Value Investors Club / Masonite (DOOR)

Description

• Masonite is an effective duopoly in interior doors, and the two control ~55-60% of the domestic door

market (split evenly). The industry has consolidated significantly over the past decade with

commensurate improvements in ROIC as a result.

• We think the door manufacturing business is decent quality with meaningful barriers to entry, and the

recent stock price performance is due to idiosyncratic events that will be fixed over the next 1-4

quarters.

• The Company had inefficient staffing and additional costs related to distribution in Florida, which we

believe will pass and allow the company return to its 20-30% incremental margin formula prior to the Q2

hiccup. Furthermore, we believe the normalization of housing starts to 1.5 million from 1.2 provides a

clear tailwind for growth over the next 3-4 years.

• Door manufacturing, while it appears to be simple, has relatively substantial barriers to entry (given the

maturity of the industry). A competitor would require hundreds of millions of capital to create an

efficient, cost effective plant, and will lack the distribution footprint to supply big contracts like Home

Depot and Lowe’s.

o JPM estimates each facing manufacturing plant, along with slab assembly and finishing plants,

would require $150-$200 million each, and another $75 million for die plates

o International competition tougher as transportation is generally cost prohibitive

• With the current valuation at ~7.5x forward EBITDA, we think the company can earn mid double digit

IRRs over the next 3-5 years assuming housing volumes are in line with forecasts, margins expand

slightly from ~13% to 15%, and the company buys back shares with its FCF

Company / Industry

• Masonite is the #1 or #2 in US across interior and exterior doors

o 60% of sales in US, 16% in UK, 13% Canada – very US centric

o Generally even split across newbuilds and RMI: North American residential new, 40%, residential

repair 40%, non-residential 20%

o Doors actually last 30-100 years; so replacement is typically for selling the home

• Industry has experienced substantial consolidation with over 6 manufactures in 2010 down to 3 today.

This type of movement in market share consolidation generally hints at increased cooperation and

overall higher returns for existing players.

• Total door market for residential is $4.5 billion - Jeld-Wen and Masonite each have 28%, followed by

Therma-Tru at 11%, and then private guys 5% or lower. Given that the market in totally is not

extraordinarily big and is also mature, it seems unlikely that new entrants will enter the field

(particularly in context of high capital costs). Rational assumption is that consolidation continues to

occur until we have perhaps ~3 big players remaining.

• Within interior doors, Jeld Wen and Masonite have around 35-36% each. Next biggest is a measly 6%

o Furthermore, the #3 and lower players are typically door assembly companies that still source

door facings from Door/Jeld-Wen. The two competitors have 75% global capacity of interior

doors.

• Within exterior, Therma Tru is actually biggest at 23%, Masonite at 20%, Jeld Wen at 18%, etc.

Competition stronger in this segment

• Non residential doors amount to $5 billion, and Masonite is the largest player vs VT Industries (2x the

size). However, the market is very fragmented here

• Other sources cite the market relatively similar in size: “The U.S. residential door market stood at $11bn

in 2015, having grown at a 7.5% compounded rate over the last five years. In unit terms, the industry

sold 45 million doors in 2013, a decline of 6% on a compounded annual basis from 2008. This compares

to the recent industry peak of 84 million units shipped in 2003. According to Freedonia, demand is

forecast to increase at a compounded rate of ~6.5% through 2020, generally reflective of fundamentals

in the housing market and residential remodeling.”

Barriers:

• Expensive – high capital commitments:

o Per JPM: ‘We estimate each facings manufacturing plant costs between $100-$150 million, with

each slab assembly plant requiring a $20-$25 million investment… and each pre-finishing and

pre-hanging plant requiring a $9-10 million investment (with multiple plants required to service

various regions). Additionally, a new entrant would need to invest in die plates, which would

likely require an additional $75 million investment (DOOR’s current estimate of the value of its

die plates) in order to have a full product line offering.”

Our conversations with experts suggests the numbers might be even higher

o Given net incomes of 5-6%, if a company spent $200 million on a manufacturing plant and wants

to earn a 10% ROE, it would require ~20 million of net income, or $400 million of sales… this is

versus DOOR’s total sales of <$2 billion.

o Margins, as you see are quite low:

• National distribution network means high distribution costs/partnerships, particularly with Lowe’s and

Home Depot. HD is ~20% of Door’s North American sales, Lowe’s around 10%, and wholesale (over

3,000 distributors/dealers) are 50%.

o Very difficult to win and sevice HD/Lowe’s given demands of these large customers and service

quality required. Just look at the most recent quarters starting (Q2’17) – even DOOR is struggling to make

distribution and service quality in new areas it is tackling. A small player without the resources,

selection, and time to market will not be able to compete

• Distance – cost prohibitive for foreign producers to export in.

o This is basically shipping wood

o DOOR shipping costs is 8% of revenues – net income margins are 5% - Overseas shipping would

be pretty hard to justify

Drivers to returns:

• Pricing power – low single digits (company has been able to pass on commodity inflation over the past

year and has already increased prices during and following Q4 to offset commodity price inflation). The

projected price increases (~2%) we believe may exceed inflation/cost cutting

• Volumes – housing starts in the US (residential) are still at ~1.2 million, below the long term average of

1.5 million. With the recent increase of first time home buyers returning to majority of sales, and

housing starts moving down to more affordable starts, we believe volumes will be a positive contributor

until starts normalize (and perhaps overshoot)

• Positive mix – fiberglass doors, etc. – low single digits (ongoing mix shift)

• Operational leverage – while incremental margins have been weak in North America, we believe the

idiosyncratic nature of Florida operations along with increased transportation costs/weather and

hurricane impacts in Q4 were responsible. Given the cost structure and incremental margins that were

achieving 30-40% prior to the middle of 2017, we believe the company’s mid to long term targets of mid

teens EBITDA margins are achievable during the same time frame housing starts normalize.

Valuation

DOOR is now trading at 7.3x 2019E EBITDA and ~6x 2020 EBITDA. Not only is this very cheap on an absolute

basis – this is the valuation for an increasingly oligopolistic market with increasing consolidation, modest to

decent barriers to entry, and still below normalized levels of end market demand. Not only is the stock cheap on

an absolute basis, it is also trading at its lowest range over the last 5 years:

Using back of the envelope math, we think a 16% IRR is reasonable over the next 2-3 years+, broken out as 6% organic growth

(reverting to single family starts over the next 4-5 years), margin expansion of 4% as margins increase from 13%

to 15% given incrementals ought to be 20-30%, and current FCF dividend yield of 5-6%.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Housing starts continue to revert to normalized 20 year

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			2018	2019
Price:	66.00	EPS	4	0
Shares Out. (in M):	28	P/E	16.5	0
Market Cap (in $M):	1,878	P/FCF	20	0
Net Debt (in $M):	462	EBIT	205	0
TEV (in $M):	2,340	TEV/EBIT	11.4	0