Description

We are long shares of JELD-WEN.

JELD is one of the largest door and window manufacturers in the world, with the #1 or #2 position in most markets it competes in.

The company operates 115 manufacturing facilities in 19 countries and reports sales in 3 regions: North America, Europe and Australasia.

Revenues are split 45%/45% between residential new construction and repair and remodel (R&R), with the remaining 10% coming from non-residential construction (mostly in Europe).

Thesis: JELD is in the early to middle innings of an operational turnaround.  The company has a recently refreshed Senior Management team with experience across many leading industrial firms.  We believe management brings financial discipline and best practices to what was a family owned and operated business that overextended itself leading up to the housing crisis.

The operating history is important, and in many ways, it is the juice to the JELD story moving forward.

JELD was founded in 1960 and made its first international acquisition in Europe in 1992, and went on to enter the U.K market the following year, Canada in 1997 and Australia in 1999.  Between the early 1990’s and the start of the Great Recession the company made 40+ acquisitions.  In addition to an aggressive expansion abroad the company made a number of acquisitions in the US and had more than 250 separate P&L statements within the company.  For good measure, they also bought some car dealerships and golf courses.  Basically, they used a 15 year bull market to lever up the company via wide ranging geographical and industry level M+A - then the housing crash hit and the company paid the price for its lousy balance sheet and not integrating any of its acquisitions.

In late 2011, Canadian private equity firm Onex bought a majority stake, de-levered the company and put in place better financial reporting systems.  The CEO they brought in decided to fight for market share in JELD’s largest market (North America doors) even though the market had consolidated to a duopoly post-crisis, and EBITDA margins plunged further. 

In early 2014 Onex hired Kirk Hachigian as CEO and began to make operational improvements.  Mr. Hachigian is now the Executive Chairman of the Board following the 2015 hiring of CEO Mark Beck who was at Danaher for two years following a long stint at Corning.  A new CFO was brought in and nearly every senior management position turned over in the 2014-2015 time period.  Many of the executives came from Cooper Industries (which was sold to Eaton in 2012) and other leading industrial firms like Danaher, TRW, etc.  So while private equity invested in 2011, the turnaround didn’t really begin in earnest until a few years later and we believe that all the low hanging fruit hasn’t been picked.

The current management team aggressively pushed price in North America, and set about integrating the international acquisitions, implementing a global sourcing program and restarting a tuck-in M+A strategy.  Margins have more than doubled since 2013 but still have a ways to go to reach the company’s longer-term target of 15%-20% EBITDA margins.  JELD IPO’d earlier this year and following a secondary offering, Onex now owns less than 50% of the company.

JELD management plans to improve margins 100-150 bps per quarter for the foreseeable future following a three-pronged strategy of:

-Operational Excellence

-Profitable Organic Growth

-Strategic M+A

On the operational excellence front, input cost savings via a global sourcing platform is the most important driver.  Management is also doing the standard six sigma implementation, lean manufacturing, standard manufacturing key buzz word game (let’s get a kaizen in there for good measure) with the goal of reducing warranty expenses via higher quality product and lowering overtime expenses.

In order to organically grow in a profitable manner management has walked away from low/no margin business which is hurting the top-line this year (guidance for 1.5-3.5% revenue growth, below industry peers in 2017 before returning to industry-level growth in 2018), and continuing its re-investment in R+D.  JELD significantly underinvested in the business coming out of the recession, and recent re-investment actions have doubled the number of new product introductions in 2016.  JELD is working more closely with channel partners via loyalty programs to gain share, has pushed price, and is working to improve mix which ties into the third strategic pillar of M+A.

As management improves operations, consolidates regional businesses, and improves sourcing, strategic M+A will become a more important part of the JELD story.  Since August 2015 management has purchased 6 businesses for $172 million (excluding recent Finnish door company acquisition) with combined revenues of $254 million.  Management is prioritizing middle to higher-end niche companies with strong brands and margins.  JELD pays 7x-8x EBITDA and wants to be able to bring the purchase price down to 5.5x within 12 months through integration and expanded distribution.  JELD is at the low-end of a 2.5-3.5x leverage ratio and will generate significant free cash flow while growing EBITDA so there is significant firepower here.  JELD management spent a good chunk of 2016 tied up with the IPO but the pipeline is strong and we expect the M+A pace to pick up.  Even though management has done numerous acquisitions (despite going through the IPO process), has listed M+A as a strategic priority, and has spoken about the large M+A pipeline on conference calls, virtually none of the sell analysts include any benefit from capital allocation in their models.  It’s worth noting that management is comped 50% on EBITDA and 50% free cash flow – the EBITDA compensation is not ideal for a company with an M+A focus but we think there are good opportunities across the globe and hope they accelerate consolidation of the European door market.

Management has made solid progress professionalizing the company and improving EBITDA margins over the past three years but given how bad the situation was when they took over we think there is still significant room for improvement.

I’ll briefly running through the businesses and M+A potential by region. 

North America is expected to be the strongest market looking forward with strong single family housing starts expected in 2017 and 2018, and continuation of recent trends in the R+R segment.

JELD is the only company that offers a full-line of windows and doors and has a national distribution network via wholesalers and retail home centers with a high concentration of sales through Home Depot.

The US door market is a duopoly with Masonite and has consolidated since the recession.  The companies control door skin production which is a more complex, capital intensive industry with high fixed costs.  Both companies are competing rationally, the outlook is strong and there are likely no M+A opportunities. 

The North American windows market has far more competitors and JELD is looking to make acquisitions at the mid to higher end of the market.  JELD is currently the #3 player in residential windows in the US and #1 in Canada.

JELD’s European business is nearly all doors, and it is the only region with a significant non-residential component to the business mix.  JELD is the only company with a platform to serve nearly all countries in Europe and is the low-cost producer.  Europe is earlier in the residential and commercial cycle and management has stated that Europe is 18-24 months behind the US in pricing.  The door market is highly fragmented and JELD recently announced the acquisition of a Finnish door company, hopefully the first of many acquisitions in the region.

The Australasia region is primarily comprised of Australia and a source of investor concern.  Australia’s housing market is expected to slow significantly this year (more so in multi-family but single family also expected to be down mid-high single digits) and JELD is 70% exposed to new residential construction.  Australia is roughly 10% of revenues and JELD has productivity improvements in the region but this will not be the strongest region in 2017 and 2018.  JELD does have leading market positions in windows and doors and last year purchased the #2 player in windows.  Since the acquisition (a family run business not well run vis a vis profitability – sound familiar?) JELD has doubled EBITDA margins.

Valuation

2017 is a top-line transition year for JELD as management is walking away from low margin businesses in the US and to a lesser extent Europe.  Management expects revenue to increase 1.5-3.5% in 2017 and return to industry level growth of 4-5% in 2018.  Margins will expand in both years as strategic sourcing, cost cuts, and hopefully some level of pricing are put through to the market.

We’re slightly ahead of street estimates before layering in M+A opportunities and think that JELD will ramp M+A now that they IPO has been completed and the company will be below the low end of its target leverage ratio by next week’s earnings report.

JELD was aggressive in pushing price mid-single digits in 2014 and 2015 (catching up to market prices after competing for market share) and achieved 2% pricing in 2016.  Many analysts think pricing will remain flat.  Management has said they “can still bring some price” and have spoken about getting customers prepared for annual price increases.  It will be a challenge to realize the pricing the company did in the 2014-15 period but something in the 0.5%-1.0% range seems reasonable given the strength in the US market and recovery in Europe.

Margins have room to expand through strategic sourcing, mix shift, operating leverage and M+A.

We estimate in the next 18-24 months JELD can increase EBITDA to $600+ million and generate FCF / share of $3+ and trade into the high $40’s.  

Risks

Cyclical end markets tied to residential new construction and R&R markets

Australia housing market slowdown worse than expected

Management fails to increase margins due to macro or

Management sits on their hands and watches $1 billion of cash build up on the balance sheet by 2019

Management makes poor acquisitions to boost EBITDA in order to get paid

Catalyst

Continued margin improvement

M+A in higher margin niche products, European door market