Description

Investment Thesis and Recommendation

We recommend a BUY of BC with a price target of $149.12 (12.6% 5 Year IRR). First, we are bullish about Brunswick’s best-in-class Boat and Propulsion segments. Notably, we believe that Brunswick’s expansive boat dealer network represents a wide economic moat that allows Boat and Propulsion to maintain their market leading positions and share of new boat and engine sales.

More crucially, our assumptions do not depend strongly on new boat buildout. Boats and marine engines require high levels of maintenance, and Brunswick has created an extremely sticky aftermarket for itself. Thus, we believe that their Parts and Accessories segment will generate stable, recurring cash flows across the multi-decade lifespan of each engine and boat in their wide install base. Additionally, the most visible risk for Brunswick is a newbuild boat downturn in an adverse economic environment; however, we believe that these fears create an opportunity for entry because the sticky profits generated in Propulsion and P&A are largely resilient to economic slowdowns.  

Company Overview

Brunswick Corporation (NYSE: BC) is an American manufacturer of recreational marine products. The company operates through three segments: Propulsion, Parts & Accessories (P&A), and Boat. Propulsion (37% of revenues) manufactures engines for leisure boating. P&A (34% of revenues) offers a range of engine parts and consumables including oils and electrical products. Boat (29% of revenues) manufacturers and distributes leisure boats including sport and fishing boats. Despite the even revenue contribution split, the three segments contribute drastically different amounts to Brunswick’s EBIT. Propulsion and P&A are much more profitable businesses (14% and 15% operating margins, respectively) than Boat (10% operating margins), and the two account for just over 80% (49% and 31%, respectively) of BC’s operating income.

Company Positioning

In the US, approximately 200,000 recreational boats are projected to be sold annually. New boat build numbers faced their largest decline in 2011, but they have now rebounded to an average of ~190,000 annual boat sales between 2013 and 2020. Boat operates in a largely fragmented market, and estimates place Brunswick’s boat market share at ~14% of the total US market. To purchase a boat or boat engine, retail customers must go to a registered boat dealer. Boat dealers and servicers are obligated to undergo a training program with a specific boating company, and most dealers typically only carry a few different brands.

Dealer exclusivity is no coincidence as dealers are offered stronger volume-based rebate programs depending on their level of brand exclusivity. Put differently, the fewer boat brands that a dealer carries, the stronger of a rebate program that the dealer receives. When asking one dealer why his shop exclusively carried Brunswick products, he informed us that the decision boiled down to “Rebates. They’re tied to volume sold. You have to do the math in your head.” New Brunswick boats come outfitted with Brunswick branded engines, creating a powerful flywheel from boat sale to engine sale to aftermarket sale. Additionally, the sale of Brunswick boats—which are all outfitted with Brunswick engines—alongside share gains in engines caused by strong boat dealer stickiness has resulted in Propulsion having a roughly 45% marine engine market share, in what is essentially a duopoly with Yamaha.

The Boat Segment and the Start of the Aftermarket Flywheel

Brunswick’s boat segment generated $2.1b in 2022 revenues with a 10% operating margin. As mentioned above, Boat is not a lucrative segment, and the vertical was effectively a break-even business until the last few years. However, it is valuable because BC boats come equipped with Mercury (BC) engines, which grow the serviceable engine install base for Propulsion and P&A. In Boats, five out of the top ten most recognizable brands are Brunswick-owned, with names such as Sea Ray and Boston Whaler. Boat manufacturers do not disclose specific per-brand sales, but a 2019 equity research survey about brand recognition showed that BC boat brands were the 1st, 2nd, and 4th most publicly recognized ones. The aforementioned boat dealer dynamics favor scaled, incumbent players, and Boat’s leading brands give us the confidence that Brunswick can maintain, if not grow, its share of the new Boats sold each year. This creates a profitable flywheel for increasing the install-base of engines and boats that will need repair in the aftermarket.

Duopoly in Propulsion

Propulsion generated $2.8b in revenue on a 22% adjusted operating margin in 2022, and the segment is driven by Mercury: one of the two leading recreational boat engine brands. While there are four significant players—Yamaha, Brunswick’s Mercury, Suzuki, and Honda—in the recreational boat engine space, the former two each control 40-45% of the market. Mercury is the preferred freshwater engine, and they succeed through their high horsepower engines. On the other hand, Yamaha’s bread-and-butter offerings are their midrange 40, 50, and 60 horsepower motors that are often used on the sea.

Regardless of these differences, the most critical decision-making point when choosing a marine engine brand is the ability to easily purchase and service the engine. After all, “If someone says brand X is the best, but you can’t get service and support for brand X within 400 miles of you, then it is not a good choice.” However, other than select boating cities, “Most places do not have many Honda and Suzuki boat servicers. If you need serviceability anywhere else like the Midwest, you have to stick to Mercury and Yamaha.” This unique dealer structure means that boat and boat engine owners can neither purchase nor service non-Yamaha and non-Mercury boats in many parts of the United States. Since only Yamaha and Mercury have the dealer and servicer network penetration to span the US, the two boat engine titans are uniquely able to maintain their outsized market shares, which creates a powerful flywheel effect. Notably, new boat buyers seek out marine engine brands with local dealers, and these dealers will overwhelmingly be Mercury and Yamaha ones. In turn, marine dealers are incentivized to stay with Mercury and Yamaha to capture customer demand, which completes the flywheel. Moving forward, Brunswick should be able to hold its overwhelming share in Propulsion due to its unique structure as an integrated producer of boats and engines and the structural benefits of incumbency bestowed on Yamaha and Mercury.

Significant Protected Recurring Revenues in P&A

Brunswick’s P&A segment sells parts that can range from gears to engine impellers. The overarching theme is that these are generally recurring purchases or repairs made in the aftermarket. It is no secret that boat maintenance is costly, and most sources place annual boat maintenance expenditures at ~10% of the boat’s total cost. Especially as boats and engines age, the need for new parts and accessories becomes increasingly prevalent. 

When purchasing new parts, boat owners and dealers are quite hesitant to use non-OEM products. Upon purchase, Brunswick boats and engines are equipped with a warranty agreement that protects the boat if and only if the vessel has been properly maintained. Using non-OEM parts typically constitutes a violation of this agreement. Additionally, it is true that some parts are physically interchangeable; however, boat owners are typically forced to use OEM products when replacing more complex and expensive ones. Indeed, when replacing complex engine parts or maintaining the boat’s control and electrical systems, “you have to use OEMs, a generic one just won’t work or fit.” Thus, we believe that Brunswick’s P&A segment operates in a sticky aftermarket which allows them to generate recurring revenues into the far future from their large boat and engine install base. Indeed, the average outboard engine offers anywhere between 1500 to 2000 hours’ worth of run time, which translates to 20 years’ worth of engine repair revenues for P&A after each Mercury engine installation. For customers who have either purchased a BC boat—which come with BC engines—or have a Mercury engine on their non-BC built boat, the uniqueness of parts and strict warranties preventing repairs with replacement parts from different OEMs safeguards Mercury’s aftermarket revenues over the long boat lifespan.

Risks and a Mispricing Opportunity  

         The clearest risk for Brunswick is a weaker consumer environment where expensive, discretionary purchases like new boats are likely to become depressed. To this point, Brunswick forecasted 2023 Boat segment revenue to change -5% to +3% YoY. However, seeing as Boat is roughly 1/3rd of BC revenue, and a significantly smaller proportion of income due to it having lower segment margins than P&A and Propulsion, Brunswick is still forecasting to grow EPS in 2023 up to $11.00. Further supporting our valuation against potential macroeconomic slowdowns is our conservative estimate for newbuild boat sales: a conservative 160,000 new boats were projected in 2027E, around 30k less than the average number of boats sold over the previous decade. Even if we dial down our 2023E boat buildout assumptions from 188,500 new boats (historical) to a depressed 150,000 new boats, we still arrive at an 12.4% IRR. After all, based on our primary research and historical trends, economic downturns are more likely to impact new boat purchases, rather than replacement behavior, which creates an entry point for equity investors.

Valuation and Key Assumptions

1. Total new boat build grows at a discount (a depressed 160,000 in 2027E) to the historical ~190,000 annual new US boats.

2. Propulsion and Boat experience slightly increasing market shares (200 bps and 100 bps respectively), and P&A continues to generate protected revenues from Brunswick’s install base. All segments enjoy small pricing power (3.0% to 4.0% annual price increases), at a discount to historical rates. 

3. Slight margin expansion (13.9% 2022A vs 16.0% 2027E EBIT margins) given shift to more lucrative segments and an increased focus on pivoting towards more profitable manufacturing facilities.

4. 20% multiple discount in Bear and Bull cases. Base multiple in-line with more discretionary pure-play boat manufacturers with narrower install bases. 

Catalysts

• Resiliency of aftermarket and engine segments in boat downturns draws investor attention

• P&A begins to enjoy the maintenance revenues from the COVID-19 boat buildout

Catalyst

• Resiliency of aftermarket and engine segments in boat downturns draws investor attention

• P&A begins to enjoy the maintenance revenues from the COVID-19 boat buildout