) division would be a catalyst to the share price and multiple and as we believe no value is currently be accorded the business, it offers investors a free call option.

By way of background, Consumer and Professional Products (“CPP”) is a global provider of branded consumer and professional tools and products for home storage and organization, landscaping, and enhancing outdoor lifestyles. Marketed through the heritage AMES Companies, it sells a loosely connected product portfolio under such brands as True Temper, AMES, ClosetMaid, Cyclone and Hunter Fan (recently acquired in November 2021).

The CPP division, over a prolonged period, has had continuous growth and profitability challenges. One of the major issues has been while the AMES brand has a long history dating back to 1774, it has been pieced together through a number of loosely connected acquisitions of companies in different segments of the large and diverse market, with little synergies to glue the pieces together to provide both cross cross-pollination and scale opportunities. Also, some of the recent acquisitions, like Hunter Fan, have been called out by investors as being ill-advised and expensive. Moreover, while having a global sourcing team, this division has been manufacturing a significant portion of these products in the USA, which has positioned the products at a premium pricing level relative to overseas sourced product from competitors. 

Compared with other public peers, CPP’s EBITDA in the last few years in the high single digit range trails competitors like Stanley Black & Decker’s Tools & Outdoors division and Fiskers-Terra division, who have reported over the last few years margins in the high-teens and low to mid-teens respectively. The combination of a recent soft industry environment coupled with increased raw material, supply chain and labor costs have hard hit the CPP division. Sales have been under pressure during the last few quarters while retail inventories have expanded, resulting in a significant decline in CPP profitability. The following charts illustrates the recent decline in CPP’s profitability.

CPP has been a constant area of focus for GFF management. In November 2019, the company announced the “AMES Strategic Initiative,” which aimed to improve operations at CPP. One year later, GFF expanded the initiative to include $130 million of projected cash and non-cash expenses to provide $30-35 million in annual cash savings by December 2023. However there had been little progress from this initiative and given the inflationary impacts from the pandemic and the retail inventory build, the situation has not changed much. 

This prompted the company on May 3rd, as part of its strategic review options, to take more dramatic actions to improve profitability at the division. The company will be moving to an asset-light, global sourcing strategy for many of its tools, handling and storage products. The division will close four manufacturing facilities and four wood mills, reducing its U.S. facility footprint by approximately 1.2 million square feet, or 30%, and its headcount by approximately 600. Management expects the global sourcing strategy expansion is expected to be complete by the end of calendar 2024 and its actions will enable CPP to achieve 15% EBITDA margins, while enhancing free cash flow through improved working capital and significantly lower capital expenditures.

However, given management's past history and that they have provided little insights as to the potential cost savings and what the new CPP business model will look like, investors have adopted a more conservative outlook. Current sell-side consensus estimates for the CPP division call for revenues of ~$1.2b and EBITDA of ~$55 million for the fiscal year ending September. For FY24, consensus EBITDA is for EBITDA of ~$65 million on ~4% revenue growth, or about a 5% EBITDA margin. Thus, expectations are low for CPP profitability, and clearly are not modeling a recovery in margins anywhere close to management's target, or even the recent ~9% margin levels. Given the skepticism relative to management’s margin target, suggesting that the bar is set very low, any early signs of success over the next few quarters would likely be somewhat of a modest catalyst to the shares and help investors to begin to assign some value to this division, which we believe is currently about nil. 

Even based on the modest sell-side consensus profitability forecasts we believe the division should command some value; especially in the hands of a potential acquirer looking to restructure the operations and improve the management team. Assuming an EBITDA run-rate of ~$60 million and a modest multiple of 5-6x, translates into a value of ~$6/share. In order to build a factor of safety into our analysis, we have not included this amount in our target price, which is already burdened with the full corporate overhead of both divisions.  

The Shares Are Attractive On A Number Of Different Valuation Measures: When valuing the shares, it is noteworthy to highlight the divergence between the increase on profitability over the last few years compared with the lag in recognition of this in the shares price. Highlighting the unrecognized improvement in GFF’s profitability is the fact that while the shares are currently selling at a price at or below the levels of the Fall 2021, overall consensus EBITDA in calendar 2023 of ~$470 million will be ~90% greater than the level of calendar 2021 (the prior high-water profitability mark) and consensus EPS of ~$3.90/share is roughly 3x higher than the prior period.  

On various valuation measures, we believe the share are attractively priced. On calendar 2023 profitability and FCF, at the current of $32 price, the shares are valued at an EV/EBITDA multiple of 6.7x, a P/E of 8.2x and a FCF multiple of 7.3x. 

The following charts show that the shares are currently trading at the lower end of their historical valuations and not discounting the structurally higher level of profitability the company is now recording. 

Using different valuation metrics, we believe the intrinsic value of the company’s assets is significantly higher than the current share price. Our SOTP analysis suggests that the value of the company’s assets is between $50-$60/share. Using a FCF multiple of 13.5x-16x, translates into a share price of $50-$60/share. Using near mid-point of the company’s historical 5-year NTM EBITDA range (7x-12x) of 9-10x, translates into a share price of ~$50-59/share. 

We believe downside protection will be provided by the combination of the company’s $258 million share repurchase program, enabling the company to repurchase ~16% of the outstanding shares at current prices, as well as the valuation of the stock already being at the low end of its historical valuation on various metrics.  

Catalyst

• Continuing to record good revenue growth in the company’s HBP division to show demand trends are normalizing and not set to significantly recede.

• Showing evidence that the recent price increases in the overhead door industry are sticking by posting strong HBP EBITDA margins at least in the mid-to-upper 20% range in future quarters.

• Demonstrating any evidence that the new restructuring in the company’s CPP division is bearing fruit with division costs coming down and margins improving.

• Voss Capital gaining an additional Board seat.

• Management adopting a more shareholder friendly posture in speaking with investors, possibly via an improved investor relations program, to provide better information on such subjects as the structural changes with the HBP division post the CornellCookson acquisition, detailing CPP cost savings and the new corporate business model.