Description

Synopsis

We believe Briggs & Stratton (BGG or Briggs) is in a period of accelerating structural decline. Electric mowers are rapidly taking share of the core walk-behind segment that Briggs services with its engines. At the same time Briggs customers are rapidly shifting their product offerings away from the most competitive consumer segments. While Briggs has done a good job expanding into commercial offerings that are less impacted by the move to electric mowers this is too little too late. We see Briggs’ core earnigns moving to < $0.80 a share and at 10x (given declines and an increasingly stretched balance sheet) there is still a lot of downside from today’s ~$12 a share.

Overview

Briggs & Stratton is the largest producer of engines for outdoor power equipment. They also produce their own outdoor power equipment. ~70% of the business relates to lawn mowers (of which > 80% are push mowers) with the other 30% including portable generators, power washers, snow throwers, portable lighting, and air compressors. The company’s business is situated in two divisions: Engines and Power Products. The Engines segment produces engines for third parties and their own Power Products segment (roughly 8-10% of Engine segment sales). While the Engines segment represents 59% of sales (before eliminations) it accounts for 86% of operating profit (in FY 2017).

70% of sales are in the United States with the 30% outside of the US occurring mostly in Europe, Australia, and Brazil. The engines customer base is highly concentrated. The top 3 customers for the Engines segment represent ~50% of sales (MTD, Husqvarna, and Deere). MTD and Husqvarna are both > 10% customers for the overall business and close to 20% for Engines. Over the years Briggs’ core customers have increasingly sourced engines from lower cost locales (particularly China). As recently as 2009 Briggs sold > 10m engines (at peak they sold ~12m). In FY 2017 (end June) the company sold 7.4m. More recently battery powered products have started to take share and now represent a bit more than 10% of the market. BGG’s engines do not address this market.

To combat these trends the company has expanded the Power Products division largely through acquisition. They now sell their own products under brands such as Briggs & Stratton, Snapper, Simplicity, Ferris, Allmand, etc. It has had some missteps in the product portfolio, which has historically focused on the low end. The recent focus of the company is expanding its commercial business, which it sees as a higher quality, faster growth end market. It also believes this market to be insulated from the threat of battery powered products. Commercial sales as a percentage of the total have increased from 12% in FY 2012 to > 24% in FY 2017.

Bear Points

Battery powered mowers are a real threat at the point of inflection

According to our fieldwork and calls with industry experts, three years ago there were 10-20 fully electric walk behind lawnmower options. Two years ago the number was > 30 and last season it was > 70. Electric mower penetration has increased from < 10% of the market to just over 10% now (up to 15% according to some estimates). Not only are offerings increasing rapidly, but price and performance are improving dramatically. Electric mowers are now being offered at < $300 (versus > $400 before) with larger ones averaging in the $300s. A comparable gas-powered mower costs between $200 and $250. Electric mowers are more convenient than gas powered mowers as they do not require fuel, are cleaner, less bulky, and quieter. Electric products have now begun to outperform gas powered variants in terms of cutting power. Consumers prefer the electric offerings and the price points are closing. Texas is a smaller lawn market and in turn has significant corded offerings. This is further evidence of the drawbacks of gas in the eyes of the consumer.

The online selection at Home Depot and Lowe’s have skewed battery powered in recent years as they introduced exclusive models (such as Home Depot’s offering with the Chinese manufacturer EGO). However, on the floor electric mowers have been less prevalent with a typical lineup having two out of ten models electric. This year we have heard the mix might go towards 5-6 electric offerings.

Last year Ryobi introduced the first electric riding mower and there are even new offerings in the commercial market (to be discussed later). We expect price points for walk behinds to continue to decline double digits with enhanced performance as well. The company has no way to combat this trend in the engines division and virtually nothing in the products segment. It recently mentioned it has one outdoor product it offers in Australia. At this point electrics are taking share at the lower end of the market where again the company has the highest exposure. The Street has been dismissive of the trend, but we believe offerings and penetration are at a point now where it can no longer be ignored. Over time we will likely be surprised on the downside by topline performance in engines.

Core customers are shifting away from mower categories dominated by Briggs engines and sourcing cheaper engine options from countries like China 

The company’s three largest customers accounted for 42% of sales in Fy 2018 (ending June 2018) down from 47% in FY 2017 and 49% in FY 2016. The second largest customer, Husqvarna, has a multi-year target to reduce input costs significantly. They put pressure on engine pricing by using Chinese manufacturers. While costs in China have risen, they are still ~30% lower than the company’s. Husqvarna recently announced that it is exiting is consumer products division, which includes brands like Poulan Pro that we believe make up most the sales of this customer. Our discussions with Husqvarna reps suggests that while the Husqvarana brand will remain active it will be moved to a premium position and will offer more electric products. Husqvarna may very well go away as a customer.

The largest customer of the three is MTD, which has a JV with a Chinese manufacturer of engines. The company is private, but industry contacts are able to track the production capacity of the JV, and it is steadily increasing. The third major customer (Deere) has a strategy of going towards the high end. It has been discontinuing lower end products sold at mass retailers like Home Depot that use smaller engines, which constitute most of the sales of the company. On the higher end Japanese competitors like Honda and Kawasaki have dominant share and have been expanding production. The following shows sales to the two largest Briggs customers (MTD and Husqvarna) back to 2007.

The product business portfolio is weak

The company’s portfolio is primarily on the low end. It has effectively dismantled its independent dealer channel and now sells most products through the mass market. One of its core brands is now produced by a third party (with its engines) and sold exclusively at Wal-Mart. This is the most competitive part of the residential market and the most challenged in terms of the secular threat from electric products. The Power Products segment has improved profitability in recent years through cost cuts, but still only earned a 1.6% operating margin in FY 2017 and < 16% gross margin. This is despite the engine business selling engines to the product business below market (as deduced from the low gross profits in intercompany eliminations). Compare these gross margins to Husqvarna at 32%, Generac at 35%, and Toro at 37%.

The recent hope for the division lies in commercial growth. They now breakout commercial sales as a percentage of revenue. Here they say gross margins are 400bp higher than in the consumer business, which would imply ~24% margins. They also say it grows at 2x GDP due to the trend to outsourced lawn care. We will address the risk from this in more detail below but note three points. First, the trend to outsourced lawn care is an overall negative for the business as it attacks core engine profitability. Second, the commercial business for Briggs is not all mowers and includes things like towable lights and some generators. These are fine products but do not necessarily represent significant growth areas. Third, this is a competitive business that is getting more so as electric solutions enter the marketplace.

Valuation

Historically the company has been very poor at forecasting topline but better on margins. On average it has missed revenue expectations by 5% plus. They have done better on margins by continually cutting costs, but that activity is slowing. Last week the company reduced FY 2019 EPS expectations from $1.40-1.60 to $1.10-1.30, and the low end may be ambitious. We this year we forecast $1.04 in our Base Case but see < $0.95 as possible. Next year we see continued earnings declines to $0.80 in a Base Case and $0.54 in a Bear Case. At 12x $0.80 there is still > 20% downside and at 9x out Bear Case 60% downside. Note that the way to look at leverage is on a trailing four quarter basis. Net Debt now stands at $333m with a $230m pension deficit. Adjusted EBITDA will be < $140m, so this is becoming more levered right as earnings and cash flow deteriorate. In our Bull Case we have the company fighting their way back to ~$1.20 in earnings. At 15x the stock presents a lot of upside, but we believe the scenario to be very difficult to achieve.

Catalyst

-Continued Engine declines from electric penetration and customer attrition

-Product portfolio issues due to the same electric pressures

-Balance sheet becoming more of a concern as cash is being put into restructuring with no improvement in margins