American Woodmark (NASDAQ:AMWD) is a company related to housing whose stock price is among the rubble of the recent sell-off. It’s an understatement to say it has a simple business. The company makes cabinets. I think I can understand this. There are certain factors that are appealing – capable of 20%+ ROE in good years, chairman owns 24% of the company, and a net cash position. I didn’t find much of a competitive advantage though as it is heavily reliant on Lowe’s (NYSE:LOW) and Home Depot (NYSE:HD) for 70%+ of its sales. While I don’t think people will find new ways to store their dishes and whatever else people put in cabinets, the heavy concentration on one product line and 2 selling channels makes this a pass. It’s an interesting example of competitive dynamics and insightful for future analysis.
It does not get more boring than this. American Woodmark makes cabinets. That's it. Just wood, screws, hinges, and a coat of paint/veneer/lacquer. There's no secret sauce here. No hidden assets. The owned manufacturing plants are in places like Gas City, Indiana, or Hardy County, W.V., (that means the middle of no where, not even an incorporated municipality). There's really no angle here other than the pessimism surrounding its current industry. The company was originally a division of Boise Cascade in the 1980s until a management LBO.
The company is sort of cheap. It actually canceled the dividend at the end of August as well, which practically had no relative effect since it coincide with a broader sell-off. The company has averaged $0.92/share or $15m in net income over the past 10 years. It’s earned ~$30m in good years and lost ~$20m in bad years. The 10-year average ROE is 7.82%. At a current price of $13/share, it definitely will be worth more in a housing recovery since earnings will be above average. The business has remained cash flow positive due to cutting back discretionary capital expenditures and closing down plants. Bankruptcy risk is arguably minimal due to a net cash balance of $45m ($70m cash, $14m is restricted contingent on the $25m debt from its revolver). Its defined pension benefit plan is underfunded by $38m using an 8% return assumption, so while it won’t bankrupt the company, the financial condition is not as stellar as a passing glance would lead one to believe.
I think this is indicative of several things, but importantly it is a reason to be hesitant about the qualitative attractiveness of the business. Sales growth through the boom came on the back of Home Depot and Lowe’s. There are instances – power tools, white goods, etc. – where people are going to come in and buy exactly what they want, but Home Depot and Lowe’s both have exclusive brands that American Woodmark produces for them. They account for 70%+ of sales, so you tell me who has the upper hand in this relationship.
I don’t like to just say something then hope the facts bear this out. There are certain instances where a concentration of sales isn’t awful. Defense contractors don’t seem to get the short end of the stick, which is a pity for taxpayers but not shareholders. Why do I think AMWD doesn’t have this kind of relationship?
From Fiscal 2002-2006 (April start), revenue went from $499m to $838m, or a 68% increase. During this same period A/R + Inventory went from $66m to $122m or an 84% increase. This slight divergence in revenue growth and A/R + inventory isn’t terribly worrisome on its own, but A/P only grew from $23m to $34m, or a 47% increase.
So working capital didn’t grow in line with revenue, it outpaced it. If you just use the difference between A/R + Inventory and A/P, it went from $43m to $88m, or a 102% jump. So the increased volume AMWD was doing with Lowe’s and Home Depot went solely to the benefit of the retailers. That isn’t it either. AMWD has to install its own promotional displays at these stores and the cost sits on the balance sheet at $6.6m in the most recent quarter. That’s just another indicator that the company doesn’t call the shots.
Another way to look at it is observe that from 2002-2006, the company’s sales went from $499m to $838m, but net income went from $32m to $35m. That it couldn’t eke out more than $3m in profit from $339m in revenue from the scale of producing more cabinets indicates zero operating leverage, which is bizarre. Even when the sky knew no limit, the company didn’t go along for the ride – although it is not suffering from it. The ROE from 2000-2006 actually dropped from 22% to 14% during a housing bubble! So the business quality actually declined since it took a greater investment on behalf of owners to maintain the same amount of profits.
In a prior post on housing, I mentioned how it wasn’t intelligent to simply pluck numbers from historical results and assume they will be achievable in the future. In the past 12 months, AMWD has had $474m in revenue and reported losses of $20m, whereas in 2002, it reported profits of $32m on $499m in revenue. The difference? Even though AMWD and plenty of others have closed down plants and cut down, the market is still weak. Straight from the 10-Q:
the Company’s largest remodeling customers have continued to utilize aggressive sales promotions in the Company’s product category to boost sales. These promotions typically included free products and cash discounts to consumers based upon the amount and/or type of cabinets they purchased. The Company’s competitors have participated vigorously in these promotional activities and the Company has generally chosen to meet these competitive offerings.
In both good and bad times, the market is pushing around AMWD, which has little control over its destiny. In its defense, management is doing a good job operationally. It is turning inventory over 18x annually or every 20 days. Not that it’s in any way comparable, Owens & Minor (NYSE:OMI), a company I’ve written about, turns inventory over 10x and consistently gets awards for being a very efficient distributor. Dealing with a tangible good like cabinets, it's impressive that it achieves this. It is a shame it isn't achieving attractive returns as a result though.
AMWD never maintained steady margins through the boom (declining in fact) so it is difficult to peg a “normalized” earnings range. If the company managed a 10%-12% ROA like it did in 2002-04, earnings could be $26-32m. Even though 6-7x normalized earnings is a generally attractive proposition, the paucity of returns makes the business unattractive to own and the customer concentration creates risks to achieving normalized earnings. The company does have the financial wherewithal to be around for a housing revival, assuming it doesn't lose key customers.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.