Fortune Brands Home & Security, Inc. (FBHS) is a solid long-term investment in the home improvement market. The company leverages its wholesale customer base as well as the vast presence of segment retail leaders Home Depot (HD), Lowe’s (LOW), and Menard’s to distribute its products. The company relies heavily on key strategic acquisitions in order to “drive outperformance in an environment of more moderate growth” but is also exhibiting strong organic growth in some core segments.
At the current price and valuation, I believe Fortune is still a good investment even though the stock has appreciated nearly 70% since the start of the year and more than 30% in the last three months.
Fortune’s largest revenue stream is wholesale, which accounted for nearly half of the total revenue in Q3 2019. Home Center retailers, the second-largest sales channel, accounted for about a quarter of total sales for the period.
Amongst these channels, the fastest-growing one is the Home Center retailers segment, which grew 11% on a year-over-year basis compared to Q3 2018. The wholesale segment also grew, but only by about 3% over the prior period. The drag during the quarter was from the segment containing smaller eCommerce customers and merchants. These revenues are only disaggregated for the U.S. market, which grew at an overall rate of about 5% during the quarter.
International sales have been showing some momentum, and Q3 2019 revenues for the segment grew by 8%. The segment itself now contributes about 17% of total revenues.
As I mentioned earlier, a lot of the company’s growth over the years has been through strategic bolt-on acquisitions that have, so far, helped the company to grow its top line as well as improve profitability.
The most recent acquisition of Fiberon in September 2018 is now a year old and will start contributing to organic revenue growth from Q4 onward. To that end, the company is expanding coverage and distribution of the brand’s products in the West and Southwest regions of the United States.
But even excluding Fiberon’s revenues and forex impact, Fortune’s Q3 2019 revenues grew 3% on an organic basis. In this current environment of slowdowns in housing, tariff pressure and overall market softness, that’s not a shabby organic growth rate, especially in a fragmented market where even the largest players don’t have that much pricing power.
This past quarter, growth was hampered by Cabinets, Fortune’s largest reporting segment, which showed an interesting trend. According to incoming CEO Nicholas Fink:
“sales of value price products in the U.S. were up mid-single digits while sales of mid to higher price point products were down mid-single digits.”
That means Cabinets needs a shift toward value products that make revenue growth possible. And all hopes are pinned on the new President of the division, Dave Banyard, to deliver on that mandate.
The company has shown a high level of consistency and accuracy at finding the right brands to acquire that subsequently become accretive to revenues as well as margins. In addition, it is actively (if not proactively) addressing issues of greater immediacy such as a core business segment with flat-to-negative growth. I see no reason for that to change in the foreseeable future.
The company has been able to maintain its normalized net income at the +7% level for the past three years. During the same period, EBITDA margin has remained above the 15% level.
In many cases, companies tend to aggressively price-cut the competition in order to grow revenues. That’s usually not sustainable in the long run. Although Fortune has been seeing margin contraction since early 2018, recent quarters look relatively stable. In addition, levered free cash flow margin as of September 30, 2019, was back above 7% after six quarters.
Source: SA Premium
Balance Sheet Health
Fortune’s cash position is about as safe as can be. According to CFO Patrick Hallinan:
“With a longer duration across our debt structure at attractive interest rates, we have the liquidity to ensure the flexibility to invest for growth both organically and inorganically.”
That “flexibility to invest” is now going toward pivoting the Cabinets business, expanding Fiberon’s reach, heavily marketing the reborn Moen brand, and continuing to look for M&A opportunities.
Fortune has a favorable debt profile with healthy cash flows to adequately service its well-structured indebtedness. It also returns value to investors through a ‘measured’ dividend payout with a current forward yield of 1.4%.
The impression you get when you look at how carefully Fortune spends its money is that the company is financially very conservative. That can be an invaluable asset when you’re facing growth challenges in your largest revenue segment but also have to balance investment needs against continuing shareholder returns and staying ready for potential acquisitions.
As such, the key outgoing members of senior management have done a fantastic job of steadying the ship in a challenging environment, while incoming members bring the exact talent needed to shake things up in the core Cabinets business and take the company to the next level of growth.
At this price point, the valuation multiples aren’t over the top. With a forward earnings multiple of around 17, it’s par for the course in terms of the sector median.
With new management at strategic points in the organizational structure and a clear focus for the future, I think this company is a little undervalued right now. It might not make sense for dividend investors, but if you’re looking for total returns – capital appreciation with dividend growth – then the stock is definitely worth a closer look.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.