Introduction

After writing up their peer American Woodmark (AMWD) – see here – I thought I’d swing around and take a look at MasterBrand Cabinets (NYSE:MBC). Similar to AMWD, MBC stock price is down about 25% since March, leaving me wondering if there’s any irrational selloff happening. And after going through their results, I do think there’s some sizable upside potential if the broader market is indeed stabilizing like I think it is. Fundamentally, MBC is ultimately positioned to grow over time being tied to growing end-markets – residential construction and R&R – and I prefer their competitiveness to AMWD.

Sales: Stable

I spent time discussing AMWD’s business and MBC is their peer with a relatively similar sales composition. Based in Ohio, MBC manufacturers, well, cabinets across 20 manufacturing facilities – most of which are in the U.S. – with an accompanying 21 distribution facilities they push those through. Compared to AMWD, MBC tends to under-index to the Builder channel, with around 11% of sales coming from this customer base. However, they tend to over-index to the dealer and distributor (D&D) channel with it comprising 53% of sales, and then the Home Center (Retailer) channel comprising the remaining ~36% of sales. And product-wise, they sell across the full spectrum of cabinet types, from stock to semi-custom to full custom/premium.

Q1 2024 sales came in at $638M, down nearly 6% from the ~$677M they posted in last year’s Q1. And in Q4, they posted $677M in sales, so we’re looking at a similar decline of 6% on a sequential basis too. This sequential trend catches my attention because as I wrote about in the AMWD write-up, it appeared that the industry as a whole tends to have a seasonal uplift in calendar Q1 thanks to the Builder channel seeing a seasonality benefit. Although, versus AMWD, MBC has much less Builder exposure, so they’re understandably going to receive less seasonal benefit, but it still makes me wonder if MBC’s sales softened.

If we break this out, in Q1, sales for the Dealer/Retailer/Builder channel were $315M/~$243M/~80M. Unfortunately, however, thanks to the reclassification of sales by segment in the FY23 10-K, we don’t know precisely how sales came in for Q4 by channel, which obviously then makes it hard to evaluate the sequential trend. But based on their commentary, however, I think we can reasonably infer that their Builder channel indeed saw an improvement in sales sequentially, and it was their R&R exposure – Dealer and Retail channels – that offset sequential sales growth on the Builder side:

“Our customers servicing the U.S. single-family new construction market, we saw demand increase year-over-year, high single digits in the first quarter. Demand trends improved across multiple regions with large production builders continuing to outperform other segments of the market.

…

As for our dealer and retail customers who primarily service the repair and remodel market, demand continued at a similar pace to the fourth quarter of 2023. On a year-over-year basis, we saw demand decline high single digits in both our retail and dealer channels as customers continue to note lighter-than-usual foot traffic and extended decision lead times. This was in line with our expectations for this portion of the market as consumers remain hesitant to make large ticket purchases given general macroeconomic uncertainty. Those who are willing to commit to larger purchases are being more thoughtful about total project costs and choosing fewer features in their order.”

Let’s unpack this assumption – i.e., that Builder grew while R&R channels declined. First, similar to AMWD, we need to recognize that on a year-over-year basis, there is some pricing headwind, apparently to the tune of ~600 bps such that when we adjust sales for this, volumes were flat year-over-year. Behind this trend, this is primarily reflecting the effect of trade downs reducing ASPs – across both new construction and R&R channels – as consumers became more cost conscious, but there were also some selling price reductions from increases in promotional activity, particularly on the D&D side which is where they over-index.

Did pricing worsen on a sequential basis too? It’s hard to tell. My sense, however, is that there was maybe a little bit of further decline into Q1, but not much. I don’t have quantitative evidence; I’m simply inferring from their tone, and comments about 2024’s guide contemplating the “the continued effect of trade downs – across all channels – and a more normalized pricing environment, including customary promotions.” I’d note, however, that AMWD has been talking about their promotional intensity being relatively similar year-over-year and not worsening sequentially, so that wouldn’t be totally consistent. But in any event, for MBC, it does appear that prices may have been something like a 50-100 bps headwind sequentially – something low as pricing more broadly has seemingly stabilized, but not necessarily o.

What this means for volumes then is that while maybe they were flat on a year-over-year basis, they were implicitly down still in the mid-single-digit range sequentially, reflecting the dichotomy noted earlier – i.e., Builder up and R&R channels down. As I noted earlier, my initial suspicion was that they were underperforming on a seasonally-adjusted basis, but that appears to be the wrong assumption. For one, if we look at results on a year-over-year basis, sales declined 12% year-over-year in Q4, so the decline of 6% today is certainly an improvement, and they’re implicitly bucking the seasonality of the comparable 2022/2023 period (which also reflect a decline). But then if we look at FBIN’s old filings (pre-spin) for their 2019 results, they posted ~$625M in Cabinet sales in Q4 2018 and then $573M in Q1 2019, a ~9% decline. And the same thing is reflected in the Q4 2017 to Q1 2018 period, with sales trending from $626M to $557M. In other words, then, perhaps AMWD is merely outperforming and that MBC’s present sales trend, as reflected by the year-over-year growth rate improvement, is indeed seasonally-normal. In fact, based on their historical seasonality, MBC could actually be performing better than typical seasonality.

From what I can tell then, the market appears to be relatively stable then today based on seasonally-adjusted sales trends. Of course, sales are down year-over-year from price – which mostly reflects a softened market – but as I talked about in the AMWD write-up, we can infer more broadly that demand is not deteriorating materially anymore. Although, you do need to segment this – Builder is outperforming the R&R side right now.

In any event, AMWD’s results do make me wonder whether MBC’s sales declines were entirely market-related or whether they lost some market share. For instance, if we look at AMWD’s sequential results, for the Dealer/Retailer/Builder channel, sales sequentially increased ~10%/~9%/~5%. Or, in other words, while both MBC and AMWD seemingly experienced similar Builder sales growth, AMWD clearly outperformed MBC in the R&R channels with high-single-digit growth whereas MBC likely declined for, again, what is seemingly just normal seasonality. But what this means is that AMWD very well could have taken market share here.

Thinking about the Retailer channel for a second, it’s indeed plausible they took share directly from MBC. If we zoom out, there are really 3 retailers the industry sells through – there’s Lowe’s, Home Depot, and then Menards in the North to Midwest. Both AMWD and MBC service these retailers and, collectively, service the majority of business for those retailers. AMWD claims to have around 27% of the Builder channel market, for instance, and when I look, then, at MBC doing $242M in quarterly retail sales versus AMWD’s $174M, that more or less implies that MBC has around 40% share, for which collectively, means that both AMWD and MBC supply around 65% of the market here. Thus, if MBC was indeed losing market share, it’s not unreasonable to think it might have gone to AMWD.

But let’s just say, hypothetically, that AMWD did take some market share – I don’t at all feel confident that this is going to be an ongoing trend. If we just first contextualize this from a value proposition standpoint, there’s nothing really structural that’s changed – that I can tell – which would support this, neither from AMWD’s end or MBC’s. Instead, what very simply could have happened is that perhaps on one line or category, AMWD was a little more aggressive in winning it at a retailer when they do their product line reviews – this dynamic has been documented historically.

Taking that and then zooming out to evaluate longer-term performance, MBC has outperformed AMWD. I mean, first, if we just look at the past 12 months, both MBC and AMWD are down 6%, so that immediately starts to disconfirm the notion that AMWD is a structural share winner. But if we zoom out a little further, MBC has – organically – grown sales by ~14% since 2019 versus ~6% for AMWD. Indeed, one thing that was apparent from having followed both businesses over the past year is that MBC vastly outperformed as an organization during the dynamic period post-COVID amid inflation and changing demand conditions. As one example, AMWD was mightily behind in getting price passed through whereas MBC was not, hence the margin dichotomy over this period.

So, I don’t think it’s prudent for the market to at all assume that AMWD is changing direction versus MBC and that we should expect them to take share going forward. While that could be the case today, I don’t think it continues, nor do I think it’s all that material. Instead, I find it reasonable to believe the market is stabilizing at large and that MBC could see growth going into the end of the year. They’re guiding for FY24 sales to see a “decline of low single-digit percentage to flat,” which would imply their FY23 sales of $2.726B to come in around $2.7B assuming a 1% decline. That’s reasonable – assuming Q1 sales amount to 23-24% of full-year sales (per 2018 and 2019 seasonality), that implies full year just a smidge over $2.7B at 23.5%. But frankly, I wouldn’t be surprised if they exceeded this guide based on Q1 trends.

Now, for modeling purposes, we do need to add a final adjustment – MBC acquired Superior Cabinetry in July (post-quarter), so that’s going to add sales on top of what they guided. They don’t disclose how much revenue Superior generates annually, but we do know that they posted $58M in LTM EBITDA. Assuming go-forward EBITDA looks more like $50M to account for the industry softness since (on an annualized basis) and margins look like MBC’s corporate average of ~12.5%, we’re looking at ~$400M in annual sales. So, for modeling purposes, I’m assuming normalized annual sales come in at ~$3.1B.

In any event, for the years ahead, my conclusion isn’t dissimilar to what I concluded for AMWD – both businesses have reached maturity and based on recent trends, expect it to remain that way. That is, there’s de minimis untapped market demand – sales changes will, by and large, be dictated by macro conditions and market share – there’s little internal opportunity to grow sales irrespective of market trends. To this end, again, I think a GDP+ rate of ~2-3% is reasonable over a full cycle.

Margins: Normalized

Margin-wise, EBITDA margins came in at 12.4% (~$79M), an increase of 40 bps compared to 12% in the prior year Q1, although down 30 bps from the 12.7% margins posted in Q4. I tend to contextualize this as a fairly solid margin performance, all considered. From the top, it’s certainly possible, per my earlier writings, that some of the margin degradation on a sequential basis was driven by a degradation in contribution margins as we’ve talked about with pricing being potentially down (which is definitely the case on a year-over-year basis). And on the other side of the same token, consistent with this and consistent with AMWD’s comments, they’re seeing some of their input costs start to rise lately:

“We’re seeing some commodities increase in material. It’s sort of similar to the way it was prior to COVID. You have, what I’d call, some normal inflation in certain categories. And obviously, we still have labor inflation that has not changed. And so we’re reacting to that the way we normally do, which is evaluating our pricing every quarter to adjust to factor in if anything moves outside the boundaries of what we can overcome through productivity and other things.”

Now, per the above, they’re talking about pushing this cost inflation along via price, so one might think that these are simply being price through to maintain margin, but there’s a lag between when price and costs are respectively recognized – which is more or less immediately for costs, and then prices are recognized when the inventory flows through. All told, this amounts to generally around a 60-90 day lag, which is basically how long it takes the inventory to flow through. So, in the meantime – for Q1 – there could’ve been a slight contribution margin degradation from a timing mismatch here, even if their updated pricing does reflect updated costs.

From an operating leverage standpoint, it’s a mixed bag of impacts. On the one hand, from a sales perspective, sales are down ~6% sequentially, so that immediately engenders operating deleverage. Holding everything constant, there are various fixed costs, particularly at the SG&A line in the form of salespeople expenses and fixed back-office staff, but even at the COGS line too in the form of labor utilization, which is a material cost for them. Consistent with this too, gross margins were ~33% in Q4, compared to ~32% in Q1. And also, versus low-double-digit EBITDA margins, they called out targeting 20% incremental EBITDA margins, reflecting just this leverage. But all told, this was naturally a headwind sequentially.

However, with that in mind, if they were to post 20% decremental sequentially, they would’ve been about $1.5M lower, so one could have reasonably expected margins to come in lower in Q4, all else equal. Or, said differently, there was some SG&A leverage partly offsetting the gross margin decline. To this end, reported SG&A declined from ~$152M in Q4 to ~$138M in Q1, trending from 22.5% of sales to 21.6% of sales, a ~110 bps improvement (this is reported, not adjusted SG&A, so the bridge to EBITDA won’t perfectly match dollar-wise). Part of this is reasonable as they expense outbound freight and sales commission which’ll come down on a dollar basis, but like COGS, there are various fixed costs that won’t.

Evidently then, they’ve been taking some costs out to offset this deleverage. However, I guess I’m a little surprised to see this trend because they’ve concurrently been making investments. For instance, on the Q4 call, they talked about making $15M of “investments” in SG&A in FY23, and furthermore, these investments were seemingly growing into Q4 as they were calling out a sequential increase in Q4 SG&A because of it. To this end, it’s not unreasonable to think there may have been some offsetting savings, but those were reported at the gross margin level, partly offsetting the negative impacts they were seeing there. Indeed, they attributed some gross margin tailwinds year-over-year from “cost savings from our strategic initiatives and continuous improvement efforts.”

So, when I try to explain this, I definitely get the low-single-digit decline in SG&A on a year-over-year basis – between labor inflation and those aforementioned investments, it’s relatively understandable to see how, despite the 6% sales decline year-over-year, their SG&A still grew. However, on a sequential basis, it’s not so clear. But ultimately, whether it is or isn’t, it’s a directionally good sign, although not necessarily a trend I’d expect going forward. For one, they’re going to continue making more investments – which I’ll cover here shortly – but by and large, their cost profile is largely normalized at this point – i.e., suitable for today’s demand.

Zooming back out, there is some negative mix impact to the sequential margins too, which makes me wonder just how much cost savings benefits there were to offset the headwinds from the remaining variables. But either way, the Builder channel tends to have the lowest margins overall and thus, with Builder sales performing better than the R&R channels, this should have been a slight headwind. How much is always hard to tell, but I think it’s fairly minimal.

On a forward-looking basis, it certainly could be the case that gross margins experience further degradation depending on how impactful the cost inflation is. But by and large, as they’ve demonstrated over the past few years during higher-than-average inflation, this is a business – and market – that can pass that inflation through, so I don’t have much concern here, particularly given that the cost environment isn’t totally abnormal or rampant. I also contextualize gross margins as largely normalized today, competitively speaking. And the same more or less goes for mix – seasonality can influence mix, but their channels should grow relatively similarly.

The SG&A (operating expense) line is a little less clear. From a sales perspective, if I’m right, and they do indeed achieve $2.7B in annual sales or ~$675M quarterly (excluding Superior), that would be nearly $40M higher than the quarterly sales they’re posting today (for seasonal reasons). As such, I would expect some sales leverage in the near term when I think about margins on a full-year basis.

Now, some of this is just seasonality in expense recognition – i.e., Their margins fluctuate quite a bit during the year irrespective of sales. For instance, in Q1 last year, they posted 12% margins of ~$677M in sales, but then in Q3 2023, they posted 16.2% margins on nearly the same sales level. Specifically, it appears that Q1 expenses overstate the full-year average, so if think about them posting ~16% margins from Q2-Q3 on average, and then ~12.4% here in Q1, that averages out to ~15% margins (~$405M) on ~$2.7B in sales.

From an expense perspective, however, those aforementioned investments aren’t expected to stop – they’re expecting to make further “tech” investments, most of which will flow through SG&A and for which they expect it to amount to $20M for the year. That’s about $4-5M a quarter – some will be capex spend – but from what I gather, some of this is indeed one-time spend that won’t recur. It’s not clear just how much – maybe half? – but I think it’s reasonable to expect only a percentage of this to be recurring. And furthermore, there should be offsetting benefits, otherwise what would be the point of the investments? So, for simplicity, I’m merely assuming that $2M sticks per quarter going forward, implying annual EBITDA of $397M on $2.7B in sales, or 14.7%.

As a cross-reference, they’re guiding for $385M in adjusted EBITDA for FY24, which would amount to ~14.25% EBITDA margins at the midpoint on their guided sales, so we’re clearly in the ballpark here. We don’t have perfect insight into the anticipated puts and takes around their investments, so I feel more comfortable probably using their guidance for modeling purposes. However, per the above math, it wouldn’t be unreasonable – to me – if they beat this. I’m not expecting material offsetting savings from the investments as they’re seemingly dealing with more customer experience areas than cost takeouts, so if there are “savings”, it’s unclear that they’d come relatively soon.

Now, the final thing we need to do is adjust for the Superior Cabinetry deal, and luckily, their guidance doesn’t include this acquisition as it was post-quarter, so we don’t have to do a bunch of work backing it out. Per the 8-K, they paid ~9x EBITDA, implying EBITDA of ~$58M on a TTM basis. Of course, seasonality isn’t immaterial, but for simplicity sake, assuming ~$14.5M per quarter, that would imply Q1 EBITDA of ~$93.5M. We don’t know what their margins look like just yet, but what’s interesting is that they think they can capture synergies of $28M, or ~$7M on a quarterly basis, which would be a ~7.5% increase to their earnings power.

“We expect to deliver annual run rate cost synergies of $28 million by the end of year 3 following the close of the transaction. These synergies will come from areas including procurement, facility optimization and overhead expenses, and we have strong confidence in the delivery of these synergies.

In year 1 and 2, following close, we expect to deliver approximately $10 million and $24 million in cost synergies, respectively. Beyond these cost synergies, we also anticipate commercial synergies across the company’s complementary channels and product lines, although these benefits and opportunities are not included in the figures on this page.”

So, we’ll see. It’s a 3-year journey for them. But either way, if we think what a normalized FY24 might look like then – i.e., assuming Superior was purchased on January 1 – it’d seemingly imply ~$435M in annual pro forma EBITDA (I’m assuming only $50M in run rate EBITDA for Superior to adjust for lower present demand conditions – that is, what their next 12 months EBITDA might look like). This, then, is probably a good earnings power base for us to value them off of going forward on $3.1B in sales.

Valuation: Close To Fair Value

Versus AMWD – whom I may be unfairly critical towards based on recent moves – I’m more comfortable with MBC’s capital allocation on a go-forward basis. If we look at capex, it’s consistently been running in the mid-$50M range for the 3 years, and in Q1, they spent another $7M. For FY24, they’re guiding for $60M in spend, which bakes in “accelerated investment”:

“As Dave mentioned on our last call, we made the decision to accelerate investment in the business, specifically in our tech-enabled initiative, and we saw this higher investment spending continue in the first quarter. We plan to further ramp our investment spending, and we still expect 2024 capital expenditures to be in the range of $55 million to $65 million.”

From what I can gather and contextualize, the mid-$50M level is about a normalized spend – i.e., capital that needs to regularly go towards maintaining their manufacturing facilities and equipment plus making some competitive-related investments. However, sure, one might reasonably point out that those “tech” investments won’t continue forever. And such investments are really across the board too from manufacturing to internal (finance) to channel (customer) – it’s not just one area. For instance, MasterBrand Connect is their own platform designed to create seamless transactions and management for their customers (dealers and distributors, for instance). As they point out, these tech investments are helping them be more efficient in realizing just how much inventory is appropriate, as well as improving collections and gaining customer insights.

In terms of what this means for capex, it’s hard to say precisely. The number they’ve thrown out there is that about $20M is being allocated to these tech initiatives, suggesting that without such spend, normalized capex – to maintain equipment – might look something like $40M. Maybe so. But for one, they’re telling investors that most of that $20M is booked in SG&A, not the capital expenditures line. And then two, I think it’s more prudent anyways to think these investments are not just one time in nature, but recurring to maintain competitiveness. So, for those reasons, I feel more comfortable assuming capex remains at this $60M level, which would amount to ~2.2% of sales, slightly below the ~2.5% AMWD spends.

There were various one-time transactions post-spin, but the rest of their FCF had primarily – and attractively – gone to debt repayments with some share repurchases. However, post-Q1, they decided to do something big, acquiring Supreme Cabinetry for $520M, amounting to ~9x TTM EBITDA on a pre-synergy basis and ~6x post-synergy ($25M) basis. This is obviously a sizable purchase for a business with $2.4B in assets pre-acquisition, but it’s not necessarily a poor use of capital.

9x EBITDA is probably higher than I personally would be comfortable underwriting, but it’s not awful should the market indeed stabilize and further, they indeed extract some synergies from the deal. Will they capture all? It’s hard to tell. However, one, it’s unreasonable to think they can capture some given simply just overlapping costs and winning new customers that legacy MBC can begin selling through. And then two, Dave and the rest of the team have shown to be solid operationally, so maybe while I don’t expect them to capture all, I do feel fine thinking they’ll capture some. So, if they got this down to ~7x, after interest, capex, and taxes, this can turn out to be a solid, double-digit return.

From a capital structure perspective, they issued $700M 8-year notes (due in 2032) post-quarter at a 7% interest rate to fund the acquisition, which amounts to a favorable deal. They’re currently paying just over 8%, net – SOFR plus low-2% – on their existing debt, so this should save them a million or so in annual interest expense. But all considered, so far, they’ve demonstrated decently thoughtful capital allocation moves. I don’t expect them to do another acquisition, but instead prioritize debt repayments, making capital allocation a lower-risk angle here.

Putting this together, at today’s price of ~$15/share with 127M basic S/O, that’s a ~$1905B market cap. Minus Q1-end cash of $154M, adding Q1-end debt of $708M, and adding ~$690M for the issued notes (after fees), that gets me to an EV of ~$3.149B.

If we sum up the earlier analysis, I get sales of $3.1B and EBITDA of $435M, which more or less represents their FY24 guidance on a normalized, acquisition-adjusted basis. SBC isn’t added back (good for them), but subtracting D&A at 2.5% ($77M), interest expense of $105M – which conservatively assumes no debt is refinanced – and taxes at 25%, this gets me to ~$190M in net income. Adding back our D&A and then backing out capex at, say, 2.2% of sales ($68M) – we don’t know Supreme’s capex just yet – that spits out FCF of ~$199M.

What’s this worth? Well, I valued AMWD at 14x, but I’m comfortable assuming 15x for MBC to give credit for better operational execution and competitiveness, and less capital allocation risk. While a premium, this still implies a long-term EBITDA growth rate of ~3.5% thereabouts, something that doesn’t put them out of range with what’s achievable for them in my opinion. That implicitly amounts to a market cap of $2.985B. Discounting back to today (half a year) gets me to a present value per share of ~$23/share, which compares with ~$15/share today.

Conclusion

All considered, I like MasterBrand and am happy to follow them over time – it’s a simple, relatively easy-to-understand business levered to a growing, albeit cyclical, end-market. Fundamentally, while I don’t contextualize there being much more room for growth outside of what the market grants given how mature the industry is, the market isn’t pricing really any growth over time notwithstanding the market’s history and what appears to be a stabilizing market. Furthermore, I do see MBC as better operators than AMWD and would probably prefer them as a result. All told, I think investors can earn decent returns at today’s prices should those conditions hold.