- Will the company see continued strength in its subsidiaries to drive future revenue and earnings growth?
- How is Griffon valued as compared to the industrial goods industry?
- How well will the stock perform as compared to S&P 500 over the next two years?
Griffon Corporation (NYSE:GFF) is positioned well to be an outperforming stock. It is diversified across three main subsidiaries that it manages in the industrial goods industry. Griffon's subsidiaries (The AMES Companies, Clopay, and Telephonics) offer home and building products, plastics, and communication products in the U.S. and internationally. The company should perform well as the housing market recovers and as a result of a growing backlog for Telephonics. The company is positioned well in terms of valuation and growth to outperform the S&P 500 over the next two years.
We have heard most companies explain how the cold winter negatively impacted their revenue and earnings, but Griffon actually benefited from the cold as the company sells snow shovels and related non-powered items in its Home and Building Products business. This business is divided between two subsidiaries: AMES and Clopay Building Products. In addition to snow tools, AMES also offers a variety of non-powered landscaping products such as shovels, spades, scoops, rakes, edgers, wheelbarrows, planters, striking tools, pruners, garden hoses, and lawn accessories. Together, AMES and CBP comprise 33% of Griffon's total operating profit. The snowy winter resulted in an 18% revenue increase for AMES for Q2 2014.
The key to the success of this business is due to the large retail reach among a large network of stores. These products are sold in many of the major retailers such as Lowe's (NYSE:LOW), Home Depot (NYSE:HD), Wal-Mart (NYSE:WMT), Costco (NASDAQ:COST), etc. This wide reach allows Griffon to achieve success through a large network of stores in the U.S. and internationally. Some consumers may seek out Griffon's specific brands, while many consumers will have plenty of exposure to the products in numerous stores and purchase them based on the wide availability and based on the look of quality of the products. The products also sell because they are of high quality. When consumers see the AMES name, they can be confident that they're purchasing a product with a quality that can get the intended job done.
Clopay Building Products (CBP) is the other subsidiary in Griffon's home and building products segment. CBP achieved a 1% revenue increase for Q2. CBP is the largest manufacturer of residential garage doors and one of the largest manufacturers of commercial sectional doors in the U.S. CBP sells its products in Home Depot and Menards. Clopay has the distinction of being the only residential garage door brand with the Good Housekeeping Seal of Approval. This distinction provides consumers with a good sense of trust and reliability over the competition.
With the housing market in a multi-year recovery, I think that AMES and CBP are likely to achieve incremental revenue increases, which should drive gains in earnings. As more consumers purchase homes and as new ones are built, the demand for Griffon's home and building products should increase. I would expect AMES and CBP to produce gains in the mid-single digits for this year and again in 2015.
AMES is doing some restructuring that is expected to result in $10 million in savings for 2014 and another $10 million in savings for 2015. The restructuring involves the closing of some manufacturing facilities to consolidate the operations into two Pennsylvania locations. The savings will allow for a significant boost in earnings over the next two years.
Griffon's Telephonics subsidiary did report a 14% year-over-year decline in revenue to $104 million for Q2 2014. However, the decline was only due to a special situation where the quarter was compared to Q2 2013 which benefited from $13.2 million of electronic warfare program revenue. This revenue was not available in Q2 2014. I think that Telephonics should do well as this subsidiary offers products that are funded more generously than other areas of defense spending. For example, Telephonics specializes in advanced electronic information and communication systems. This includes things that are important for security and safety in the current global environment such as: Integrated Homeland Security systems; logistical support for aircraft intercommunication systems, radar; air traffic management services that support air and missile defense systems; and other surveillance & reconnaissance systems. These offerings typically remain well-funded due to the sensitive nature of security. With threats of terrorism remaining on the table, Telephonics should perform well over the next few years.
Telephonics should experience strength for Airborne ISR equipment, continued demand for upgrades, and growth in new projects such as the U.S. Navy's Fire Scout program. This subsidiary's backlog has increased 9.5% since September 30, 2013 to $486 million. Telephonics comprises 39% of Griffon's total operating profit. The backlog is strong, but Telephonics is still subject to government spending, which can be difficult to predict. Overall, I think that the products/services from Telephonics are among the least likely programs to be cut by defense budgets as they address terrorism and political unrest, which remains a constant threat in the world today. I think that a low single-digit gain is a reasonable forecast for Telephonics this year.
The last of Griffon's subsidiaries is Clopay Plastics, which comprises 28% of total operating profit. Revenue for Clopay Plastics increased 7% to $152 million in Q2. Clopay Plastics produces functional specialty plastic films for health care and industrial uses. Some examples include moisture barriers for diapers and feminine hygiene products; protective barriers for single-use surgical gowns, drapes, and equipment covers; and packaging for hygienic products, house wrap, and additional products. More than half of the plastics business is in Europe and Latin America, so the success of this business is significantly tied to the economic health of those regions. Europe is achieving small but positive gains in GDP, while Latin America has posted volatile results for the past few quarters.
Clopay Plastics is likely to benefit from the increasing use of disposable diapers in developing countries. Another positive trend is the increasing immigration in major global economies. These trends are contributing to increased demand for innovative cloth-like, breathable plastics, laminated products, and printed products. With that in mind, this subsidiary is poised to produce increased revenue over the next few years. I think that gains in the mid-single digits are likely for the plastics business in 2014. This subsidiary is also improving its operations to increase its margins to over 10% with a goal of continuing its gains from there. This should lead to solid increases in EBITDA.
Griffon is undervalued as compared to the General Building Materials industry and the S&P 500. The stock took a 30% hit this year after reaching an overbought level. The stock had a good run since the end of 2011, so it was due for a sizeable correction. However, there wasn't much negative news to trigger the sell-off. Investors may have overestimated the impact of the cold winter weather on the business. Granted, the doors business took a hit during the cold weather, but AMES performed well on sales of its snow tools. I think that the selling is overdone and that investors can get in on the stock at a nice valuation.
Here's how Griffon compares with the industry and the S&P 500:
Price to Sales
Price to Book
Price to Cash Flow
We can see from the chart that Griffon is undervalued as compared to its industry and the S&P 500. Griffon's low price to sales ratio shows that the stock is priced attractively in relation to sales. If the company were trading at the industry average price to sales ratio, the stock would be over $41 instead of the current price of $11.
The stock is also priced just below its book value per share, while the industry and S&P 500 is trading over 2X their book value per share. This shows that the stock is priced attractively as compared to its balance sheet. Griffon does have 2.8 times more current assets than current liabilities, which demonstrates that there should be no issues in paying off short-term debt. The company also has 1.57 times more total assets than total liabilities, which shows that Griffon is in good shape over the long term.
Griffon is also attractively valued in terms of cash flow. The company produced $90.8 million in operating cash flow for the past twelve months. This cash flow is managed well as $23 million was left as free cash flow after capital expenditures of $68 million. Griffon used a portion of this to pay shareholders a 1% dividend. With its price to cash flow below the industry and S&P 500, Griffon's stock has room to run higher.
Further reinforcing Griffon's undervaluation is the fact that the company achieved nearly $2 billion in revenue for the past 12 months, but the market cap remains at only $546 million. Griffon's enterprise value is $1.28 billion, which is the theoretical takeover price for the company. This reinforces the idea that the stock has plenty of room to run.
The AMES business is subject to seasonality and the demand for its products is influenced by the weather. For example, the lack of snow could reduce demand for AMES' snow tools in the winter. Nice, warm weather in the spring/summer is conducive for its garden tools/products. If the spring/summer months have more rain and storms than normal on the weekends during the peak gardening season, it could have an adverse effect on sales of garden tools. The Clopay doors business did experience a slowdown in sales this past winter because of the cold winter. The doors business typically performs well during mild weather.
Telephonics depends a lot on government spending, which can fluctuate based on budget decisions. However, as I mentioned earlier, the surveillance and security products/services that Telephonics offers typically remain well funded with global unrest and terrorism still lurking.
The plastics business is susceptible to resin pricing as an input cost. The company will have to either pass on any future increases in resin prices or eat some of the price increases, which could reduce sales and profitability.
Likely Scenario for the Stock
Given that the stock is undervalued as compared to the industry and the S&P 500 and taking the performance of Griffon's subsidiaries into account, the company should achieve strong stock gains over the next two years. On the top line, Griffon should achieve a 3% increase in revenue in 2014 and about a 4% increase for 2015 based on the expected sales of the subsidiaries.
On the bottom line, Griffon's efforts to improve operations should produce significant increases in gross margin. Plant consolidations and other operating efficiencies will drive the gain in gross margin over the next two years. The gross margin should increase by about 50% annually for the next two years based on the improved operations. Taking the revenue and gross margin gains into account, earnings should grow by about 55% this year and next year. EPS for 2014 should be about $0.45 with 2015's EPS growing to about $0.70. This growth and the undervaluation should allow the stock to easily outperform the industry and the S&P 500 over the next two years. I see a reasonable 30% to 50% annual upside for the stock for 2014 and 2015.
The downside is protected by Griffon's dedication to buying back stock. On May 1, 2014, the company authorized a new $50 million share repurchase plan. There is still about $4.5 million remaining on the older repurchase authorization that originated in August 2011. There has also been a lot of insider buying among various directors, thus showing conviction that the company is valued attractively. The buyback itself should help increase EPS and reduce the amount of shares outstanding. The result of this should put a floor under the stock price and protect the downside. I don't know if GFF will be a 'BFF' (best friend forever) for investors, but it does look likely that the stock has a high upside potential with low downside risk for the next two years.
Disclosure: I 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.