American Woodmark (AMWD) is one company I’ve looked at as a company whose stock price is among the rubble of the recent sell-off and is related to housing. It’s an understatement to say they have a simple business. They make cabinets. I think I can understand this. There are certain factors that are appealing: It was capable of 20%+ ROE in good years, the chairman owns 24% of the company, and it has a net cash position. I didn’t find much of a competitive advantage though as they are heavily reliant on Lowe’s (L) and Home Depot (HD) for 70%+ of their 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 two 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. Their owned manufacturing plants are in places like Gas City, Ind. or Hardy County, W.Va. (that means the middle of nowhere, not even an incorporated municipality). There's really no angle here other than the pessimism surrounding its current industry. They were originally a division of Boise Cascade in the 1980s until a management LBO.
The company is sort of cheap. They actually canceled their dividend at the end of August as well, which practically had no relative effect since it coincided with a broader sell-off. The company has averaged $0.92 a share or $15 million in net income over the past 10 years. It’s earned approximately $30 million in good years and lost about $20 million in bad years. The 10-year average ROE is 7.82%. At a current price of $13 a 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 $45 million ($70 million cash, $14 million is restricted contingent on the $25 million debt from its revolver). Their defined pension benefit plan is underfunded by $38 million using an 8% return assumption, so while it won’t bankrupt them, 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% or more 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 $499 million to $838 million, or a 68% increase. During this same period A/R + Inventory went from $66 million to $122 million 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 $23 million to $34 million, 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 $43 million to $88 million, 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 their own promotional displays at these stores and the cost sits on their balance sheet at $6.6 million in the most recent quarter. That’s just another indicator that they don’t call the shots.
Another way to skin the cat is to observe that from 2002-2006, the company’s sales went from $499 million to $838 million, but net income went from $32 million to $35 million. That they couldn’t eke out more than $3 million in profit from $339 million in revenue from the scale of producing more cabinets indicates zero operating leverage, which is bizarre. Even when the sky knew no limit, they didn’t go along for the ride — although they are no 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 my 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 $474 million in revenue and reported losses of $20 million, whereas in 2002, they reported profits of $32 million on $499 million in revenue. The difference? Even though AMWD and plenty of others have closed down plants, 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 with little control over their destiny. In their defense, management is doing a good job operationally. They are turning their inventory over 18 times annually, or every 20 days. Not that it’s in any way comparable, but Owens & Minor (OMI), a company I’ve written about, turns their inventory over 10 times and they consistently get awards for being a very efficient distributor. Dealing with a tangible good like cabinets, it's impressive that they achieve this. It is a shame they aren’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 they managed a 10-12% ROA like they did in 2002-04, earnings could be $26-32 million. Even though 6-7 times 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. They do have the financial wherewithal to be around for a housing revival assuming they don't lose their key customers.