Description
Masonite is a maker of mostly residential doors. Sales are tied to new home starts and remodeling activity, and to a lesser extent commercial real estate.
1) A return to 1.5M starts should push EBITDA to $265M in 2016 vs $105M in 2013, including the benefits of lower costs as the company automates some plants
Starts are currently below 1M. an increase of 0.5M should cause Masonite's volumes of new construction doors to rise from 7.9M in 2013 to 12.6M in 2016. with flat pricing this should cause north American new construction revenues to grow from $462M in 2013 to $810M in 2016. As a check, Masonite has nearly 40% of the market and there are approximately 30 doors per home (around 24 for multi family and 36 for single family homes). Masonite should sell 6M more doors (40%*(1.5M - 1M)*30). Masonite should see 25% incremental margins without any price increases. they have a high fixed cost structure and their plants are under utilized. they have recognized much higher incremental margins recently as they have raised prices. a 25% incremental margin on the $350M revenue growth = $88M in incremental EBITDA.
The replacement/remodel market should grow volumes MSD, above GDP growth. 2013 revenues of $568M should grow to $665M including inflation. at 25% incremental margin, this will add $25M in EBITDA
the non res market should grow HSD, similar to non res construction overall. 2013 revenues of $290M should grow to $385M, adding nearly $25M in EBITDA
the rest of world market should grow MSD. revenues grow from $410M in 2013 to $466M in 2016. this should add $15M in EBITDA
I expect them to automate another plant at a capital cost of $22M that will add $7M to EBITDA as past automations have done.
combined: $105M in 2013 EBITDA should increase by $88M + $25M +$25M +$15M +$7M= $265M in 2016 EBITDA
2) the key to the story is pricing. Can the duopoly of Masonite and Jeld Wen raise prices. Modest pricing assumptions add $50M to EBITDA
Recently, a negative report was published indicating that Jeld Wen controls pricing and is fighting for market share. in which case, even if housing starts recover, $265M is too high an estimate for 2016 EBITDA as competition will reduce margins.
they control 80% of the market. approximately 40% each. the negative report assumed it was 25% Masonite and 50% jeld wen. my impression is that they are basing their math on jeld wen's overall revenues which includes windows. their estimate of Masonite doors produced in the US seems too low to me as well. my research suggests it is fairly equal. but that is besides the point, what matters is that there is a duopoly with barriers.
There is a duopoly in the US wood door market. Masonite and Jeld-Wen control 80% of capacity with the remaining 20% spread across a few regional players and mom and pop assemblers. There are two steps to making a door. First, you must make the “door skins”. This is the outer shell of the door, a thin film that makes up the front and back of the door. This is a capital intensive business that operates more like a chemical plant. The second stage is to assemble doors, this is small scale and a total commodity business.
The industry is different than last cycle. Before, there were 4 door skin manufacturers, now there are only 2 in North America. The door assembly market was very fragmented. Masonite stopped selling skins to independent assemblers and instead began acquiring them on the cheap after the bust. Jeld-Wen has begun to follow suit although they still sell skins to independent assemblers. The results in that the big two now control 100% of north American skin capacity and 80% of assembly capacity in the wood door market.
2.A. There are real barriers and I believe that the two companies can raise price materially without competition stopping them.
Barrier #1 - scale and market share needed to make door skins cheaply.
- Need massive share of independent assemblers
- The addressable market for a plant is typically 1/3 of the US at most due to transport costs. If prices rise enough it could make sense to ship to 50% of the US
- Jeld wen has 6 plants, Masonite 2. Each plant averages 12% of the market. We are told jeld wen’s plant size is about as small as you can get. The implication is an entrant needs 10% national share.
- If you can serve ½ the USA, that is 20% of your region. That is 100% of independents in your region since the big 2 have 80% of capacity.
- On top of that, a plant can’t run every SKU. Only the main ones and a few others. Therefore you can’t get all of the independent’s business.
Barrier #2 - quality standards. It is hard to replicate quality. Sourcing raw materials is hard. Not easy to get cheap and consistent quality. Know how is also a modest barrier, skins plants are really chemicals plants.
Barrier #3 - imports are not a threat due to poor quality that is inherent with making door skins abroad and due to transport costs
- The increased costs are 1) ocean freight, 2) increased inventory (extra 9 weeks of inventory due to longer lead times), 3) increased land freight once the skins reach the US shore and 4) the cost of higher defect rates. A defect costs 5x the selling price of the door if a problem occurs after installation. The increased cost consists of labor, painting, finishing etc.
- They should be able to raise prices over 10% in this part of their business. they have already raised prices twice this year.
2.B - The negative report was correct that Jeld Wen was competing on price. What's missing is an understanding of why that is very likely over. Jeld Wen fired that CEO and hired someone new
The former CEO of Masonite became the CEO of Jeld-Wen. He was let go from Masonite in a bitter fashion. My work suggests he was let go primarily because of his focus on volumes instead of price. In 2011 and 2012, while at Jeld Wen, he attempted to compete on price thinking that Masonite was very weak after emerging from bankruptcy. It helps that Jeld-Wen is now owned by Onex Corp (OCX CN), a Canadian private equity company. After a couple of years of competing for market share, EBITDA went nowhere at Jeld Wen and he was let go early in 2014. Their new CEO is a former Eastman. He is focused on ROIC. Channel checks indicate that both companies are now focused on price.
One thing I find confusing is why anyone would suggest that Jeld Wen would compete for market share at the expense of price in a duopoly (the negative report asserted this). That is completely irrational. That is one step away from saying a monopoly will compete for market share by lowering its price. In reality, Jeld Wen's former CEO was irrational and too aggressive. Their private equity owners realized it and pushed him out of Jeld Wen in favor of someone who comes from a company with a strong reputation of thinking about FCF and ROIC.
2.C - impact: assuming a 2% pure price increase each year in US new construction, 2016 EBITDA forecasts rise from $265M to $305M. You can argue for more and reach closer to $350M.
- they can also take price in retail and arguably a bit more in new construction.
2.D ROIC - these forecasts imply a low double digit after tax ROIC in the US and still leave room to raise prices
targets and valuation
I forecast DOOR will do > $300M in EBITDA in 2016 and significantly more in 2017 as door sales lags housing starts by close to a year.
their current EV of $1.8B is < 6x 2016 EBITDA.
at $305M in EBITDA , DOOR can do $6.50 in FCF assuming modest buybacks along the way. I would not be surprised if they can do $350M and $7.50 in FCF.
most peers CURRENTLY trade at 15x-20x 2016 FCF and over 8.5x EBITDA. The low end of this range suggests a $75 target. at 13x 2016 FCF of $6.50 you get a $85 target. at 15x $7.50 you get $112, which implies 9.5x the $350M EBITDA forecast.
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.
Catalyst
housing starts
price increases