The Behr Necessities

Masco Corporation, a recent addition to the Fairlight portfolio, has quietly transformed itself following a near death experience in the GFC. The company has evolved from a low quality, cyclical business dependent on the traditionally volatile US new housing construction to a durable, high returns on capital, stable compounder. It is our view that this transformation appears to have gone largely unnoticed by the market, with the valuation remaining essentially unchanged.

Missteps of a once great company

While Masco Corporation has endured a tumultuous past decade, it was once firmly placed in the stock market hall of fame. In 2003 the business had just increased its dividend for the 47th consecutive year, earning it a place in the top 10 publicly listed companies in the world for consecutive dividend increases. It was first listed in 1936 as the ‘Masco Screw Products Company’, selling automotive parts to the Detroit auto industry. However, the impressive growth track record can be traced to the founder Alex Manoogian’s 1952 invention of the world’s first single handle hot/cold faucet. Unfortunately for Masco, success breeds complacency and Manoogian’s son Richard took the reins as CEO in 1996. An acquisition binge followed with $10b spent on 42 companies, ultimately sowing the seeds for the company’s dismal performance leading into the GFC.

Shrinking to its quality core

With the stock plummeting 80% between 2005 and 2012, the Masco Board decided to completely overhaul the business. A new management team was installed with a mandate to restructure Masco, keeping only the businesses with high returns on capital, high margins and those that sell into the much more predictable repair and remodel market. The ensuing transformation from 2014 to 2020 has been impressive:

• Five segments have been whittled down to two; with the highly cyclical insulation, windows and cabinetry businesses divested.
• Returns on capital have increased from their GFC lows of 5% to an impressive 25% today (See Figure 1) whilst margins expanded from 10% to 18%.
• Net Debt/EBITDA has reduced from a concerning 3.4x to a sensible 1x today.
• Management also proved themselves astute capital allocators over this period, repurchasing 25% of the shares on issue.

Masco’s competitive advantages

Unsurprisingly, the Masco that new management have built has returned to the roots from its halcyon days. Masco today is essentially a holding company for two dominant brands: Delta Plumbing (the original home of Manoogian’s 1952 faucet) and Behr Paint.  

Delta Plumbing manufactures and sells a range of plumbing products through wholesale (to professionals) and retail channels (The Home Depot and Lowe’s). Its competitive advantages are derived from 70 years of cumulative investment in brand equity and superior scale (it is one of the largest plumbing products businesses in the US).

Behr Paint is the #1 DIY Paint brand in the US, selling exclusively through The Home Depot. Fairlight is cognisant that this introduces a degree of customer concentration risk, however it does also confer a raft of competitive and financial advantages. Behr has been able to expand market share without spending on company owned stores, its supply chain is incredibly efficient as it has been purpose built to serve Home Depot and shared marketing campaigns reduce costs while increasing the reach of Behr’s brand. This symbiotic relationship has been in place since 1978.

Behr Paint was developing together with The Home Depot the Behr brand back when The Home Depot had but two stores and we were mixing stain in a 55-gallon drum with a canoe paddle. No, that's no joke, we're proud of that canoe paddle, we've got it in our lobby believe it or not. – Keith Allman, Masco CEO

The Fairlight View

With the transformation towards the repair and remodel market complete, management are now free to focus on the growth opportunities ahead. Fairlight believes that there are several structural tailwinds supporting R&R growth for the long term; including continued ageing of the US housing stock, increasing house prices and DIY focused Millennials buying their first home. It appears however, that the market has not rewarded Masco’s decision to focus on returns on capital and quality with the stock languishing on an average P/E multiple of 19x since 2014, declining to 15x today. (see Figure 2).  This combination of attractive valuation, underappreciated quality and prospects for long term earnings growth has resulted in Masco being added to the Fairlight portfolio.

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