Masco Corporation (NYSE:MAS)
November 15, 2011 9:20 am ET
John G. Sznewajs - Chief Financial Officer, Vice President and Treasurer
Timothy Wadhams - Chief Executive Officer and Director
Mark Wiltamuth - Morgan Stanley, Research Division
Mark Wiltamuth - Morgan Stanley, Research Division
Okay. Welcome back. My name is Mark Wiltamuth. I'm one of the members of the retail team, here to introduce Masco Corporation. Tim Wadhams, President and CEO, will be our speaker; and we're also joined with John Sznewajs, CFO. And I'll turn it over to them.
Thank you, Mark, and thank all of you for joining us today. Masco is a global leader in the innovation and marketing of quality building products and services. Last year, our sales were about $7.5 billion, and this year through 9 months, we're down about 1% on a comparative basis. And just to give you a perspective, back in 2006, the same portfolio of businesses did about $12.5 billion in terms of top line, which gives you a little bit of perspective of the impact of the housing downturn on our business.
We think there are a lot of attributes, aspects of our business that are important to understand the position that we have in the markets that we serve. And I'd like to start with scale. We believe that we're the largest manufacturer in the world of both cabinets and faucets, the largest non-commodity supplier to Home Depot, the largest supplier to Lowe's Kitchen and Bath segment, largest supplier of architectural coatings for the do-it-yourself market in the United States and the largest U.S. installer of building products for new home construction.
We also have very strong positions in the distribution channels that are important in our markets. For big box retailers, our size and our importance gives us the opportunity to enjoy relationships from top to bottom in those organizations. And we also have over 1,000 full-time Masco sales service field representatives assisting those businesses.
From the homebuilder's standpoint, we have a unique direct-to-builder model. And as I mentioned earlier, we're a national installer of building products. And for wholesalers and dealers, which are typically smaller customers, our size, our expertise, our financial strength allows us to assist them with things like technologies for displays and training programs for employees.
Our brands are very important across all of those channels. And I'd like to talk about our brands in the context of our operating segments. We report our financial information in 5 different segments. And we'll start with Cabinets.
Cabinets has been one of the 2 segments that we have that has been most impacted by the downturn. But we do have very significant brands in this segment. In North America, KraftMaid. KraftMaid was recently recognized by J.D. Powers as #1 in customer satisfaction. Merillat and Quality brands are 2 of our other cabinet brands in the U.S., and we also have a countertop brand called DeNova. Market conditions in this segment have been very challenging for us. A lot of promotional activity in terms of the big box and dealer-related channels from a retail perspective. And in Europe, we have 2 businesses that also participate in this segment. We've got one in the United Kingdom that serves basically new home construction or public housing. And I think you're all familiar with some of the austerity measures that are in place across Europe, including impacting that particular business. We also have a ready-to-assemble furniture/cabinet manufacturer in Denmark that has seen some significant top line challenges, as well as some commodity cost increases for particle board.
In North America, we combined our retail cabinet group, Builder Cabinet Group, about 2 years ago. And we're seeing some good benefits from that process, given that process, we exited or elected to exit ready-to-assemble cabinets in North America from a strategic standpoint. We also have done some things to commonize the architecture for our Merillat and Quality brands, which allows us more flexibility from a manufacturing standpoint in terms of the ability to make both of those brands on the same chassis or carcass, if you will.
And we've done a reasonably good job of advancing ourselves in terms of the dealer side of the business. That's an area where we've been underrepresented. We've had a dealer advantage program that we've been implementing over the course of the last 3 to 5 quarters that has started to get some very good traction. And we've won some business with large builders. Unfortunately, we're not seeing a lot of activity in either of those channels, but we think we're in a very good position going forward.
We also have a countertop solution that we're very excited about, and we've got 3 new programs in the big box area that are getting some very good traction at this point in time. For Lowe's, we have a kitchen cabinet program, where we can provide granite tops along with the kitchen cabinets. And we can deliver those at the same time, which takes a lot of time out of the process, but also takes a lot of angst out of the decision-making process as well, because we can provide that when people come into Lowe's to look at cabinets and make their selections.
We also have 2 Vanity programs, one at Lowe's and one at Home Depot, which include both the cabinet and the top for the bathroom. And that's kind of important because we're seeing continued reluctance for folks to undertake a large remodel job like a kitchen. We've seen a little bit more activity for lower ticket or less expensive-type projects like a bathroom. And we're really excited about these. These are just getting some traction now, but we think we've got some great upside opportunities with these programs.
Plumbing has been a segment for us that has been one of our star performers over the course of the last 2, 3 years. We've got some excellent top line and also some very good margins in this segment. Two leading brands here are Hansgrohe, which is located in Schiltach, Germany. Hansgrohe has done a very nice job of global/international expansion, penetrating a lot of emerging markets and has seen some significant growth from a lot of project work in that context. The other brand that's very strong in this segment is Delta. Delta is a U.S. brand, North American brand, primarily. And we've made significant investments in terms of strengthening this brand through innovation and additional expenditures and really pleased to communicate that we've been able to increase our unaided brand awareness through last July, for a 3-year period by 11% -- 11 percentage points, and that is a pretty significant improvement. So a lot of good work going on there.
We believe we're gaining share in North America with the Peerless, Delta and Brizo brands. That's sort of a good-better-best kind of selection. We talked a little bit about international growth with Hansgrohe. That continues to go very well. And we're making some investments at Delta to see what we can do in terms of further international expansion with that particular brand.
We're also extending the Delta and Peerless brands to other Masco products, tubs and showering systems. And one thing that's really kind of interesting is we've got, also have a hot tub business with Hot Springs and Caldera brands, which are leading brands in that segment. And we've seen some really nice growth in an area that is highly discretionary and very expensive. But we've been able to take share in large part because we've seen a lot of competitors go out of business. And given our financial strength, we've been in a good position with new product offerings and, certainly, a very strong dealer network.
Really proud that Hansgrohe was recognized by the Federal Republic of Germany for a design award again. They've done that -- been a recipient of that several times. And Delta recently got some significant recognition in terms of an advertising program around their Touch Technology and certainly proud of that. Delta was also recognized recently by the EPA as the WaterSense Partner of the Year. First time that we have gotten that recognition, and again, something that our organization is very proud of.
Our Installation business is the other segment that has been most dramatically impacted by the downturn. We have basically 3 businesses in this segment. That includes Masco Contractor Services, where we install building products for primarily for new home construction. We also have Service Partners, which is a distribution business. We distribute building products as well. We also have a business called WellHome, which is an assessment business for existing homes in terms of energy efficiency and comfort. And we recently started to fold that business into our contracting service business so that we could leverage their expertise in terms of marketing, lead generation, et cetera. They do -- and the retrofit side of the business has been a very, very successful for us over the course of the last couple, 3 years, both through the WellHome initiative as well as through the contracting service business. We've seen some very nice growth there. And we've also seen some nice market share opportunities in terms of our contracting business. We've done a nice job of penetrating the multi-family channel. We've won business with new builders. Again, unfortunately the fact that we're well positioned doesn't necessarily result in a lot of top line at this point in time given the dynamics of the industry.
We further simplified our business by announcing 3 weeks ago in our earnings call that we're going to divest of 4 businesses within this segment. That includes our framing business; a precision framing business; 2 commercial drywall businesses; as well as a millwork business. Those businesses have top line of about $100 million and operating losses of about $20 million from an EBIT standpoint.
Decorative Architectural Products includes our Paints and Stains with the Behr and Kilz brands, very, very strong in the industry. We also provide hardware in this segment for cabinet- and bathroom-related hardware. And as you can see, the margins in this segment continue to be very strong, although we've seen some slowness across the industry in terms of top line.
We continue to leverage our resources to pursue top line opportunities. Behr is an exclusive brand at Home Depot. So in terms of our opportunities to grow, we've been looking at initiatives around the Pro with Home Depot. We have a Direct to Pro program. We also recently launched Kilz Pro-X, which is a new paint formulation directed at the professional painter through the Home Depot, and we set all of the stores, I think, in the May, June timeframe of this year. So we're getting a little bit of traction with that program and certainly have some very high aspirations both ourselves and Home Depot going forward in terms of the Pro opportunity.
Behr was recognized by Home Depot as Partner of the Year in the Paint aisle at their vendor meeting just a month or so ago. Behr also continues to achieve #1 rankings in a variety of products and machines by an independent consumer study. Our Kilz brand incidentally does very well in that same study. And Kilz was recognized in a recent Harris Poll as the highest ranking paint brand. And again, Behr did very well in that poll as well.
Liberty has got some exciting new programs that will roll out over the course of the next couple of quarters. We'll be able to talk more about that. But we have incurred a lot of cost in this segment for those programs related to Liberty, as well as some of the initial costs related to the launch of the Kilz Pro-X program.
This gives you a little bit of a visual of the product that I mentioned a second or 2 ago.
Other Specialty Products for us includes our windows in both North America and in the United Kingdom, as well as hand tools under the Arrow brand. We have the Milgard brand on the West Coast, predominately in California, Washington State, Oregon, Nevada, Arizona. Very well positioned and very highly regarded and significant market share. Milgard, we believe, over the course of the last couple of years, has continued to take share in the western part of the States, in terms of both our repair/remodel market, as well as the new home market. They've also extended their reach into Texas, as well as Western Canada. And we're excited about those opportunities.
We did announce earlier this year that Milgard is exiting the Glass business. That was announced in September. Further simplification of the business and the supply chain, the work that we're doing. We also announced on our earnings call a couple of weeks ago that we're going to close 3 additional manufacturing facilities in this segment. We anticipate the charges related to that will be about $30 million, of which $5 million is cash. And we ought to save about $7 million on an annual basis.
Our Window Group in the United Kingdom continues to do a really nice job from a share perspective. They've seen some competitors go out of business and our staying power has put us in a good position to pick up additional opportunities there. And we have a really exciting retail opportunity that is in the early stages that we'll be able to talk a little bit more about in the next couple of quarters.
And I should point out that Arrow recently launched a new staple gun at Lowe's, the T50 Elite. Really proud that Milgard received from Window and Door Magazine the most innovative product for a large window manufacturer. And that's our Essence Series of windows. It's a high-end window, it's a fiberglass wood window. And we launched that about a year ago and have gotten some really nice traction with that product.
Milgard's also come-out with some premium colors for their vinyl windows series, working in collaboration with Behr, that allows them some upgrade options for that product group.
We've talked about our major brands: KraftMaid, Merillat, Quality Cabinets, Hansgrohe, Delta Faucets, Milgard, Behr, Kilz and Arrow. But as you can see from this collage, we've got several other brands that are very important to our customers across the channels that they serve and in the niche markets where they participate.
We've also got significant operating leverage. We estimate that over the course of the last 4 years through the end of last year that we've taken about $500 million of fixed cost on a gross basis out of our cost structure. Now that's not been the easiest thing in the world as you can imagine. We've had to close probably 25 different manufacturing facilities, 125 to 130 different installation branches. And we've seen our headcount go from north of 60,000 down to about 30,000. So again, a lot of difficult activities and certainly ones that have been tough, but certainly necessary under the circumstances given the business conditions. We believe that our maintenance CapEx approximates about $110 million on an annual basis. And we have contribution margins from a company-wide standpoint that average about 30% on incremental volume. So a lot of operating leverage in terms of our business.
We also generate a lot of cash flow. If you go back to the period 2003 through 2007, we averaged about $1 billion of free cash flow per year during that time frame. At the same time, we invested about $1.5 billion in capital expenditures and another $300 million in displays. We also during that same 5-year period repurchased about 30% of our outstanding shares, about 150 million, 160 million shares of our stock. And as you can see, '08 through 2010 continued to generate pretty strong cash given the circumstances.
We've talked about some of the attributes that we think are important. Scale, we're big in all the markets that we serve; strong positions in the distribution channels; leadership brands across all of our product categories; operating leverage; and a very strong history of cash flow.
And before we go to Q&A, just a couple of comments to close. Market conditions obviously continue to be very challenging. We anticipate that in 2011, housing starts will probably end up approximating where we were last year at 590,000 or 600,000, roughly. Seems like we're on track for that. Mentioned that bigger ticket remodel continues to be slow and has been for some time. We also continue to see a lot of competitive activity in the retail channel. I talked a little bit about promotions, particularly with Cabinets. Commodities have been a bit of a challenge for us. We estimate that price/commodity relationships for this year compared to last year are about a negative $30 million. And about 1/3 of that is represented by a hedge that we had in place that kind of a good news/bad news kind of a situation that went south at the end of the third quarter. But having said that, we've done a really good job, I think, of offsetting a significant commodity cost this year.
We continue to focus on the things that we can control, and that includes managing our cost structure aggressively. We talked about some of the divestitures in the Installation segment, some of the compliant closures related to our Window business. We estimate that from September through December of this year, that we'll probably have about 750 further headcount reduction based on actions that have been announced primarily in the Installation, Cabinets and Window-related businesses.
In terms of the longer term, we continue to be optimistic about the fundamentals for our business. We certainly believe that demographics will continue to drive household formations, which should drive demand for new homes going forward. Last year, I think household formations were only 800,000. Most folks think in the decade 2010 to 2020 that we'll see somewhere between 12 million and 14 million in terms of household formation. And obviously, we're not anywhere near that at this point in time. But once that starts to kick in, as we move out of this difficult period that we've been in, that should be a real positive for us, again, given our operating leverage. On the repair/remodel side of the business, the housing stock averages about 39 years. As I mentioned earlier, our sense is that there's a lot of pent-up opportunity in terms of repair/remodel activity that could be postponed or delayed. The foreclosed properties that have come on the market, obviously, have been fairly distressed in certain cases and kind of beat up. So our sense is that as we look out, there should be a lot of opportunity for us as things start to pick up and improve. We're not exactly sure when that is, but we certainly feel very well positioned to take advantage of it. We'll continue to invest in our brands, invest in innovation, and continue to position ourselves in the markets as best as we can to take advantage of that. And there's no question in our mind that we feel we've got a lot of upside opportunity and a lot of opportunity to create value for our shareholders going forward.
And with that, we'll open up the lines for Q&A.
Could you speak to how much your business correlates to new housing starts versus housing turnover?
Yes we estimate that about 25% of our top line today is tied to new home construction. Obviously we go through a lot of different channels. It's kind of hard to get an exact number on that. But we estimate about 25%. The other 75% would be related to repair/remodel activity. And just to give you a different perspective, if you went back to 2006, that mix at that point in time -- obviously, new home construction was much stronger, but we were probably about 40%, 45% new home, and about 55%, 60% repair/remodel.
And you also alluded to an emerging retail opportunity. Could you speak to that?
I think that there are many opportunities that we have across all of our businesses. We talked a little bit about the Vanity program at the big box in terms of both Lowe's and Depot. We've got new programs there. We've recently launched a lot of plumbing product at Lowe's. We are working very hard with Home Depot on a Pro initiative with Paint, which would really go through that particular channel. We've got Builders' Hardware that is launching. We talked a little bit about retail opportunities in the United Kingdom. So there's a lot of opportunity that we're either in the process of launching or will be launching over the next quarter or so. And our estimation is that on a mature basis, that could be hundreds of millions of dollars of top line. We also believe that the Pro initiative through Home Depot could be, in and of itself, hundreds of millions of dollars as well.
Two questions related to Lowe's. They said the other day that I think their comps in tickets over $500 are still negative. And in Slide 12, you talked about the Vanity program where you expect further growth at Lowe's. Is that going to come through rolling out to more of their stores, or is it replacing existing business that you have there? How do you get growth there with their sales trends? And the second question is, they've gone through some merchandising in-store ops reorganizations, line resets, reviews and things like that. Is that affecting you positively, negatively or neutral overall?
Yes, I would say that at this point in time, things there have been positive. We have launched Peerless and Delta faucets at Lowe's. We just had a major set here about 2 months ago. We also have some Cabinet opportunities with them -- Cabinet hardware, excuse me, opportunities with them as well that we'll be launching. And we talked a little bit about the Vanity program, as well as the Kitchen Cabinet program both with tops, granite tops with the kitchen and tops with the Vanity program. So from our standpoint, we've recently won some new business. So it's really more predicated on some of the innovation and some of the opportunities that we've been able to develop with them. I'm not sure if I got all of your question but...
Well, I guess what I think I'm hearing you say is that the growth through Lowe's is coming through new doors, rollouts of your programs to new stores there. It's not coming through organic.
Yes. Well, new stores are always certainly helpful. But our sense is that we've won business in terms of some of these product groups that I just mentioned that really represent some things that we're doing from an innovative standpoint as well as, I think, some really good merchandising and marketing-related ideas.
Can you just talk a little bit more about the Behr agreement at Home Depot? Kind of the history in terms of exclusivity is that kind of what the terms look like in terms of moving out? Is that something you would look to kind of expand beyond that channel? A little detail there, maybe.
Okay. I think the question is talk a little bit more about the history of Behr with Home Depot in that channel? Yes, Behr and Home Depot have kind of grown up together. You go back to when Home Depot was launched, I think, early '80s if I'm not mistaken. Behr was a relatively small paint company at that point in time and developed a relationship with Home Depot, and that relationship has been exclusive for as far back as it goes. And we have enjoyed -- I think both of us have enjoyed a very positive outcome from that. We have about 450 folks that we have in the field who work in the Home Depot stores. These are all dedicated to Behr and the paint aisle. So we've made a significant investment from that perspective. We've had a lot of innovation that has been industry-leading through the relationship. For example, the Color Center. If you go in and you're trying to match colors with certain fabrics or other things, we came out with the Color Center back in, I think, '03. We also came out with Paint and Primer in One about 3 years ago, which has been a homerun for both of us. We've done some things with low VOC. We've talked about the Kilz program today. So that relationship I think has worked very, very well for both of our enterprises.
And you foresee that continuing moving forward?
Yes. We definitely would see that continuing going forward. As we mentioned, we've got a couple of initiatives now, the Direct to Pro initiative using the Behr brand, as well as the Kilz Pro-X initiative that currently is set at Depot. And I think exclusive for a period of time at Depot, we'll probably be able to branch that out over time. But yes, I see that relationship continuing.
And then just one other question. How much of that $1.6 billion in cash is in the U.S.?
How much of our cash is in the U.S.?
Is in the U.S.
Yes we have about $1.6 billion of cash on the balance sheet as of the end of September. We also have access to about $1 billion of bank lines. So we've had a bank line in place, haven't drawn on that in probably 15 years. But the question is, how much of our cash is in the U.S.? And about 75% of our cash would be in the U.S., John?
John G. Sznewajs
I think about $500 million is in Europe.
Yes. And the rest would obviously be in the U.S. Any other questions?
Could you talk a bit about your business in the U.K. and your position with Kingfisher. Sales trends there have been significantly better. Their same-store sales trends have been better than Home Depot and Lowe's. Just talk a little bit about your business abroad?
Yes. Question is about -- a little bit about our business in the United Kingdom. We have 3 businesses in the United Kingdom. We have a Cabinet businesses I mentioned earlier that has principally served the public housing, new construction market. We have a Plumbing business that is more a source and sell business and we have a Window business. And the most challenged business in that segment would be the Cabinet business. Again, tied more to new home construction. The other 2 businesses have done reasonably well. We believe that they're both taking share and both have pretty strong positions in the channels that they serve. I can't tell you specifically how they're doing with Kingfisher or any other individual entities. I don't know, John, if you have any sense of that?
John G. Sznewajs
We made a little bit of inroads on some of our vanities at retail in the U.K. But beyond that, our Window business principally serves the contractor market, so there's not a lot of sales there. Same with our -- our Plumbing business principally serves the plumbing trade. So not a lot of retail business in either of those 2 companies.
Yes. We're holding our own in both Plumbing and Windows, but Cabinets has been more of a challenge.
Tim, you had mentioned a tough environment out there. But within the environment, are you seeing more activity in the lower price points? Are there some positive movements there? Or is that still trending negatively also?
Yes. Generally speaking, I think that there is a fair amount of focus on value price points. We see that more in the big box channel in Cabinets, for example. We have enjoyed having the KraftMaid brand as a semi-custom cabinet, and it's typically been positioned at the higher price point for both Home Depot and Lowe's. And there has been more trade-down, if you will, or more emphasis I think on value opportunities with heavy promotions. If you went back a few years, we saw a lot of opportunity for trade-up. Typically, when someone does a kitchen remodel, one of the dynamics after they're done is sort of a remorse that they didn't do more, maybe didn't stretch more, maybe didn't go for upgrades. And certainly in the past, we were able to do probably -- able to communicate that maybe and had more opportunity for the trade-up. But now, it's probably a little bit more focused at value price points come. Having said that, KraftMaid continues to be the leading brand, we believe, in the big box channel. Opening price points for things like spas have helped us a lot with product. Same thing with windows. A couple of years ago, we came out with a window directed at lower price points for the production builder. So we tried to cover all the distribution channels with price points throughout that and generally, have pretty good presence that way.
Two quick questions. I think in the past, I've heard you say that 1 million-ish home starts is kind of what you need to see in terms of getting back to kind of double-digit EBIT margins. And then separately, I think I've heard you talk about targeting break-even margins or cash flows on a couple of your businesses. Maybe you can talk about those 2 items and how you define breakeven?
Sure. In terms of a breakeven, what we've said is that our Cabinet business and our Installation business have been very challenged. And we've seen some fairly significant losses the last couple of years. And what we mentioned in our call a couple of weeks ago is that we're pushing those businesses in those segments very, very hard to see what they could do to get close to breakeven, assuming no lift in the macro environment. Now that is not our guidance necessarily. We're not -- we'll issue our guidance in February when we do our fourth quarter earnings call. But what we've really asked those businesses to do is plan for a comparable macro environment for 2012 and see what it's going to take for us to get as close to breakeven as we possibly can. We're talking about that on an EBIT basis. We're in the process of going -- our planning process is in process as we speak. And we haven't gone through the review of those businesses at this point in time, and we'll give some updates when we have our fourth quarter earnings call. But our anticipation is if we don't get to breakeven, we anticipate seeing some dramatic improvement versus where we were in 2011. The comment about 1 million starts, our sense is, and again, we haven't gone back and looked at this. We talked about this a couple of years ago, but I think it remains directionally accurate. We think at 1 million starts that our sales opportunity, assuming the commensurate improvement in repair/remodel activity, which would probably be the case, we'd be looking at a top line somewhere around $10 billion, $10.5 billion, we believe. And our sense is that we could achieve margins at high-single digits and possibly low double-digit at that kind of level. Again, given the operating leverage, we feel pretty comfortable about that.
Mark Wiltamuth - Morgan Stanley, Research Division
Okay. If that's it, we'll move over to the break out room. It's just down the hall. Thanks.
Okay. Thank you very much.
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