|Shares Out. (in M):||23||P/E||0||0|
|Market Cap (in $M):||522||P/FCF||0||0|
|Net Debt (in $M):||272||EBIT||0||0|
|Borrow Cost:||Available 0-15% cost|
MarineMax (HZO) finds itself in a highly cyclical industry with bad economics and a strategy proven to destroy shareholder capital. We see ~40% downside in our base case.
This short has been written up two times before on VIC by rand914 in December 2007 and Siren81 in April 2016. We are writing it up again as we view the stock to be attractive after running up from Q1 2018 earnings.
Company Background and Strategy
MarineMax commenced operations in March of 1998 through the acquisition of five independent recreational boat dealers. Since inception in March 1998, MarineMax has acquired 28 independent boat dealers, two boat brokerage operations, and two full-service yacht repair operations. MarineMax has funded these acquisitions with $189 million in cash and $97 million in stock. Once under the MarineMax umbrella, management seeks to achieve various operational synergies including new brand offerings, more accessible vendor financing, and providing additional sources for customer financing.
Through this roll-up strategy, MarineMax became a significant distribution channel of Brunswick Corporation’s (BC) Marine Division – specifically the Boat division – representing 24% sales or $329 million in FY 2016.
MarineMax caters to the more affluent buyers with a new boat average selling price just shy of $200,000. This average is highly skewed due to the price range of MarineMax’s offerings. The Company sells yachts with multi-million-dollar price tags reaching north of $35,000,000 as well as pontoon and jet boats for as low as $15,000 to $20,000. Pricing and mix have been a material driver of same-store sales since the financial crisis.
The boating industry was crushed during the financial crisis. This cycle’s average unit volumes remain more than 40% below the prior cycle average. Current volumes are still below pre-recession levels by >30%.
Quality of the Roll-up Strategy & Capital Allocation?
MarineMax typically purchases companies at 3 to 6 times trailing earnings (Source: Q2 2016 CC) which is accretive as MarineMax currently trades at ~16x TTM earnings. One question to ask is why someone is willing to sell to MarineMax at such a discrepancy in valuation. Yes, MarineMax is the largest player in the industry (granting a slight advantage from scale) and is offering liquidity to a smaller illiquid business, but a >60% discount in value to MarineMax seems a little too steep.
One likely reason is the financial prospects of these targets:
CFO – Q2 2016 Conference Call
“Just like our own earnings have doubled from last year and maybe doubled the year before that, the other dealers are seeing that as well. So, when you start to put a multiple on something, there's at least something you can discuss about from a payment perspective which results in healthier discussions quite frankly.”
CEO – Q3 2012 Conference Call
“…our motto is we pay based on historical earnings of a multiple and the earnings have been negative or low for a lot of them. And even though they are good dealerships, they are in a lot of cases, they are not willing to accept nothing or pay us to take the dealership. And so, that's -- the good news is there is no one out there else that is really competing and so it is not like we are going to lose the opportunity going forward.”
While the businesses they are buying are inflecting to positive earnings, the quality of these businesses is likely suspect, as it took more than half a decade of economic expansion to return to earning a profit. Additionally, there is no one else buying these assets. While this could be viewed as a positive, we see it slightly differently.
1) If no one else is buying, you might be buying a bad asset.
2) If the target is losing money, why not wait for organic acquisition and save your capital. (i.e., the target goes out of business and your existing units in the market win a portion of the customers)
The quality of the roll-up strategy has played out with the closure of 63 stores since MarineMax began operations. As of FY 2017, the company operated 62 stores. Over 50% of the stores acquired through FY 2017 have been shut down.
Management has stated 53 of the stores they own today did over a billion of revenue in 2006 and 2007 or ~80% of total revenue in those years. The stores shut down appear to be immaterial to revenue which leads to another question: why expend the time and resources in pursuing acquisitions in the first place?
In January 2018, the Company announced they were buying Island Marine (a boat dealer located in New Jersey). Island Marine did $10 million in revenue in this last fiscal year and operated two stores. This transaction represents <1% of MarineMax’s FY 2017 revenue. This acquisition would need to double store sales in a year to make a noticeable impact going forward.
We view MarineMax’s roll-up strategy as a waste of management’s time and as a poor use of capital. If we were long, we would want to see the excess capital generated by the business returned to shareholders. While the Company did announce a buyback, they continue to allocate capital to acquisitions.
Inventory and Debt Financing
The Company invests most of its capital in inventory which represents ~60% of total assets. Inventory is slow moving with annual days of inventory on hand of ~170 during good years and up to >250 during the financial crisis.
Aged inventory hurts for a variety of reasons:
1) Customers desire new models. If a dealer is stuck with last year’s boats, they must mark them down to move them.
2) Inventory is financed (more on this later). The longer a boat sits on the dealer’s lot the more interest they must pay thereby impairing the profitability of their business.
3) If inventory sits on the dealer’s lot it takes up capacity under their floorplan financing and prevents the dealer from buying new boat models. This furthers the incentive to sell older boats at lower prices (i.e. lower gross margins) to create the capacity to buy newer inventory.
To support sales growth, MarineMax invests additional capital into their inventory. This capital converts back to cash when demand falls and inventory is liquidated. When demand falls, competition to move inventory increases with price functioning as the main driver to close a sale. This repeated industry response to weak demand results in the liquidation of the industry’s largest capital investment at cyclically low prices and destroys capital in the process.
In a healthy market, gross margins average ~25% while a recessionary environment leads to margins around 23% (2009 was particularly brutal at 15%). While 200 bps of gross margin may not seem like much it is impactful as profit margins are slim in the industry. In the past eight years, MarineMax’s profit margin has ranged from negative 240 bps to 250 bps. While we are not underwriting another great recession, we do see MarineMax’s large inventory investment as a risk – especially in light of the industry practice of competing on price in the face of weak demand.
As previously mentioned, boat dealers use floorplan financing to finance their inventory. The current terms of MarineMax’s floorplan financing are as follows:
• The interest rate is pegged to one-month LIBOR with a 345-bps spread. As of 9/30/17, the Company was paying 4.7% on its debt.
• $350 million commitment from Wells Fargo (upped from $300 million in May 2017)
• Max leverage ratio of 2.75
• Current ratio greater than 1.2
One catalyst we look to is rising rates. MarineMax’s debt is floating which will hamper profitability in a rising rate environment. Potentially more impactful than its cost of debt is the additional cost on a customers who finance their boat purchases. Higher rates will likely lead to lower demand. As is often cited in MarineMax’s earnings calls, financing is as easy as it has ever been. So, it can only get harder from here.
Return on Capital and Growth
After the recession in 2008, the profitability of the Company materially changed driven by the decline in industry volumes. Pre-crisis ROIC was high single digits/low double digits; in today’s environment, mid-single digit ROIC is par for the course.
Management and Insider Selling
MarineMax is a family business run by William H. McGill Jr. age 73. He owns roughly 10% of the business but has been selling shares regularly in the low 20’s. While these sales are sourced from stock compensation they provide a good indication of where McGill thinks fair (or above fair) value is in his business. The exercised options typically have ~3.9 years left at the time of the sale indicating some level of opportunistic selling. Total proceeds since the beginning of 2013 cumulate to $9.6 million.
McGill’s son, William Brett McGill, appears to be the heir apparent, and a transition is likely in the next few years given William H. McGill’s age along with the appearance of a new risk disclosure on management succession in the latest 10-k filing. The son has been at the Company since 1996 and in a management role since 1998. There is no indication he would change the Company’s current strategy.
The Long Thesis (we struggle to see one)
1) Sales accelerate leading to margin expansion through fixed costs leverage.
Peak operating margins for the company was 7.1% in FY 2000 on sales of $550 million. FY 2006 saw operating margins of 6.9% on sales of $1.2 billion. Current operating margins are 4.3% on $1.05 billion of revenue.
What would it take to hit 7% margins? Well, incremental operating margins are typically 8-9% when not entering or emerging from a recession. At 8% incremental margins, MarineMax would need to increase sales by 270%.
We are not optimistic this cycle will see margins reach their prior peaks. Sales per store have already eclipsed their prior highs and incremental margins fell year over year in FY 2017.
2) Owned real estate is worth something
Sure. MarineMax owns 28 of their locations out right and 19 of these locations are on waterfront properties. While there may be value in the real estate, it does not appear that the family will unlock any of this value in the future from the liquidating the real estate *and* returning the capital to shareholders. In the interim the business earns well below its cost of capital.
3) The industry will recover to previous volumes.
We view this as unlikely. While boats are a classic example of status and wealth, especially a $35 million yacht, the general public is increasingly drawn to experiences rather than possessions. (Plus, who would want a $35 million-dollar yacht when you can subsidize Tesla with vehicle deposits and flamethrowers?) Seriously though, MarineMax’s business produced stronger returns in 2006 when the average sales price was $116,000 than in 2017 when the average sales price was $195,000. This change in average sales price is not due a shift in product offering either (in 2006 the Company’s product offering included more expensive boats than it did in 2017) rather its is attributable to lower volumes of lower priced boats. The typical entry boat buyer, the main customer of these lower priced boats, appears to have left the market and yet to return in a meaningful way. Frankly, we doubt they will ever return to their previous levels. As a result, MarineMax will have a muted total dollar market to compete in than before.
Shout out to WT2005 for their comment in Siren81’s HZO write up for highlighting the following charts as a proxy for this shift in consumer preferences. As WT2005 pointed out, recreational goods and vehicles is a massive category indicative of the level of competition in scarce leisure time.
More money in people’s pockets will lead to incremental consumption and MarineMax may benefit from this. We believe the current price has baked in the tax cut.
There should not be much competing away of profits through price reductions either as boat dealers are operating just above breakeven levels thus not paying significant tax.
There is conversation that the hurricanes in Florida, which makes up more than 50% of revenues, will drive demand to replace boats damaged in the storm via insurance proceeds. This is a possibility and same store sales may be higher in the coming quarters as a result providing a lift to the stock.
MarineMax is the largest dealer of Sea Ray boats and yachts. Sea Ray represents 23% of MarineMax’s total revenue while MarineMax accounts for over 50% of Sea Ray’s total volume.
On December 5th, 2017 Brunswick Corporation (BC) announced it was selling its Sea Ray division and Meridian brand. BC did not disclose the sales price, but other disclosures gave us some insight into the manufacturer’s economics.
Sea Ray was an unprofitable division for BC generating an operating loss in the latest fiscal year, and growth appears to be slightly positive and described as “flat, plus or minus”. Brunswick CEO made the following comment about investments in sterndrive and inboard boats thereafter, “Those investments had really been done a couple of years ago largely that I wouldn’t characterize we’re making investments today in that area.”
Sea Ray’s new owner may invest in the business to drive higher sales, but industry trends are not in their favor.
Bull Case – ~25% upside or $29 Target [Frankly silly assumptions]
Base Case – ~40% downside or $14 Target
Bear Case – ~65% downside or $8 Target
Base Case Assumptions
We used sales per store as our primary driver for revenue. We adjusted the beginning sales per store metric to include our estimated impact of the acquired stores. Total revenue growth in year 1 (2018) is 14%.
We hold store count flat as we view the M&A program as capital destructive. We included the Island Marine acquisition’s two stores.
We use an 8% incremental operating margin consistent with the Company’s average incremental margins in healthy markets.
Tax rate is at the low end of the Company’s guide
We use a 10% required return on equity. We believe a business of this quality should demand a higher rate of return than 10% as exhibited in MarineMax’s 3 to 6 times purchase multiple.
Bull Case Assumptions
The Company grows in perpetuity at 10% forever and ever and ever and incremental margins are 9%.
Bear Case Assumptions
Future growth is 5% per year till 2022 when a four year period of weak demand hits the industry. 15% required return on equity. Incremental margins of 7%
• Tax cut drives increased boat buying.
• Hurricanes drive incremental boat buying in 2018 from previously damaged boats.
• Management gets religion and returns all excess cash to shareholders in a buyback.