sturti
Summary
Following my coverage on Masco Corporation (NYSE:MAS), which I recommended a hold rating as I wanted to wait for one more quarter of data before considering a change in recommendation. This post is to provide an update on my thoughts on the business and stock. I reiterate a hold rating and wait for 3Q23 results to see if MAS is on track with the bull case. If so, I think this will be an attractive long-term investment if the share price persists below my price target of $103.
Investment thesis
MAS’s $439 million in EBITDA and $1.19 in EPS for 2Q23 were much higher than the $373 million and $0.96 expected by consensus. Both plumbing and DAP saw increases in profit margins and revenue, which led to the considerable outperformance. At a high level, management acknowledged the difficult demand climate in the near future, but they also mentioned how pricing changes and increased efficiency helped to mitigate the impact of decreased demand in the second quarter. Management increased their FY23 EPS guidance to $3.50-3.65 due to a successful second quarter. Management also increased the EBIT margin expectation from 15% to 16%, an increase of 100 bps from the previous guide. This new guidance should help maintain near-term valuation and numbers by setting a floor for consensus projections for FY23 margin.
However, I should point out that the higher margin guide had no effect on 2H23 implied performance because the guidance was updated to account for the huge 2Q23 beat. Notably, management highlighted the fact that 2H will continue to face a challenging volume outlook, the lapping of price increases in 2022, and additional growth investments. Since the latter are such sizable and weighty expenditures, I anticipate that they will dampen margin performance in the near term. For instance, MAS will begin construction on a new paint distribution and production facility in Ohio and bring online a European plumbing plant. Furthermore, the margin beat in 2Q23 can be attributed in part to the deferral of expenses until 2H23, which means 2H23 will see disproportionate pressure. MAS’s past performance also suggests that the 3Q margin will be greater than the 4Q, on average, therefore a shortfall in the third quarter would raise the likelihood that MAS would fall short of 2H23 expectations. Further, I got the feeling that MAS is facing continuing economic headwinds in Europe (inflationary still ongoing) and China (consumer sentiment weak), which I believe to accelerate in 2H23 and put pressure on international segment.
However, on the bright side, inventories in North America are back to normal, with sales roughly matching purchases. This indicates that the next few quarters will be profitable regardless of demand levels. In addition, management claims that low-single-digit deflation this year is supported by input costs, with copper and zinc both below the 2022 average. This bodes well for results in 2024.
Despite the positive price activity that ensued after the 2Q23 earnings were released, I believe the results were mixed. On the one hand, margin performance has been excellent, greatly above consensus. However, the volume estimate for 2H23 is bleak, and 2H23 will also lose the benefit of price increase in 2022.
My bull case for MAS is that, assuming consumer sentiment and housing-related end markets recover from their recent lows, I believe MAS will see improved performance in the second half of the year and beyond. Deflation in the cost of raw materials and shipping has somewhat neutralized the effect of falling unit sales, and the pricing strategies put in place over the past two years continue to hold. As an additional boost to EPS in 2024, I point out that this year’s repurchase projection of $350 million suggests a significant increase in 3Q and 4Q compared to the first half. To confirm that MAS is on track with the bull case, I would wait for the findings of 3Q23 to be released.
I believe the fair value for MAS based on my DCF model is 103.82. My model assumptions remain the same, as I previously noted that, based on a long-term view of the MAS business, it should be able to consistently grow at mid- to high single digits, as we have seen in the past. This should trickle down to a consistent growth in FCF over time, well supported by any share repurchase or M&A programs.
Own calculation
Conclusion
MAS 2Q23 performance was impressive, exceeding consensus expectations with strong EBITDA and EPS figures. The management’s strategic pricing changes and increased efficiency helped mitigate the impact of reduced demand in the near term. However, challenges lie ahead in the form of a difficult volume outlook for the second half of 2023 and the absence of the previous year’s price increase benefit. Additionally, economic headwinds in Europe and China may add pressure on the international segment. Despite these challenges, positive factors such as normalized inventories in North America and deflation in raw material costs provide some optimism. The bull case for Masco relies on a recovery in consumer sentiment and housing markets in the latter half of the year and beyond.
To determine if Masco is truly on track with the bull case, I think it is prudent to await the release of 3Q23 results.
