Description

Investment Thesis

MasterCraft (NasdaqGM:MCFT, “MasterCraft” or the “Company”) is a long. MasterCraft is a leading designer, manufacturer and marketer of recreational powerboats. Concerns that coronavirus will result in a recession and a downturn in boat sales has led MCFT to decline ~50% YTD, resulting in the stock trading at 3x 2019 EBITDA, 3x 2019 P/E and a 20% LTM levered FCF yield (~30% once backing out growth capex). Assuming mid-cycle EBITDA of $50mm, mid-cycle EPS of $1.50/share, and conservative multiples of 7x EBITDA (~20% discount to 3-year average of 8.7x) and 10x P/E (~34% discount to 3-year average of 15.1x), MCFT should trade at $14/share, resulting in ~90% upside from today’s price of $7.46. Assuming the historical average multiples instead would imply a higher share price of $20, or ~170% upside.

Company Overview

MCFT operates through three segments: MasterCraft, NauticStar, and Crest. The MasterCraft segment (MCFT’s legacy business, 67% of sales and 88% of EBIT) produces recreational performance sport boats and luxury day boats under the MasterCraft (#3 market share in the ski/wake category) and Aviara brands, which are used for water skiing, wakeboarding, and wake surfing, as well as general recreational boating. The NauticStar segment (acquired in 2017, 17% of sales, 0% of EBIT, #6 market share) offers boats that are used for saltwater fishing and general recreational boating. The Crest segment (acquired in 2018, 16% of sales, 12% of EBIT, #8 market share) produces pontoon boats for use in general recreational boating.

Recognizing NauticStar and Crest are not market leaders, the majority of MCFT’s earnings come from MasterCraft, whose brand has the #1 market share in the ski/wake category (Malibu has two brands which combined cause it to have the #1 market share). Please refer to the prior write-ups of MCFT for additional background on the Company. In addition, the Company’s March 2020 investor presentation is quite good and helpful (albeit not refreshed for potential impacts from coronavirus).

Financial Overview

MasterCraft has a market cap of $141mm, debt of $142mm, and cash of $40mm, resulting in an enterprise value of $242mm. MasterCraft’s fiscal year ends June 30^th. For the LTM period ending 12/31/2019, MasterCraft had sales of $461mm, gross profit of $110mm (24% margin), EBITDA of $76mm (16% margin), and EPS of $2.56 (adding back the impairment charge). Cash flow from operations was $48mm and capex was $19.5mm, resulting in levered FCF of $28mm (6% of sales). The business has essentially zero working capital given the majority of inventory is held with dealers (who can have inventory days of 6 months or more compared to MCFT at 1 month). The business has historically generated a ROIC above 15%.

The Company’s has modest leverage for a cyclical business (1.9x gross, 1.3x net) consisting of a $35mm fully drawn revolver and $107mm term loan, which matures in October 2023. With rates having come down recently, the interest rate on the loans should drop to ~3%.

Other than an $80mm special dividend and $5mm share buyback in FY2016, the Company has not returned any capital to shareholders despite generating healthy FCF and has instead spent FCF on acquisitions. Per its March 2020 investor presentation (which is not updated for coronavirus), the Company’s focus (pre-coronavirus) was to invest in growth projects and lower leverage to 0.5-1.0x (vs. 1.3x currently). In a cyclical business, we see no issue with lowering leverage to this range (and think buybacks could be ill-timed if done at the top of the cycle), but would like to see more capital returned to shareholders. That said, we are not too concerned about dividends and buybacks for this business given we think this stock is not a long-term buy and hold candidate and is more of a hold for 2-3 years waiting for the market to recover (assuming this year has a steep drop in sales) and then exit once earnings and/or multiples recover. Dividends and buybacks, while nice, are not where the bulk of the return is going to be generated with MCFT.

Given the possibility of a recession, we believe this is a lower risk at the moment, but would note management’s track record of acquisitions over the past few years is not great, having purchased businesses that have good but not great market positions, and having taken write-downs on their acquisitions which have been less profitable than MasterCraft’s legacy business.

Recent Developments / Projections

Yesterday, MCFT announced the Company was going to stop manufacturing operations indefinitely effective today due to coronavirus. Management also withdrew prior FY20 guidance. A week earlier, the Company fully drew down its $35mm revolver and we estimate currently has ~$40mm of cash on the balance sheet ($5mm as of 12/31/19 plus the recent $35mm draw). The Company did not provide any guidance for the potential loss of revenue and earnings during this period, and to what extent losses could be reduced through various efforts, such as temporary layoffs, hiring freezes and/or salary reductions.

Other boat manufacturers have made similar announcements. On a positive note, Malibu, which is MCFT’s primary competitor, announced it was suspending operations at its manufacturing facilities from March 24^th through April 6^th (i.e., only a two week period). While this period could be extended, we don’t think Malibu would have provided the April 6^th date if the company felt there was a strong chance it would get extended.

The key buying season for boats is from March to September when the weather is warmer. As a result, the first analysis that needs to be done is a liquidity and covenant analysis. The Company’s debt has a 2.75x net leverage covenant, which steps down to 2.50x at year-end. Our model suggests the Company’s volumes would need to decline more than 50% for the covenant to be breached. While we think this could be an extreme downside scenario in that ski/wake retail units declined 60% during the GFC from 2007-11 (noting it took several years to trough) and the next recession will likely not be as severe, we built our model around assuming a 50% decline in sales in calendar 2020, resulting in sales of $230mm. For our downside analysis, given MCFT and MBUU were not public during the GFC, we analyzed HZO as a comp. We assumed 30% decremental gross margins to project gross profit of $40mm (17.5% margin, vs. $109.5mm of gross profit last year and 23.8% gross margin). We assumed the Company could cut its SG&A in half from $43mm to $20mm (i.e., going from 9.4% of sales to 8.9%). We assumed D&A of $9.4mm (same as last year) to get EBIT of $20.4mm (8.9% margin vs. 14.4% last year) and EBITDA of $29.8mm (12.9% margin vs. 16.5% last year). With interest expense of $3.5mm and taxes of $3.9mm, net income is $13.0mm and EPS is $0.69. On the cash flow side, levered FCF would be calculated as net income of $13.0mm plus $9.4mm of D&A plus $1.7mm of working capital unwind (note working capital is 0.7% of sales) less capex of $1.0mm results in levered FCF of $23.1mm. Deducting the $9.2mm of mandatory term loan amortization would result in levered FCF post amortization of $13.9mm.

As a result, at 12/31/2020, the Company would have cash of $54.3mm ($40.4mm current balance plus the $13.9mm change in cash), a revolver balance of $35mm, and a term loan balance of $97.4mm ($106.5mm at 12/31/19 less the $9.2mm mandatory amortization), resulting in total debt of $132.4mm and net debt of $78.1mm. Under this scenario, net leverage at 12/31/2020 would be $78.1mm / $29.8mm = 2.62x, which is higher than the net leverage covenant of 2.50x. That said, in this downside case, there is not much cushion, but there may be more cushion than we are modeling once taking into account various EBITDA add-backs under the credit agreement that we may not be taking into account.

Off of our downside calendar 2020 estimates of $29.8mm EBITDA and $0.69 EPS, MCFT is currently trading at 8.1x EBITDA and 10.8x P/E, which we view as appropriate mid-cycle multiples and very attractive trough multiples. Note analysts have not yet updated their estimates, so forward trading multiples off of analyst estimates are not currently meaningful.

As noted at the beginning, our share price target is $14, representing 90% of upside. We note this is a substantial discount to MasterCraft’s 52 week high of $26.74 and all-time high of $37 back in September 2018.

Key risks include (a) a prolonged and steeper downturn that pressures earnings, liquidity and the Company's net leverage covenant and (b) the risk that it takes longer than expected for dealers to work off existing inventory and that key MCFT dealers go through bankruptcy.

Catalyst

o   Coronavirus macro situation improves, thereby improving boat demand forecasts

o   The Company manages liquidity well during a potential downturn, mitigating fears of a covenant breach and need for external funding at a potentially dilutive price