Brunswick Corporation: A Compelling Growth Story At A Value Price

Brunswick Corporation (NYSE: BC $77.30) MV = $5.9bln; EV = $7.7bln; 3mo ADV = 0.99mm shares

Trades @ 5.4x 2023E EBITDA; 10x 2023E FCF; Net Leverage Ratio (2021 EBITDA) = 1.8x

Blended Price Target: $111 or 44% Upside

Author: Philippe Kurzweil | pjsubstack@gmail.com                                                  

Date: 5/14/2022

Disclaimer: I own common shares in BC. Please do your own work.

LINK TO 1-PAGER HERE

Intro:

A long-time player in consumer leisure products, Brunswick Corporation (ticker: BC) has transformed into a high-growth marine company with an improved cost structure and growing mix of recurring earnings. Today’s BC has significant runway to grow – it has a Propulsion business that is rapidly gaining share, a less-cyclical Parts & Accessories (P&A) business that is rolling up smaller players and a Boat business that will benefit from a multi-year restocking cycle. Yet despite these positive tailwinds, the market still values BC as a highly cyclical stock trading at peak earnings. Considering both sum-of-the-parts (SOTP) and recession analyses, BC is worth 44% more than where it trades today, with upside potential of 85%. Management agrees, seeing the stock as ‘significantly discounted’ and recently doubling its share repurchase guide for 2022 to $300mm+. Ultimately, we see a favorable risk-reward as positive supply/demand dynamics, an improved cost structure and sizable mix of recurring earnings protect the downside, while continued execution, driven by BC’s vertical integration, product innovation and compelling capital allocation results in a higher multiple on higher earnings.

Business Overview:

“So we have an exceptional position of leadership and scale in the marine industry. We're much larger and more capable than any other business in the industry. We sometimes refer to that as authentic leadership because there are a lot of proof points . . . we have the world's largest recreational boat business, the world's leading marine propulsion business, the world's largest and most comprehensive parts and accessories business and distribution business. And since we acquired Freedom Boat Club in 2019, we're also the world's largest boat club operator.” – CEO David Foulkes CL King Conf. 2021

Founded in 1845 and listed in 1925, BC has a rich operating history, most recently completing a significant transition to become a pure-play marine powerhouse. By exiting its lower margin and more cyclical large boat business in 2018, augmenting its higher-margin and less-cyclical P&A business and selling its non-core Fitness business in 2019, BC has reshaped its portfolio to become more focused and better aligned with marine industry trends. Today’s BC reports in three main segments, each of which have industry leading positions: Propulsion (40% of revenue and 45% of Operating Income or OI), P&A (33% of revenue and 40% of OI) and Boats/Business Acceleration (27% revenue and 15% of OI). These businesses are highly complementary: Boat sales fuel Mercury engine and P&A sales, engine sales to other boat builders also fuel P&A sales and P&A’s large distribution network facilitates its aftermarket engine sales (‘repower’). Critically, 42% of current OI is recurring and includes the aftermarket portion of P&A, the repower portion of Propulsion and the small but rapidly growing Freedom Boat Club portion of Boat. Further, by repositioning its more cyclical OEM boat/engine businesses, expanding its P&A business, and taking out $500mm in fixed costs since 2008, BC is now better positioned to weather a downturn.

Propulsion: A Misunderstood Engine For Growth

“We are continuing to see this incredible secular Mercury share gain story play out. And the wind is really at our back at the moment, especially as you see us adding capacity where others are not. We'll be introducing new products at a rate that other people can't match.” – CEO David Foulkes Q4 21 Call

Given its lack of public or pure-play comps, BC’s Propulsion business (Mercury Marine) may be the most underappreciated businesses within the company. A $5bln industry globally, the propulsion industry has seen some secular shifts including a) the shift to higher horsepower (HP) outboard engines; b) the shift away from diesel inboard engines to gasoline outboard engines; and globally c) the shift from 2-stroke engines to more fuel efficient 4-stroke engines. Predominantly a producer of outboard engines, Mercury has seen rapid share growth (160bps in 2021 alone and 310bps over the last 2 years) despite its already sizable share (45% in the US, low/mid 30s% globally) as its innovation, timely capacity expansions and product introductions have lined up well with these industry trends. With $1.5bln spent in R&D and Capex since the GFC, Mercury has taken meaningful share from Yamaha (both combine for 80% of the US outboard market) and has knocked out smaller players Seven Marine and BRP. Moreover, with its focus on higher HP engines, over the last 24 months, Mercury has taken over 1,000bps of market share in the fastest growing subsegment of the engine market (300HP+). As we will touch on later, a larger install base of Mercury engines results in a long-dated engine P&A annuity that will fuel additional, higher margin growth.          

Demand For High HP Engines Outpacing Overall Outboard Engine Growth

Source: Company Presentation

We believe the market views the Propulsion business as a proxy for new boat sales and underrates its ability to outgrow the market and take price/share in both the US and global markets. BC’s vertical integration is a distinct competitive advantage that enabled it to produce 108% of its initial production expectations in 2021 and its 60% capacity expansion in high HP engines is set to unlock incremental volume at favorable ASPs. In 2021, Mercury’s ability to meet demand resulted in 17% retail unit growth in the 200HP+ segment, while the rest of the industry saw declines. We believe the market underestimates the demand creation associated with Mercury’s product introduction in the 300HP+ segment, where it is rapidly adding OEM partners and is taking share in larger boats that previously required inboard engines. In addition, Q4 2022’s capacity expansion will result in a favorable channel mix, allowing incremental volume to hit higher-margin sales channels like repower dealers and smaller OEMs. Bottom line, even with a decline in industry unit volumes, Mercury will have mix and market share gains to help offset the impact. With rapidly increasing market share, particularly in the 300HP+ segment and very limited competition, it shouldn’t have problems getting either.                                           

Mercury’s Competitive Position By HP

Source: Brunswick 2022 Analyst Day Presentation

P&A: An Anchor In Choppy Waters

“We believe about 75% of our P&A business is aftermarket and a large, large majority of that, we would consider necessary maintenance and things that you just have to either consume, right? Consumables, oils, lubes, filters or things that just need to be repaired, replaced by normal usage. . . if you look historically, even in the financial crisis, P&A only went down about 5%. So it isn't as though even in very tough financial circumstances, you see some huge change between -- change in behavior around aftermarket items on a boat. We actually saw that be extremely consistent.” -- ASG Division President Brett Dibkey and CEO David Foulkes 2022 Investor Day Q&A

The crown jewel of its portfolio, BC’s P&A segment has materially evolved, growing 4-5x from where it stood coming out of the GFC. Operating in a $6bln global market, BC has over 35% market share, supported by its large install base of engines, broad product offerings and global distribution network that serves nearly 27,000 outlets. Given 75% of the business is aftermarket and a ‘large, large majority’ being maintenance/consumable parts, BC’s P&A performance is tied to boat usage versus new retail sales, which greatly dampens its volatility as evidenced by its 5% revenue decline during the GFC. With its structurally higher operating margins (products average in the low-mid 20s) we see the significant growth in P&A as providing structurally higher margins for BC.

Looking forward, we believe the market hasn’t given BC enough credit for the P&A product and systems expansion built via numerous acquisitions, punctuated by 2021’s acquisition of Navico. Previously viewed as an extension of the Propulsion business, today’s P&A is a scaled $2.5bln business, growing DD organically, with leading market positions in P&A distribution, engine parts & consumables, control systems, electrical systems, boat components and systems, and now electronic systems. The entry into electronic systems filled a key gap in BC’s offerings and is the largest P&A submarket along with engine P&A. With a strong foothold in nearly every P&A submarket and the largest global distribution and OEM network, BC is well positioned to provide fully integrated systems to gain share of wallet with OEMs and continue rolling up smaller players. With management laser-focused on expanding its P&A business and maintaining its strong aftermarket mix, the value attributable to this business will only grow.

P&A Market Subsegment Exposure Pre-Navico Acquisition

Source: Company Presentation

Boating: Not Enough To Go Around

“But just for context, our Boston Whaler brand is sold out this year, 2022, not just at wholesale, but even at retail. We have a name on every single boat that we're going to produce this year. And although for some of our brands, it's not a full year like that, it is very unusual. We have incredibly depleted pipelines. We ended the year with something like 15 weeks of inventory versus our typical 30 to 35. And that was global. In the U.S., it's about 12 weeks of inventory. So we are down -- we produce about 40,000 boats a year and we're down by about 15,000 units of inventory. So it would take an awful lot of change in consumer sentiment to significantly impact us.” – CEO David Foulkes 2022 Ray James Conf.

Previously seen as a loss leader for Mercury, BC has repositioned its Boat segment from a value-destroying business to a value-accretive one. Historically, Boat has been mired by a high fixed cost structure that, along with a market downturn, resulted in segment operating losses each year from ’07 to ’13. Since that period, Boat has rebalanced its portfolio away from its lower-margin and secularly-challenged yachts and other inboard/sterndrive brands to more stable and growing outboard fishing enthusiast brands, which now comprise 2/3rds of the portfolio. As for price points, 78% of boats are priced below $50K, suggesting that a majority of the portfolio targets middle-income consumers. BC also rationalized its manufacturing footprint (29 plants to 10), increased its vertical integration, and ramped up product innovation, resulting in 8.4% operating margins on $1.7bln of sales in 2021 as compared to 4.7% operating margins on $2.9bln in sales in 2006. In addition, despite supply chain challenges, Boat was able to produce 95% of its original 2021 production plan, supporting its retail unit outperformance relative to the industry. The net result is that the Boat business is more durable, more efficient, and unlikely to sink BC in a recession.

While historically, a decline in retail demand has not been kind to the Boat business, we believe BC is better positioned given depleted dealer inventories and a supply-constrained market. Looking at the TTM ending Q1 ’22, dealers have 19 weeks of BC field inventory on hand, which equates to 13.6K units and implies TTM retail unit sales of 37.2K. If dealer inventories partially replenish (30 weeks versus historical 40 weeks), it will require that wholesale unit sales exceed retail unit sales by 8K units. If retail unit sales remain flat and wholesale unit sales go to 40K (BC’s current production capacity), this inventory replenishment would take 2.5 years to correct (mid/late 2024). Alternatively, all else equal, inventory restocking could offset the impact of a 14% drop in retail unit sales. Thus, the replenishment of historically-low dealer inventory gives BC a healthy cushion to withstand a downturn and a multi-year growth tailwind in a flat to positive retail enviroment.

Q1 2022 Weeks Of Inventory On Hand And Units In Pipeline

Source: Company Presentation

Looking forward, BC’s nascent Freedom Boat club, or shared boat access club has been growing rapidly and will not only be a source of recurring subscription earnings but will also become a significant repeat customer for the Boat business. Currently operating a fleet of 4K boats, clubs are expected to replace units every 2 to 3 years, implying a 1.6K unit annual demand. Critically, this demand will be steadier and less cyclical than traditional retail sales. With BC being the consolidator of choice in the shared boat access space, there is little doubt that this number will grow.

Why Are We Getting This Opportunity?

Despite firing on all cylinders and beating Street expectations, BC has fallen over 30% from its peak in May 2021 as a confluence of macro and micro factors have hit the stock. From a macro perspective, rising rates, inflation and a potential recession have all weighed on consumer leisure product stocks. During the GFC, Brunswick was hit particularly hard, reporting adjusted EPS losses of -$4.92 and -$5.77 in 2008 and 2009 respectively. From a market perspective, there has been a distinct selloff of perceived ‘COVID winners’ or stocks whose businesses outperformed in the COVID environment. Finally, on the micro side, choppy monthly retail boat registration data has led some investors to question the sustainability of retail demand. Thus, despite continued positive earnings estimate revisions for FY 22, 23 and 24, the net effect is that BC trades at a trough 5.4x EV/2023 EBITDA multiple, two turns below its 5-year average.

While these macro, market and industry concerns are real, we believe they have caused BC’s stock price to overshoot to the downside. While a recession would hit both boat and OEM engine sales, if we take the revenue impact of the 2001 recession and assume no cost cutting or inventory replenishment, we still estimate BC generating roughly $1bln of EBITDA or $7.77/share of EPS, the result of an improved cost structure and mix of stable earnings. We believe this analysis is conservative given today’s superior product mix in Boat and Propulsion relative to 2001, which all else equal, would result in a lower sales decline. As far as interest rate increases, with roughly 50% of purchases financed, we estimate that a 100bps increase in rates would only increase monthly payments by roughly $15-25. As it relates to the COVID bump, while 2020 saw a spike in retail boat sales, we believe that a) the number of boats sold in 2020/2021 is still below industry replacement levels; b) there is still pent-up demand that is being obscured by a supply-stricken market; and c) the increased mix of younger buyers may result in a structurally larger TAM. Finally, new boat registrations remain choppy given factors such as limited supply and weather delaying deliveries and do not necessarily line up with BC’s sales performance. Case in point, during the recent Q1 earnings call, management indicated that 4K retail units (sizeable compared to BC’s 40K annual unit production) have been sold but given the weather, have not yet been delivered and registered. Bottom line, we believe these risks are largely offset by both industry factors such as the favorable supply-demand dynamics and BC-specific factors, including an improved fixed cost structure and mix of products/businesses.

Compelling Investor Day Targets & Capital Allocation

“To go from our current 2022 guidance down to EPS of $8, you would have to assume that the retail market goes down 30%, meaning approximately 145,000 boats are sold in the U.S. You would need to assume that propulsion sales decreased 15% and that P&A sales dropped, on average, by high single-digit percent.

To get to a $6 EPS, you would have to believe that the retail market goes down 40%, meaning approximately 120,000 boats are sold in the U.S., which is fewer than the number of boats sold in 2009 at the depths of the Great Recession. You would need to assume that propulsion sales dropped 25% and that P&A sales dropped mid-teens percent, which is worse than the P&A business performed and any economic downturn.

In both scenarios, only modest cost takeout measures are required to maintain these EPS levels. Hopefully, this exercise has helped reinforce our internal view that our sales and earnings are more resolute and durable today than at any time in our history and that our earnings floor has indeed been raised.” – CFO Ryan Gwillim 2022 Investor Day

With all the recent turbulence, we believe the market has discounted several compelling data points shared at March’s investor day. While we find the $17/share adjusted EPS target for 2025 hard to bridge without visibility into inorganic growth, we do see a path to low-teens top-line growth, high-teens EPS growth, and critically, a path to $9.55/share of FCF in 2024. Another key data point is BC’s plans to grow its mix of recurring earnings from 42% to over 50% via organic and inorganic growth, which will result in a more resilient business and thus a higher multiple. Finally, management presented a reasonable scenario analysis that quantified the downside to earnings given adverse changes in market conditions. The upshot is that by management’s assumptions, a ‘normal’ recession should result in BC earning $8/share while a more draconian recession would result in BC earning $6 in EPS, both a marked improvement from its performance during the GFC.

Management’s Recession Scenario Analysis

Source: Brunswick 2022 Investor Day Presentation

Our conviction in the company’s growth plan and ability to generate cash is underpinned by both the industry tailwinds and BC’s capital allocation opportunities. We believe the current FCF potential of the company is being obscured by substantial growth capex spend and increases in net working capital, both of which will moderate in 2023 and beyond. On the capex side, BC is focused on cost-efficient capacity expansions in areas that have the greatest tailwinds. As discussed, on the Propulsion side, BC is augmenting its high HP engine production capacity (+20K units) to propel its continued market share gains. On the Boat side, BC is expanding capacity at its lowest-cost facilities from 40K to 50K units to further leverage its fixed cost base and take advantage of the inventory restocking cycle. Finally, on the P&A side, BC is ramping Navico production capacity and adding a new 500K SF distribution center to facilitate growth and realize revenue synergies. We believe that these capacity expansions, along with favorable industry trends and a restocking cycle, give BC strong visibility into achieving its organic growth targets. With strong earnings growth and a step down in capex and net working capital expected, we see FCF/share growing 70%+ YoY in 2023. On the inorganic side, BC is the consolidator of choice in marine P&A and shared boat access given its dominant/industry leading market positions. Despite the market’s tepid reaction, management has conviction and, on Q1’s earnings call, more than doubled its 2022 share repo guide to $300mm+ as the CEO maintains that the stock is ‘significantly discounted’.

What’s It Worth?

“I think obviously, we're trading at a discount. Obviously, the sector has had a significant pullback. And we believe that we are significantly discounted to any measure of intrinsic value. So this is a good time for us to deploy capital. We have a very strong balance sheet and are able to deploy capital very flexibly. And we certainly think that this is a great time to be repurchasing shares.” – CEO David Foulkes Q1 22 Earnings Call

At 5.4x our estimated 2023 EBITDA, BC’s valuation reflects a ‘peak cycle’ multiple and discounts both the company’s favorable outlook and more durable mix of earnings. Given the differing financial profile of the three businesses, we feel a SOTP analysis is appropriate. For Boat, there are two publicly-traded comps in Malibu Boats (ticker: MBUU) and MasterCraft Boat Holdings Inc (ticker: MCFT) that currently trade at trough multiples of roughly 4.5x 2023 EBITDA – given current sentiment, we believe this would be an appropriate base case multiple. For an upside case, we take an average of MBUU’s and MCFT’s 1-year forward EV/EBITDA multiple during 2021, which reflects better market sentiment even after the COVID bump – the result is an upside multiple of 6.5x 2023 EBITDA. Moving to P&A, given there are no publicly traded marine aftermarket parts suppliers, we consider Dorman Products (ticker: DORM) and Fox Factory Holdings (ticker: FOXF), both of which play in the aftermarket serving other industries. To be conservative, BC’s P&A business should trade at a slight discount to both given a) Dorman is 100% aftermarket versus BC’s 75% aftermarket exposure and b) Fox Factory is tied to a perceived less cyclical and more diversified set of end markets. Our base case multiple is therefore a 20% discount to their 2023 EV/EBITDA multiple or 9x and our upside multiple reflects a 10% discount or 10.5x.

Finally, with no good comps in the marine space or in other industries, we triangulate Propulsion’s multiple from what we know about the business. With Propulsion predominantly OEM focused, it is strongly tied to new boat sales, which would argue for a similar multiple as the Boat segment. That said, with its dominant market share, market share growth opportunity, improving product mix and less cyclical repower channel, we believe Propulsion warrants a two-turn premium to Boat, or 6.5x in a base scenario and 8.5x in an upside scenario. Combining all of the pieces, our base case implies a $109/share stock or 42% upside and our upside case implies a $143/share price or 85% upside.

As for a downside or recession scenario, we use our 2001 recession inspired analysis which yielded roughly $1bln in EBITDA and $7.77/share in EPS. Assuming the market doesn’t value the stock on an SOTP basis but instead uses a historically lower-end EV/EBITDA multiple of 5.5x, we get a $52/share stock or 33% downside. Under such a scenario, we still see BC generating $7 of FCF/share resulting in a substantial 13.5% FCF yield. Putting it all together, if we assume that our bear/base/bull cases have a 20%/40%/40% probability, our blended target price is $111/share or 44% upside.

Catalysts

Looking forward, we believe there are several catalysts for a re-rating. First, we see near-term execution during marine’s busiest season as highlighting the durability of demand/industry tailwinds. Next, we see the completion of capacity expansions in each business line giving investors additional confidence in BC’s ability to grow organically and take share thanks to its product leadership and vertical integration. We also see additional tuck-in P&A deals and the acquisition of additional boat clubs as giving better visibility into BC’s ability to grow its mix of recurring earnings to over 50%. Finally, the precipitous ramp in FCF over the next 2 years will give BC tremendous capital allocation optionality and allow for even more aggressive return of capital to shareholders.

Appendix: Capitalization

Appendix: Income Statement

Appendix: Current Multiples

Appendix: SOTP Valuation (Base and Upside Cases)

Appendix: Comps Analysis