Value Investors Club / Masonite Worldwide (MAS)

Description

Investment Thesis

Masonite Worldwide Holdings Inc. (OTCPK: MASWF) (“Masonite” or the “Company”) is the world’s second largest manufacturer of residential and commercial doors and is trading at an attractive valuation with +50% upside. Since the downturn, capacity cuts and consolidation have improved dynamics in the door industry (now a duopoly). A recent 5% price increase (the first in 2 years) demonstrates this rationalization. Meanwhile, Masonite has improved its cost structure and market position substantially. Now it should now be able to achieve 13% EBITDA margins (its previous peak) on 1.1-1.2M US housing starts (versus previous peak of 2.1M). This equates to $300-350M in EBITDA (5.0-5.5x the current EV) and an 18-20% FCF yield. Near-term catalysts include: 1) up-listing to the NYSE in September; 2) alleviation of post-reorg and OTC-listing stigma; 3) increased awareness and appreciation for the quality of the business and the improved industry dynamics; 4) corporate communication; and 5) potential sale. Despite its $1.4B market cap, MASWF trades sporadically. KCG (Knight), Seaport and Imperial seem to be the brokers that trade the most stock.

Reason for Mispricng & Catalysts

The Company was taken private by KKR in 2005 and filed for bankruptcy 3 years later during the financial crisis. Masonite emerged from bankruptcy in 2009 and its stock has since traded OTC with limited institutional following. However, later this quarter, the Company will be up-listing to the NYSE concurrent with a public offering, where Masonite is seeking to raise $150M for M&A. This will bring increased exposure, liquidity and incremental potential investors to the stock. The Company reports Q2 earnings this Thursday (8/8), at which point it will be in a position to update its S-1 (last amended 5/15/13 filed as Masonite International Corp) and proceed with the IPO post-Labor Day with BofA, Barclays and DB on the cover. Even before being taken-private in 2005, Masonite was listed on the TSX so has limited legacy US equity coverage.

Industry

The door industry is comprised of residential (interior and exterior) and commercial of various types. Most Masonite’s sales (73%) and most its near-term growth is expected to come from the US, so we will focus on this region (Masonite groups it as North America). Industry-wide door sales were nearly cut in half from a peak of 92.8M in 2005 to 52.0M units in 2011. In 2012, there were 56.5M doors sold, of which Masonite accounted for approx. 22.6M, implying a 40% share. Below is a breakdown of the US door market.

Door units sold have only increased 5% off the trough in 2009 while housing starts have increased over 40% during the period. Part of this is mix, but the primary reason is because the door segment is a lagging performer within the housing products space – a door is the last item added to new construction home with the historical average door purchase taking place start+6 months. However, during the latest recession and through the recovery to date, this lag expanded to over 12 months (as the start-to-finish of a home’s construction was extended from less access to financing and longer time to permitting approval). Conversely, in a normalized environment, the completion rate should increase, reducing this lag back to 6 months. The current lag is 12 months. This lag is an important factor to consider when looking at Masonite’s financial performance. Current starts provide good visibility of future year resi door sales. In 2012 starts grew 24% while completions only grew 9% with an 83% completion rate.

Volume Drivers

Residential New Construction: The best indicator for new construction residential door unit volumes are housing starts and AAMA/WDMA door data. AAMA/WDMA and Ducker Research is calling for a 16% growth in units this year and 12% growth in 2014 across North America. As noted, given the selling cycle of doors, prior year growth in starts is the best indicator of forward year demand. Total US starts (single and multi-fam) grew 28.2% in 2012 with a consensus 2013 and 2014 growth rate of 24% and 15%, respectively. The industry convention is that the average single-family home has 24 doors (20 interior, 4 exterior) and the average multi-fam has 12 (9 interior, 3 exterior).
Residential Repair: The Harvard Center LIRA Model, Home Improvement Research Institute (HIRI) and to a lesser extent, Home Depot and Lowe’s are the best indicators of remodel activity. Home price increases are also a driver of repair and remodel as more home equity compels homeowners to replace or upgrade. HIRI is estimating a 5% annual growth rate through 2015.
Commercial and Architectural: Architecture Billings Index; McGraw-Hill Construction (square footage) measure performance in this segment. Recovery in this area has been slow. McGraw-Hill Construction expects an 8% growth in square footage of commercial building in 2013 and an annualized growth of 21% from 2013 to 2015. More specialized commercial doors typically command twice the EBITDA margin as residential. Recovery in the space and Masonite’s recent M&A-driven expansion in this area (21% of 2012 pro forma revenue vs 11% in 2010) should contribute to margin improvement (more below).

Competition & Pricing

Through the downturn and since, the door industry – particularly in North America – has consolidated and rationalized. Now Masonite has a 40% share of the market and operates in a duopoly with Jeld-Wen (which has an equivalent share of the market). The industry put through a mid-single-digit price increase at the end of 2012, the first such increase in nearly 2 years.

Masonite and Jeld-Wen essentially control the NA residential door industry. Jeld-Wen was acquired buy by Onex Corp in 5/11. In 10/12 Jeld-Wen then acquired the only remaining large player, CraftMaster. Onex discloses quarterly financial data under its “Building Products” segment. The unit generated LTM revenue of $3.2B and $175M in EBITDA (55% N. America, 33% Europe, 12% Australia). This includes some higher margin window revenue. Jeld-Wen has also undertaken pretty aggressive cost cutting initiatives. From 2011 through the end of 2012, Jeld-Wen seemed to be matching every one of these cost cuts with a corresponding price cut in order to capture share. This created a less rational competitive environment. Every attempt by Masonite to raise prices was met with a price decrease from Jeld-Wen. In one particular instance, Masonite was significantly underbid for a door line with Lowe’s resulting in a loss of $70M in annual revenue for the Company in 2012. During the last quarter’s call, however, Onex/ Jeld-Wen indicated that its cost cutting had run its course. Jeld-Wen’s post-CraftMaster debt load (3.7x net debt/ EBITDA) and cost structure should have set a bottom for industry prices. The 5% price increase was effective Q1’13 and will be reflected in the upcoming Q2’13 numbers.

Masonite

Masonite is #1 and #2 in every category and is the low cost producer in most door lines in which it participates. It sells it doors through wholesale channels and home centers with HD and LOW representing 16% and 10% of revenue, respectively. Below is a table presenting the Company’s revenue contribution by type.

Over the last 2 years, Masonite has acquired 5 competitors in the higher margin architectural and commercial 2 segments. Masonite’s average door price was $54 in 2012 while the average selling price for a commercial door is $100-150 and $250-350+ for specialized architectural doors. These acquisitions added $21.4M in annual EBITDA (at time of deal announcement). Management is expecting $10-11M in synergies from these deals, implying Masonite can cut two turns of EBITDA off the purchase price multiple. The Company should be able to continue to make attractive smaller acquisitions given the fragmented nature of the rest of the market.

Since 2006, Masonite has undertaken several operational improvements and cost-cutting initiatives: 1) closed 35 facilities globally, 27 in N. America; 2) cut workforce from 12.8k to 8.3k employees (SG&A % revenue from 13.8% in 2009 to 12.2% in 2012; 3) started a lean sigma initiative saving $25-30M in annual fixed costs; and 4) opened the industry’s first fully-automated manufacturing facility in 5/13 with 2 more facilities under review for conversion (potentially $8-12M in annual savings).

The sale price per door ranges from $50 for a basic residential unit up to $300 for an architectural door. Masonite does not disclose units sold by segment so pulling apart and forecasting based on unit economics requires too many assumptions. At the investor day last fall, management provided guidance at 1.1-1.2M starts of $2.5B in revenue and $300M in EBITDA (12% EBITDA margin). The US will likely reach this housing starts rate in early 2014. Management guidance did not include any subsequent cost savings, M&A or price increases. Inclusive of these subsequent developments, Masonite should be able to achieve 13% EBITDA margins on 1.1-1.2M US housing starts. In such a scenario, the Company should generate $325-375M in EBITDA. The case presented below assumes 2014 revenue of $2.4B and EBITDA of $304M.

The Company currently operates at 65% of capacity with limited incremental capex required to meet the demands of up to an 1.5M housing starts environment. Masonite requires $10-15M in maintenance capex per year. The Company has $150M in NOLs and only expects to pay $6-8M in cash taxes over the next few years. In 2013 management expects to make a $4M cash contribution to the pension with $6-7M annually thereafter.

Valuation

At the current stock price of $50 per share, Masonite has a market cap of $1.4M (28M s/o) and EV of $1.66M ($266M in net debt). There aren’t any comparable public door manufacturers. The closest is PGT (PGTI), the producer of impact-resistant resi windows and doors, but it is small and regional. The Company trades at 10x 2013E EBITDA versus the broader home building products segment which trades at 14-15x LTM EBITDA. Given Masonite’s 12-month sales lag, the forward 2013 multiple is a better comparable to the LTM of earlier stage peers.

If we reach 1.1-1.2 M starts in 2014, this normalized level implies a 4.5-5.5x EV/ EBITDA. Masonite traded at 7-8x EBITDA from 2000-2004, but that valuation did not reflect current cost structure, scale and industry changes. At the normalized level, the Company should generate $240-290M in FCF, a 17-21% FCF yield to the current equity – an attractive price on an absolute basis given the quality of the business. In addition to the common, you can also participate through the 6M warrants outstanding listed as MASZF and MAZSF with a strike price of $50.77 (reflecting the 2011 special dividend).

Risks

-A decline in construction activity would obviously pressure performance. Masonite’s operational improvements, restructured balance with ample liquidity and rationalized industry should help offset the effects of another 2008. The Company and industry more broadly is only modestly above trough volumes now. There is pretty clearly a lot more upside than downside even if home construction moderates from here.

-Planned IPO may be delayed or not materialize. The disclosure in the Company’s S-1 is very comprehensive, making a delay in the SEC review less likely.

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

Catalyst

1) up-listing to the NYSE in September

2) alleviation of post-reorg and OTC-listing stigma

3) increased awareness and appreciation for the quality of the business and the improved industry dynamics

4) corporate communication

5) potential sale

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			2013	2014
Price:	50.00	EPS	$0.00	$0.00
Shares Out. (in M):	28	P/E	0.0x	0.0x
Market Cap (in $M):	1,398	P/FCF	0.0x	0.0x
Net Debt (in $M):	266	EBIT	0	0
TEV (in $M):	1,664	TEV/EBIT	0.0x	0.0x