Analysis

This “At Home Revolution” beneficiary is priced for credit problems, Uniform Accounting credit analysis show why markets are wrong

August 19, 2020

The “At Home Revolution” is boosting a wave of companies providing services and products to people staying or working from home more. These companies are seeing increased demand and stronger future outlooks as a result of shifting consumer sentiment.

However, the credit markets have yet to catch up with some of these companies and their ability to pay off debt.

The “At Home Revolution” has been beneficial for today’s company, yet it is still seen as an elevated credit risk.

Below, we show how Uniform Accounting restates financials for a clear credit profile. We also provide the equity tearsheet showing Uniform Accounting-based Performance and Valuation analysis of the company.

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The power of thematic investing is letting a rising tide lift all boats. Like we talked about recently with the Investor Essential Daily on Altimeter, having exposure to an outperforming industry or theme will benefit you tremendously.

One of the biggest trends right now is the “At Home Revolution.” As current government directives confine people to the house, there is more investing and spending on the home.

This at home investment includes increased spending on everything from entertainment options, to online working capabilities, and home security systems.

The home improvement industry is seeing a huge surge in demand. In a survey from Bank of America, more than 70% of Americans have decided to tackle home improvement projects.

Additionally, according to the U.S. Census Bureau, there has been a 16.6% increase year-over-year in seasonally adjusted spending on home improvement.

Consumers are spending less outside of the house due to restrictions, and are focusing instead on their homes. Companies that provide services and products to meet these needs will see strong tailwinds despite the current economic downturn.

Masonite International Corporation (DOOR) is one company poised to benefit from these consumer habits. Masonite designs, manufactures, and distributes doors for both residential and nonresidential buildings worldwide.

As people look for ways to improve their homes, upgrading doors for both security and aesthetics is one area of spend. Masonite has seen strong financial results despite the economic uncertainty, handedly beating analyst estimates the last two quarters.

Despite these huge tailwinds, the market views Masonite as a firm with an elevated credit risk. This is due to the relatively large amount of large term debt the company has taken on.

By looking at the Credit Cash Flow Prime (CCFP), we can compare the company’s cash flows to its outstanding obligations, and measure the real risk of default. Thanks to Masonite’s large cash balance and strong cash flow generation, the firm is at little risk of bankruptcy from its debt outstanding.

Masonite’s cash flows alone will be sufficient to cover all obligations through 2025. In 2026, there is a large debt maturity headwall, but Masonite will have enough of a cash balance to easily meet this need.

In addition, Masonite has a robust 100% recovery rate, indicating easy access to the credit markets should it need to refinance.

Despite all of this, bond yields for Masonite are currently at 5.1%. The market sees Masonite as possibly being unable to pay off its upcoming debt, and has priced it accordingly.

In reality, after looking at the company’s CCFP, it is clear that Masonite is not at credit risk at all. Robust cash flows and a sizable cash build indicate it is easily able to meet all outstanding obligations through 2026.

It is only when investors look past what the market is pricing Masonite’s debt at and do real credit analysis that a company’s credit risk can become apparent.

DOOR’s Credit Risk Remains Overstated; Ratings Improvement Likely Going Forward

Credit markets are overstating credit risk, with a YTW of 4.536% relative to an Intrinsic YTW of 3.106% and an Intrinsic CDS of 280bps. Meanwhile, Moody’s is overstating the firm’s fundamental credit risk, with its Ba2 rating three notches lower than Valens’ IG4 (Baa2) rating.

Fundamental analysis highlights that DOOR’s cash flows alone should exceed all obligations in each year going forward. The firm has no material debt maturities until 2026, which it should be able to service with significant expected cash build. In addition, DOOR’s robust 100% recovery rate on unsecured debt should provide access to credit markets with favorable terms if it needs to refinance, despite its small market capitalization.

Incentives Dictate Behavior™ analysis highlights mixed signals for credit holders. DOOR’s management compensation framework should drive management to focus on margin expansion and top-line growth. Moreover, management members do not have high change-in-control compensation, indicating they may not be incentivized to pursue a sale or accept a takeover of the firm, limiting event risk. However, the lack of leverage and asset efficiency metrics in the framework may bias management to lever up or dramatically grow the asset base, which may limit Uniform ROA expansion and result in reduced cash flows.

Additionally, most NEOs are not material owners of DOOR equity relative to their average annual compensation, indicating management may not be well-aligned with shareholders for long-term value creation.

Earnings Call Forensics™ of the firm’s Q1 2020 earnings call (5/6) highlights that management is confident they can capitalize on opportunities post COVID-19, and that they were positioned well to handle the current downturn.

However, they appear to be concerned about the timing of reopening in the U.S. and internationally, and they may be exaggerating the execution of the MVantage operating system. Moreover, they might be concerned about their ability to meet investment targets and their ability to sustain Architectural EBITDA.

Finally, they may have concerns about their ability to renew their share repurchase program in the near-term.

Given the firm’s healthy cash flows relative to operating obligations and robust recovery rate, credit markets and Moody’s are overstating the firm’s fundamental credit risk. As such, both a ratings improvement and a tightening of bond spreads are likely going forward.

SUMMARY and Masonite International Corporation Tearsheet

As the Uniform Accounting tearsheet for Masonite International Corporation (DOOR:USA) highlights, the company trades at a 14.7x Uniform P/E, which is below global corporate average valuation levels, but around its historical average valuations.

Average P/Es only require low EPS growth to sustain them. That said, in the case of Masonite, the company has recently shown a 5% Uniform EPS growth.

Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.

We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Masonite’s Wall Street analyst-driven forecast projects 38% and 15% EPS growth in 2020 and 2021, respectively.

Based on current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Masonite’s $93 stock price. These are often referred to as market embedded expectations.

The company needs Uniform earnings to grow by 1% each year over the next three years to justify current prices. What Wall Street analysts expect for Masonite’s earnings growth is above what the current stock market valuation requires in 2020 and in 2021.

Furthermore, cash flows and cash on hand are above its total obligations—including debt maturities, capex maintenance, and dividends. Together, this signals low credit and dividend risk.

To conclude, Masonite’s Uniform earnings growth is above peer averages but the company is trading below average peer valuations.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research