The Short Case For Brunswick Corporation

Brunswick Corporation (BC) is a global manufacturer of a wide array of boats, marine engines, and marine parts and accessories. The Company also offers a line of fitness equipment and other leisure products including billiard tables as well as operates Brunswick bowling centers.

Investment Rationale

There has been noted weakness in the marine sector recently with shares of both MarineMax (HZO) and West Marine (WMAR) falling based on reduced outlooks and weak same-store sales results. The performance of both WMAR and HZO suggest that the broader marine market is still on shaky ground and has not yet bottomed out. BC shares traded down on the news from WMAR and HZO, not surprisingly considering that HZO accounts for nearly 40% of BC’s popular SeaRay boat sales.

Nonetheless, with BC’s earnings set to be released on April 26, 2007, there may be a chance to still profit from a short position. This is primarily because share prices of various marine sector participants exhibited the same short-term recovery over the past few months that the homebuilders exhibited only to retrace recent gains after additional news was released. The “real” high to focus on should be the $35 per share BC hit in February as the stock sharply rebounded from its lows from last summer. Given that the latest news from the boating sector is showing that a trough has not necessarily been reached, there could be some extra downside left for BC.

Pros to Short

Industry Weakness: HZO warned that its fiscal year 2007 results would be reduced by approximately 70% on April 12, 2006, sending shares down about 20%. HZO’s CEO stated “Based on recent industry reports, challenging marine retail conditions are continuing. Industry data suggests that unit sales in the segments in which we operate have fallen as much as 20%.” Long-term, the marine industry will be fine and these shares should recover but the eventual industry bottom, let alone recovery, could take longer than the market anticipates.

Misleading Forward Valuation: BC shares look reasonable on a forward valuation basis, especially after the recent downward move caused by the WMAR and HZO news. Table I illustrates the EPS estimates provided by the Company and analyst community.

The risk with these estimates is that they could be subject to revised guidance well below the current range established by BC, especially when considering that HZO cut its own EPS estimates provided just a few months ago by 70%. The analysts’ estimates appear to be guided solely by BC’s guidance so the consensus does not appear to be pricing in the risk that management’s estimates will be adjusted. This is why Company shares may still be vulnerable even after the 15% haircut BC shares have recently experienced.

Another risk is that current estimates imply a trough has been reached and that 2008 will offer a quick turnaround. A January 2007 comment by AG Edwards indicates that it believed the bottom was generally reached:

“Based on a historical trough multiple near 18.5X & trough EPS of ~$1.80, we believe that BC shares have seen the bottom. Investors must now await evidence of a stabilizing U.S. marine retail environment as the next material upward catalyst.” – AG Edwards January 26, 2007

At the time, shares were trading at approximately $34 only to now be trading at closer to $30. In addition, AG Edwards has not changed its EPS estimates based on its latest BC report in late March. While timing the market is difficult, the main point from the AG Edwards comment is to illustrate that the market and analyst community may believe that a trough has been reached when there could still be significant time before that occurs. The performance of homebuilders further illustrates that some of these recoveries in stock prices were short lived and the same could be the said for boating industry.

The analyst community is also factoring in a rather quick rebound in 2008 with EPS estimates well over $2.00 per share. If 2007 results come in much lower than expected, it’s very likely 2008 results will have to be revised downwards making BC look much more expensive, even on a trough-level valuation where cyclical companies generally trade at higher valuations. Table II provides a sensitivity analysis based on the prospect of BC reducing its 2007 EPS guidance from 10%-50%.

As Table II illustrates, as long as EPS estimates remain intact or are reduced by just 10%, BC’s valuation looks reasonable. The risks become much more apparent, however, at the prospect of any guidance beyond the 10% range. Given a 70% reduction by HZO, which carries a number of notable boats for BC, a significant reduction in guidance is possible, which could be what causes a further decline in the Company’s stock price.

Risks to Short

Bad News Priced In: BC shares have already dropped 15% from their recent highs and have moved somewhat in tandem with WMAR and HZO. If their earnings release is average or even signals that the bad news is behind the industry, shares could sharply rebound. Given that the main quarter for the boating industry is the current quarter (Q2), however, it’s not likely that the Company would be in a position to issue major news from just a few weeks of data.

Outperformance by Other Segments: BC’s Billiards/Bowling and Fitness segments may somewhat offset the sensitivity to the Company’s Marine Engine and Boating divisions but this does not appear likely as both segments are relatively small. The Fitness segment generates decent operating margins (~10%) but the absolute contribution value is not significant while the Billiards/Bowling segment has been a poor performer in recent years with declining revenues, operating margins, and increasing capital expenditures. Based on BC’s correlation with WMAR and HZO, the main drivers of value are the Boating and Marine Engine segments.

Disclosure: Author's hedge fund is short BC