MasterBrand: Good Long-Term Prospects At An Attractive Valuation

Investment Thesis

MasterBrand, Inc. (NYSE:MBC) faces near-term revenue challenges due to a slowdown in its end market as a result of high interest rates and inflationary conditions, which have adversely impacted consumer sentiments. However, the company’s good execution and initiatives, such as simplifying product offerings and increased investments in its Tech Enabled initiatives, position it well for long-term growth. In addition, the long-term tailwinds from the aging U.S. housing inventory, high home equity levels, and a significant underbuild of new homes after the great housing recession of 2008 should benefit the company’s R&R and new construction business and drive revenue growth in the long term.

Further, the company’s long-term margin outlook looks favorable with benefits from cost-saving initiatives, productivity improvement, and automation. The company’s valuation is also reasonable. This, coupled with promising long-term growth prospects makes MBC’s stock a buy.

Revenue Analysis

After seeing good growth over the last couple of years due to strong end-market conditions, the company’s sales declined in the last couple of quarters as high interest rates and an inflationary environment started impacting consumer sentiments.

In the second quarter of 2023, the company posted net sales of $695.1 million, down 18.8% Y/Y. The lower net sales were due to a decrease in sales volume, driven by softer end-market demand, partially offset by higher average selling prices, primarily attributable to the carryforward impact of price increases implemented in late 2022.

Looking forward, the near-term revenue outlook continues to remain challenging. While the new construction market has performed better than expected with a good spring selling season, the high-interest rate environment continues to pressure customer sentiments. Further, last year MasterBrand's new construction sales benefited in the back half as home builders were executing record backlog accumulated due to supply chain constraints in late FY21 and early FY22. So, the Y/Y sales comparisons are tough.

The remodel business is performing worse than expected and the consumer sentiments are subdued given the high inflationary environment. Further, management noted that the consumers who are still considering remodeling projects are looking for lower price points and are willing to give up add-on features to achieve a desired price point. So, the mix is also expected to shift downwards. There is also the risk of destocking as retailers adjust inventory to the current demand levels.

One thing which is helping MasterBrand in this environment is the breadth of its product offering from stock to premium, which allows it to address customer needs across the price point.

Management is also controlling what it can control and positioning the company for longer-term growth. The company is simplifying its product offering and has implemented a common box initiative deploying standard processes across plants. This should help the company realize the full benefit of scale as the demand recovers.

The company is also focusing on Tech Enabled initiative to improve buyer experience. MasterBrand has accelerated investments in new tech platforms to improve the connection with channel partners and customers and has increased its FY23 strategic investment targets from $10 million to $15 million to between $16 million and $21 million.

The long-term outlook of the housing market is positive with over a decade of underbuilding post the great recession of 2008 creating supply deficit and driving demand for new construction. The repair and remodel outlook also remains positive with high home equity levels and aging U.S. housing inventory.

Overall, the company's revenue outlook is mixed with near-term challenges from high interest rates and an inflationary environment and long-term opportunity thanks to the company's good execution, growth initiatives, and solid demand drivers both in new construction and repair and remodeling business.

Margin Analysis

In Q2 2023, despite the decline in revenue, the company saw a 480 bps Y/Y improvement in gross margin to 34%, driven by the savings realized from cost reduction actions, the carryover impact of price increases implemented in 2022, and supply chain improvements which more than offset labor cost inflation. The improvement in gross margin more than offset SG&A deleverage and resulted in a 280 bps Y/Y increase in adjusted EBITDA margin to 15.3%.

The company's execution on the margin front has really been impressive, and keeping adjusted EBITDA flattish and growing margins when revenue is down 18.8% Y/Y is no small feat. Looking forward, while there are some near-term headwinds from continued pressure on revenues and tough Y/Y comps as Q3 margins last year benefited from record volumes, I believe management's continued focus on cost-cutting and productivity improvement should bode well for its margins in the long run. Management is currently focused on optimizing supply chain and sourcing as well as automation and other tech-enabled initiatives to reduce cost. One such initiative is implementing RFID technology across facilities to improve inventory tracking and accuracy. This not only saves labor costs as time spent tracking inventory can now be reallocated to other more value-added work, but also allows controlling working capital more tightly given improved accuracy.

Overall, the company's long-term margin outlook remains solid given management's focus on cost savings and automation.

Valuation and Conclusion

MasterBrand is trading at 9.08x FY23 consensus EPS estimates and 8.47x FY24 consensus EPS estimates which is attractive. While the company's near-term outlook is challenging due to slowing end markets, management is doing a good job in terms of execution, taking out costs, and positioning the company for long-term growth once the cycle reverses. I believe investors with a medium to long-term horizon who can hold for the next couple of years and wait for the current cyclical slowdown to reverse can consider buying the stock at the current attractive levels. Hence I have a buy rating on the stock.