By Brian Sozzi
Thursday, Whirlpool (WHR) taught investors two important lessons. The first lesson is that investors should pay careful attention to the most obscure mentions in SEC filings for they could have profound impacts (positive or negative) on future free cash flows, dividends and capital expenditure plans. In this particular instance, consider Whirlpool's announcement that it has settled a two-decade-long Brazilian case for $603.0 million, to be paid from available cash in two installments (3Q11, 1Q12). The risk of the judgment going against the company was duly outlined in the latest 10-K. Theoretically, the all knowing market should have priced in an outcome; however, given the stock's negative reaction the market may have been lulled to sleep by a case that began in 1989.
Whirlpool, however, knew better than to not disclose a possible range of outcomes; it in fact set aside a $156.0 million reserve for a judgment in this case, but indicated the final amount could be 2x to 7x greater. At 3.8x the reserve, it was at the low end of the outcome range, but surely no small chunk of change. Management had to balance the risk of having to potentially shell out $1.1 billion against paying now in the midst of volatile global sales conditions. We think management made the correct call as $1.1 billion certainly would have triggered an unfortunate set of events that $603.0 million does not, including:
- Tapping the debt markets, hindering progress on debt reduction in order to restore credit ratings.
- Alter capital expenditure and dividend plans, major no-nos. Note that Whirlpool is a manufacturer that needs innovation in product and investments in efficiency driving initiatives at its plants, in addition to a strong dividend payout at this point in its lifecycle.
Lesson number two for investors to walk away with is to filter out the one-off items from the core trends being realized by the business. In this regard, we are encouraged that Whirlpool maintained its FY11 EPS and operating cash flow targets excluding the settlement charge despite the mixed reads on U.S. housing and industrial production in key developed and emerging markets since the 1Q11 report back in late April. Whirlpool may very well be confirming Best Buy's (BBY) positive sales result in appliances in its most recent quarter, a factor more of price increases by vendors than volume in our view. Additionally, it would appear that Whirlpool has not experienced a new leg down in Europe (17% of sales), which had been a concern of ours, as well as seeing visibility into cost relief in 2H11 amid the commodities sell-off.
Once again we are drawn back to Whirlpool's valuation. Not only does the stock yield 2.6% (stock price is down 25% in the past 52-weeks and Whirlpool hiked the dividend 16% in April), but it trades on starkly discounted multiples relative to peers and historical absolute norms. Although we do not expect a significant acceleration in earnings growth from Whirlpool this year or next, current consensus estimates fail to capture the growth that is possible for Whirlpool amid a cooling in commodities prices, consistent price increases on new product introductions, and ongoing benefits of curtailing excess capacity since the recession. There is a real possibility that Whirlpool continues to aggressively pursue its dividend policy through the use of strong free cash flow generation to bolster the attractiveness of an already undervalued stock.
Above all else, for Whirlpool's leadership position in the appliance industry globally and high barriers to entry, the market should be assigning the stock a richer multiple, notwithstanding the aforementioned inputs to our analysis.