MarineMax on Shaky Ground

Oct. 1.07 | About: MarineMax Inc. (HZO)

Shares of MarineMax (NYSE:HZO), the nation’s largest boat retailer, have been taking it on the chin this year as the stock has dropped 40 percent year to date. The company, whose chains sell the popular Sea Ray and Boston Whaler brands as well as a number of higher-end yachts, has expanded aggressively since being founded in 1998, but the pace of expansion may become questionable over the next few quarters as the market for pleasure boats continues to slow on the backs of high fuel prices and weakening consumer spending.

As consumers continue to feel the pinch of falling home prices around the country, the first items to be sacrificed tend to be the high price discretionary items. Boats fall squarely into that category, and the combination of falling home prices, surging fuel costs, and a softening employment outlook has combined to put significant pressure on the boating industry. As if that was not enough, the tightening of the credit markets in recent weeks (especially with regard to jumbo mortgages) has made banks and finance companies more skittish about lending to consumers, with the likely consequence of increasing borrowing costs for big ticket luxury items such as yachts.

Given this general economic outlook, MarineMax faces a strong headwind in the coming months, and their most recent quarter suggests that the company is already beginning to feel a significant pinch. In what is seasonally its strongest quarter, MarineMax recorded a 19% drop in revenues year over year. Even worse, the company’s net income dropped to $0.50 cents a share when the plethora of one time gains are removed from the results, a decline of 44% year over year. The slowdown in sales is ill-timed for MarineMax, as now they are forced to head into the seasonally slow winter period with high inventories and a diminishing prospect of clearing these inventories. The recent swoon in the credit markets promises to further exacerbate the company’s woes by severely curtailing financing for the high end yachts that make up some 40% of the company’s revenue. While it remains to be seen what the September 30th quarter will bring for the company, broader economic data certainly does not provide a rosy outlook.

In fact, a more detailed review of MarineMax’s business reveals that the company may in fact be in more trouble than it appears. Start with the fact that in 2006, the company recorded 46% of its revenues from the state of Florida. Far from being geographically diversified, MarineMax has very sizable exposure to the Florida consumer–a weakness that could become magnified over the coming quarters. In fact, a quick look at the most recent Case-Shiller home price index (July data) reveals that the real estate markets in Miami and Tampa are among the worst-affected in the U.S., with home prices in Miami falling 6.4 percent year over year and Tampa suffering a steeper 8.8 percent decline (the second worst of all major markets in the survey, trailing only Detroit). That is precisely the kind of data that threatens to take the wind out of MarineMax’s sales, and a collapse of Florida sales would be devastating for the company.

As well, the company’s revenue and margins appear likely to be further pressured by the rising euro, which will directly affect sales of the company’s Ferratti and Azimut brand super-yachts from Italy. While these brands probably account for no more than 15-20 percent of total revenues, pressure from the rising euro is coming at the worst possible time for the company.

Moreover, it remains to be seen how severe the impact of the credit crunch will be on financing for yachts, but if the market for large consumer loans has been affected to a similar degree as the market for jumbo mortgages, MarineMax could be significantly affected in the luxury yacht market if tightening credit standards forces interest rates higher.

All in all, the near term operating outlook for MarineMax looks pretty bleak, and while the company is not yet in dire straights, a look at the company’s balance sheet reveals some potentially debilitating weaknesses. In fact, the company’s only real strength on its balance sheet is that it has about $130 million in borrowing capacity on a $500 million credit line (conditional on meeting certain financial metrics), which could provide some liquidity over the next few quarters (provided that the line of credit is not decreased if the company fails to meet its metrics). Meanwhile, the company has a combined $103 million in cash and net receivables, and $434 million in current liabilities. While the company’s total current assets are just over $600 million (which would normally be sufficient to cover current liabilities), the fact that the company’s inventory makes up just under $500 million of its current assets raises a red flag going forward. After all, meeting its current obligations will require actually selling down this substantial inventory, which would be no small feat given that the company is entering its slower period from a seasonal perspective and facing a strong economic headwind due to factors mentioned above. As compared with 2006, inventories are 12% higher going into the winter this year, a harbinger of potentially tougher times ahead (especially considering the fact that this inventory is a depreciating asset).

All things considered, MarineMax doesn’t appear likely to default on its obligations overnight, but it sports a balance sheet that looks very vulnerable to a sustained downturn in yacht and boat sales. Sales showed considerable weakness in the June quarter, and the risks seem to have only increased in the wake of continued housing price declines and turmoil in the credit markets. If boat sales fall off a cliff over the next two quarters in response to these negative trends, the next two quarters could see MarineMax’s earnings evaporate and the company swing to a loss. Even worse, a swing to negative cash flow over the next two quarters would truly put the company on a shaky financial footing, with the potential for default not out of the question if the company fails to unload its inventory. If the weakness in sales were to last beyond the next two quarters, which at this point appears likely, MarineMax could easily be pushed to the brink of insolvency.

With that in mind, I chose to enter a small short position in the stock on Friday at $14.64. I continue to believe that MarineMax has some significant risks ahead over the next two quarters, and current revenue and earnings estimates for the September quarter look to be too high in light of the weakness seen in their most recent quarter. In addition to my concerns about the company’s future described above, the stock is currently trading at more than 22 times the upper bound of management’s guidance for 2007 earnings (excluding one time gains and charges), a hefty valuation for a company with a suspect balance sheet and significant leverage to the fate of the [Florida] consumer. I believe that at the very least, this valuation has to come in significantly to properly reflect the risks to MarineMax going forward. If quarterly results continue to deteriorate, the pressure on the stock could become even more severe as the risk of default increases. Overall, MarineMax looks likely to continue trending downward over the next few quarters, and it is hard to envision a scenario by which the company could break this trend. Even if we ascribe a 15 multiple to HZO shares (generous considering the near term risks), one can easily envision the stock sinking below $10 per share over the next several months as investors continue to reassess the company’s financial health and the worsening outlook for the boating sector as a whole.

Disclosure: Author has a short position in HZO