Cyclicals Again
This is a difficult post to write.
What I want to accomplish is to explain why Brunswick - BC - $88 is in the model portfolio, and others cyclicals are not.
What you will learn is how many subjective and qualitative decisions are part of my thought process. If you are looking for complex mathematical formulas that explain my decisions, you will be disappointed.
I decided that my model portfolio should contain 10-20% economically sensitive stocks. Even though my current economic forecast is well below consensus, there is good chance I am wrong. It would be easy to completely exclude cyclicals, but I decided my portfolio should have some diversification.
I have watched Brunswick - BC destroy its competition in the boating business since I started in the investment industry in in 1984. BC has sold all its non-boating businesses (bowling, billiards, and defense products), and become a focused company. Several times I tried to own BC’s competitor, the old Outboard Marine, with generally poor results. BC just kept gaining market share.
BC made $9.00/share in 2022, and I think they can make $12.00/share in 2025. There are still many cost cutting possibilities at BC. The company is projecting $15 in earnings power by 2025, but that seems a little aggressive. What is impressive is the company actually demonstrates how they can still earn $6/share if boat sales fall 20% or more.
$12/share is my “mid-cycle’ forecast for BC, not my peak forecast. What is more controversial is that BC deserves a market multiple of 15x on these earnings. Not many cyclicals can earn this multiple, but BC should. The boating business is still growing. The competition from Japan has been minimized. BC has over 50% share in many categories. BC’s balance sheet is in great shape, interest coverage is 10x.
That leaves me a price target of very roughly 15x a $12 estimate or $180 for 2025. So I have about 100% to my target (plus a small 2% dividend yield). Reasonable people can and should disagree with my forecast. Many would contend BC is still an ugly cyclical that will never sell for more than 10x, I disagree. I think BC has won the war, and the competitors are fading.
Who should we compare BC to?
The obvious choice is Malibu Boats - MBUU - $61 and Mastercraft - MCFT - $35. Both actually use BC built engines on some of their boats. Their main weakness is they lack the BC dealer network. Maybe MBUU could make $8 in 2025, and sell at a 12x multiple. That is a $96 target on a $60 stock today, so less exciting than BC. I have less confidence in MCFT. lets call it $4 in 2025 with a 12x multiple, so a $48 target with the stock at $34. I have tried to beat BC for 40 years, now I just want to join them.
MarineMax - HZO - $33 is a very difficult company to evaluate. HZO retails boats, including BC’s. They have been trying to “roll-up” the marina business and have more exposure to the yacht business. HZO has only a $700 million dollar market cap, and just made a $500 million dollar acquisition. I want to wait for some bad news until I dig in further. Quite frankly I cannot make any estimate of 2025 earnings power at this point. Pass for the moment.
Thor - THO - $87 and Winnebago - WGO - $55 are both more volatile than BC. I just can never justify more that 10x earnings for these mobile home companies. Maybe if oil goes back to $100, these stocks could be more interesting. THO is very well run, and maybe someday they will deserve a premium.
Camping World - CWH - $22 has done a decent job of consolidating the recreational vehicle retail business, but I still do not trust the management. I will watch for now.
Polaris - PII - $115 is kind of a Wall Street darling. I do not understand the off road vehicle business nearly as well as the boating business. Maybe PII can make $12 in 2025 and sell at 15x, but to me that $180 target is shakier than BC, and the PII’s stock sells for $115 today.
Leggett & Platt - LEG - $34 has a nice 5% yield, but if earnings power is only $3, I cannot get excited about the stock. LEG makes mattresses.
Mohawk - MHK - $102 did make $15/share in 2021, but I am not sure earnings power is more than $12. MHK is flooring and carpet.
Ethan Allen - ETD - $29 is another cyclical retailer to think about. They might make $4.00 is 2023, but I cannot get that excited about 2025 because the online guys are stealing too much business.
Whirlpool -WHR - $138 is the most difficult comparison. Many would not compare boats and appliances, but I will. WHR has done a nice job of consolidating the industry, and selling off weaker businesses. I really do not like the recent European deal, and I think earnings power for 2025 is only $20, and WHR only deserves a 10x multiple. Share buybacks have really helped, but that is that really a way to grow long-term. The 5% yield is nice, but not enough to make this a buy.
Just for fun let’s think about a homebuilder. Green Brick Partners - GRBK - $32 made $6/share this year. What should you call 2025 earnings power, and what multiple should you pay for it? At best I would call earnings power $5, and I will only pay 8x for this earnings stream. GRBK does have a unique real estate strategy I want to understand better. David Einhorn, a really smart hedge fund manager, does own 38% of GRBK. Maybe everyone should own a homebuilder. Let’s see earnings in a 7-8% mortgage world.
Celanese - CE - $118 is a unique cyclical because some guy named Buffett owns 9%. Mr. B bought most of position at $152 in early 2022. There is more leverage here than I prefer debt/EBITDA is 6.5x, interest coverage is only 3.5x. This stock deserves more work. If you could prove that earnings power is $18, maybe CE is a cheap stock. CE is on the borderline between cyclical and specialty chemical maker.
Greif - GEF - $65 is an interesting stock to think about. I looked through a few dozen industrial cyclicals and this was the one that stood out. GEF makes industrial packaging. I think 2025 earnings power might be $8.00, and might deserve a 12x multiple because the company is a little more growth oriented. One more bad quarter, and this might be an interesting stock.
Williams-Sonoma - WSM - $125 is the one cyclical that might be as good as BC. WSM sells for less than 8x 2023 earnings. The pandemic makes WSM hard to judge. Maybe some of the spending on cooking is one-time in nature, but this is a small part of the business. WSM has done a great job with their slogan '“digital, but not digital only”. There is a real chance this company does not deserve the brand of “cyclical” that has been attached to it. Maybe WSM has just gained share in a fragmented furniture business. The company has a January year end, and 2023 earnings will be reported on 3/15. I will be watching with great interest. I can make the case that earning power in 2025 is at least $15, and that you should assign a market multiple of 15x, that is a $225 target. WSM is debt free and has been buying back stock.
I am happy with my choice of Brunswick as my primary cyclical holding, but Williams-Sonoma is making me think about adding an additional cyclical.