Description

Maytag is the third largest producer of home and commercial appliances under the brand names Maytag, Hoover, Jenn-Air, Amana, Dixie-Narco, and Jade. The appliance maker is an over levered dinosaur that faces a severe uphill battle with the onslaught of foreign competition, rising material cost, labor concessions, and a possible slowing consumer demand because of the anticipated rise in interest rates. With the recent bounce in the stock, Maytag appears to be a wonderful a short! The primary risk is a stupid European buyer at a small premium.

Financials
Maytag appears cheap with an enterprise value of $2.6 billion (market cap of $1.6 billion, long term debt of $996 million, and cash of $57 million) on over $4 billion in revenue. The enterprise value (EV) on the last twelve-month sales is .54 times. The EV divided by trailing 12 months EBITDA is 6.9 times.

During the greatest housing boom ever, Maytag’s recent operating results are extremely poor. Earnings per share were as high as $3.80 in 1999, then fell to $2.40 in 2002, $1.53 in 2003, and are expected to post 97 cents this year. Cash flow is expected to be between $125 and $150 million in 2004 (w/ depreciation and amortization of $165 to $175 million) Yet, MYG still pays a healthy $.72 annual dividend, 74% of this year’s EPS. The dividend yield of 3.4% supports the stock. Operating margins were 13.3% with a 12.6% ROA in 1999 and have dropped to 3.6% and 3.9% respectively in 2003!

Maytag is in the midst of an announced turn around. At a November 19th investors meeting in New York, Maytag’s management set an ambitious game plan for EPS in 2005 that has street estimates in the $1.55-1.65 range. There are several moving parts that could significantly boost or counter the assumptions. First, material cost, mainly steel, has risen dramatically over the last year. Assuming these cost stay within their guidance (which is approximately 60% of COGS); it will cost Maytag nearly 75 cents. The major positive is a $1.20 in savings left over from the restructuring of employees and plant closings initiated in 2004. Maytag expects pricing and volume to add .35 cents a share. Roughly 1/3 of this assumption is an improvement in Hover. Other expenses that will impact are healthcare and pension cost.

Maytag has a lot debt. With $996 million in long-term debt, $550 million in deferred pension obligation, and additional warranty obligations MYG has little room for error. With the adoption of FASB statement 187 on pension obligation for the last three years and a major share buyback that boosted treasury stock $1.2 billion over the last 10 years, Maytag has only $40 million in reported shareholders equity (buyback 35 million shares at cost $1.5 billion under previous management that departed November, 2000).

The long-term debt has increased over $25 million in the last year. Approximately $411 million of the debt matures in 2006, which will most likely create a funding issue. It appears the bankers are watching very closely. In the first quarter of 2004 Maytag entered into a new $400 million credit agreement. A few months later, Maytag issued $100 million in medium term notes and had to reduce the new credit agreement down to $300 million. Maytag has maintained their $57 million annual dividend at the expense of not fully addressing the health and pension obligations. MYG’s pension obligations grew materially over the last year with a change in the discount rate. At the same time it is worth mentioning that capital expenditures are have been reduced by 55% in 2004; to $110 million versus $199 million in 2003 on a company doing over $4 billion in annual sales.

Appliances
From the 40,000-foot view, let me interject one train of thought. The Asians have decimated US manufacturing of textiles and most recently parts of the furniture industry. Two years ago small microwaves and mini-refrigerators cost approximately $150. Today, the Asians have brought the price points down to the $50 range. I am a believer that whatever does not have a perishable shelf life (ala x-technology) and can fit reasonably well in a shipping container (at $3,800 per trip) is subject to the labor arbitrage. Chinese manufacturing employees make approximately $1,200-$1,500 per year. Maytag has some small manufacturing operations in Mexico; the bulk is in the United States! Maytag has about a 16% share in the global appliance market and 25% of the US. At the New York meeting, Maytag’s management stressed that this is an industry that moves 1/10th of a percent in a single year. Later in the presentation, management indicated that the Asians would probably gain more floor space in the big box retailers over the course of 2005. With 90% MYG’s sales in the US and their level of debt, a 1% change for them would cause dire consequences.


With this backdrop, let’s now analyze the US appliance distribution system.
In 2000, there were only two mass merchant appliance retailers: Circuit City and Sears. In 2001, Circuit City exited the business. The industry now has three new mass merchant retailers that sell, service, and deliver appliances: Best Buy, Home Depot, and Lowe’s. These three retailers along with Sears represent 40% of US appliance sales. These mass merchants offer consumers every day low prices that will compress manufacturing margins: a Wal-Mart bully mentality.

Sears offers their own Kenmore brand, Whirlpool, GE, Maytag, and Electrolux’s Frigidaire. Industry reports indicate that Sears recently contracted with Asian vendors to private label the manufacturing of Kenmore.

Best Buy (BBY) is the most innovative appliance retailer. Twenty plus months ago, Best Buy started carrying LG and Samsung appliances. In the beginning, 8-10 customers were hesitant to buy Korean products. Today, regional managers tell me the reluctance is 1 in 10. Both LG and Samsung offer enhanced technology products that are gaining floor space. For example, LG sells a refrigerator that has a built in Plasma on the door that is selling well. Additionally, LG’s refers offer temperature controlled meat boxes that allows meat to stay fresher for days. With companies offering innovative technology at a reduced labor rate, BBY makes 40% more in net their operating margin. It is only a matter of time before other retailers adapt Asian appliance makers. This will disrupt floor space and compress margins.

Appliances represent fewer than 10% of Home Depots total sales. Their stores have a much smaller floor space than rival Lowe’s. You can order any appliance at Home Depot, but the retailer only floor plans GE and Maytag. Under previous management, Home Depot and Whirlpool departed ways. Therefore, floor space is as good as it can get for Maytag at Home Depot. Industry sources report that Home Depot just hired a key appliance executive from Best Buy that was responsible for bringing in the Asians! Home Depot is MYG’s second largest customer sales (10%+).

Lowe’s is moving to innovative products. For example, three months ago Lowe’s started sourcing New Zealand’s Fisher Paykel. Lowe’s is selling their washing machine for $550 that only cost $17 a year to operate. It has no belts or transmissions and has an automatic sensor to determine the water level. It is proven to get cloths 80% dryer out of the spin cycle causing less wear and tear and a faster cleaning experience for the consumer. The only component that could fail is an $80 motherboard that is simple to insert. Again, technology has passed over Maytag’s appliances.

Other Business Lines
Over 40% of all vacuum cleaners sell for under $100 in the US with very little margin. In the last few years, Bissell (mid range) and Dyson (high end) have taken over with innovative features (bag-less, attachments, functionality, better extraction, etc). Maytag is losing money on Hover and will continue in the future.

Dixie Narco was the king pen in vending machines. In its NY presentation, management acknowledged severe head winds in this division from Asian
Competitors.


Conclusion
I have yet to mention that the lonely Maytag repairman is not so lonely. Reference WSJ article of December 29th, 2004, the expensive Neptune washers ($1,000 line with over 25 types issued in the last seven years) are in a serious legal dispute. Maytag reserved $18 million in additional warranty expense, but the ruling a few days ago appears the warranty expense will be multiples of the reserved amount. There are over 2 million units out in the field with 120,000 claims. In talking to the big boxes and the mom & pops vendors, MYG’s customers are up in arms with a bad taste in their mouth. They have lost their loyalty. Couple this with increasing foreign competition, the squeeze from the big retailers, rising rates on the housing sector: Maytag is in a vice. Maytag increased prices in April and November. Time will tell if the price increases will stick. Yet, they plan increase prices in early 2005. This morning, I hear Longbow is out with a note questioning January retail price increases. All this will come to a head and the dividend will eventually be cut.

Therefore, I view Maytag’s outcome as binary. Until proven wrong, my bet is MYG is a long-term fade.

Catalyst

Foriegn competition will continue to erode the brand.