Is MasterBrand Inc. (MBC) a Long Term Buy?

Founded nearly 70 years ago, MBC is the largest manufacturer of residential cabinets in North America. MBC is known for high quality products and innovative designs. Its business is closely tied to home improvement, repair and remodel (R&R), and new home construction activity in the United States and Canada.

Get our insights direct to your inbox: SUBSCRIBE

Why We are Bullish on MBC:

• In July, MBC leapt to be the 23^rd ranked stock in our Small & Midcap ranking tool due to:

1. Low valuation on numerous metrics due to a consensus negative market view
2. Powerful cash flow generation and disciplined capital allocation
3. Impressive cost controls in the face of declining top-line
4. High integrity accounting being applied to its earnings
5. A recent spin-out from a larger company, only 2 analysts covering the company and have negative to neutral price targets relative to current price targets

• In our view, MBC is cheap due to misperceptions regarding the risks the company faces.

• At just 12x earnings and 7.5x EV/EBITDA the stock trades at ~50% discount to the S&P 500.[1]

• We believe the data does not support such pessimistic multiples. For example:
  • MBC’s revenue dropped 16.8% in 2023 and 5.7% in 1Q 2024.
  • Nevertheless, MBC’s diluted EPS actually improved during both periods.
  • Few companies could sustain revenue declines like that while still growing earnings, in our view.

• Equally important: as we will explain, evidence suggests to us that the cabinet environment is turning higher and MBC’s lean cost structure could allow it to post better than expected earnings.

• The much-anticipated commencement of interest rate reductions by the Fed would be welcomed in many corners of the economy, none more so than the housing sector.

• While others buy speculative junk in anticipation of these cuts, we believe they could send demand for MBC’s products, and profits, soaring

• In such a scenario, MBC shares could potentially be revalued sharply higher with higher multiples on higher earnings, in our view.

• Notable that even on constant EPS, each one multiple point increase in MBC’s P/E ratio would translate into an MBC stock price increase of about $1.50, or around 9%.

• We recognize that the cabinet business may have few barriers to entry but as this research explains, there are industry dynamics that make it tougher for new entrants to take share than investors appreciate, in our view.

What is the Bear Case? The cabinet business has few barriers to entry. Furthermore, since participants can offer similar products to MBC’s cabinets, MBC can sometimes face significant price competition. In our view, MBC’s large size in the cabinet industry, reputation for high quality work, and proven ability to control expenses offset many of these risks.

Below we will do our best to articulate the bullish view on MBC.

Company Description

Founded nearly 70 years ago, MasterBrand, Inc. (MBC) is the largest manufacturer of residential cabinets in North America. MBC is known for high quality products and innovative designs. Its business is closely tied to home improvement, repair and remodel (R&R), and new home construction activity in the United States and Canada.

In December 2022, MBC’s former parent company, Fortune Brands Innovations, Inc., spun off its Cabinets segment to its shareholders, allowing MBC to become a standalone publicly traded company. With ample free cash flows, no AI story, and no immediate financing needs, this is hardly a company that is going to attract much attention from the analyst community at big Wall Street firms, in our view.

MBC’s largest kitchen brands include Mantra, Diamond, and Omega. About half of MBC’s revenue stems from sales to 4,400 cabinet dealers in the U.S. and Canada, 40% to retailers (primarily to the giant home improvement stores Lowe’s Companies, Inc. and The Home Depot, Inc.), and 10% to regional and large-scale home builders in North America.

A Potential “Moat” That is Poorly Understood by the Market?

MBC’s longstanding relationships with cabinet dealers is probably the company’s chief competitive advantage, in our view. Let us make our case quickly:

• The dealer channel is 1.5 times the size of the combined retail and builder channels.

• Penetrating the large but fragmented dealer channel requires significant scale (which MBC has).

• Once established with dealers, a cabinet manufacturer enjoys the advantage of high switching costs.

• More specifically, a dealer must earmark substantial funds for cabinets for showrooms, and to train its salesforce on the particulars of the chosen cabinets.

• After making such investments and decisions (for many years), a dealer is unlikely to incur the substantial costs and time to change course, in our view.

Impressive Financial Results – Even in the Face of the Downturn in Housing

MBC management is one of the most agile leadership groups in any manufacturing industry, in our view.

Indeed, sales fell about $550 million, or 16.8%, to $2.726 billion in 2023 from $3.276 billion in 2022^[2] as the end market demand slowed under the weight of the Fed’s unrelenting rate increase program. Housing starts fell to 1.42 million in 2023 from 1.55 million in 2022. Price increases that MBC implemented — and which have stuck — in the stronger 2022 housing market offset some of the current weaker housing market headwinds.

Yet, MBC’s 2023 gross profit and adjusted EBITDA fell only 4.2% and 6.8%, respectively. Furthermore, MBC’s adjusted EBITDA margin improved in 2023 (14.1% versus 12.6%), and its diluted EPS increased to $1.40 in 2023 from $1.20 in 2022 as the company cut its costs by closing manufacturing facilities and simplifying manufacturing processes under its “Align to Grow” program. Indeed, MBC estimates that it realized about $50 million of “continuous improvement savings” in 2023.^[3]

MBC is continuing to feel the effects of trade downs and a more promotional selling environment. Bigger R&R jobs still are not as prevalent as they were a couple years ago. Consequently, MBC expects its 2024 revenue to range from flat to a low single digit percentage decline, slightly better than the 2024 industry growth projection of a low single digit percentage point fall.^[4]

The good news about that is neither the company, the street, or investors expect much of anything in the future. One of the best investors the KCR staff has ever had the privilege to work with used to always ask management “What could go right?” He was particularly fond of doing this when the stock of a company had been relentlessly rising yet nobody was bullish. MBC stock has doubled since its spin-off and nobody is asking that question, from what we can tell. Let’s see if we can provide a possible “answer” below:

Could the Cabinet Market be Turning Higher?

Two measures — one qualitative and the other more quantitative — suggest the overall cabinet business has bottomed and may be in the early stages of an upturn. First, in the table below, we summarize MBC CEO David Banyard’s comments over the last four quarters on demand levels in the company’s dealer, retail, and builder segments.

Clearly, dealers and home improvement retailers concluded that end consumers became increasingly cautious beginning in 2Q 2023, and that wariness seemed to peak in 4Q 2023. In 1Q 2024, the consumer mindset has not returned to the high degree of optimism in 2022, but it does appear to be getting “less bad.”

Interestingly, cabinet demand from single family home builders avoided a noticeable dip over the 2Q 2023–1Q 2024 period. Moreover, Mr. Banyard’s description of builders’ 1Q 2024 demand is more constructive than his 4Q 2023 summary.

Second, a cabinet industry data set could likewise be foreshadowing a more rapidly improving industry environment than most expect – a consensus view which is presumably reflected in MBC’s discounted share price. We note the following:

• The Kitchen Cabinet Manufacturers Association (KCMA), a non-profit organization founded in 1955, represents almost 300 cabinet makers across North America. The KCMA surveys its participants each month regarding sales activity, and typically about 57 members respond with detailed sales data on the magnitude of custom, semi-custom, and stock cabinet sales during the period.

The chart below shows the year-over-year percentage changes in custom and aggregate (custom, semi-custom and stock) cabinet sales since September 2022, as reported by KCMA’s members.

• Overall cabinet sales turned lower in June 2023, and custom sales went negative three months later. Not surprisingly, the declines in custom cabinet sales proved deeper than aggregate cabinet sales last winter and into the early spring of 2024.
• However, sales of custom cabinets turned higher in April, and overall cabinet sales rose one month later. Of course, this nascent positive trend could be premature, but it seems possible that the improving April and May data could be implying a return to better times faster than many forecasters expect.

Acquisition of Supreme Cabinetry Brands, Inc.

On July 11, 2024, MBC completed a $520 million cash acquisition of Supreme Cabinetry Brands, Inc. from the private equity firm GHK Capital Partners^[5]. MBC had reached an agreement to buy the cabinet manufacturer in May 2024. Supreme Cabinetry produces two well-known cabinet brands: Dura Supreme and Bertch. The Bertch brand is especially well known for premium bathroom cabinetry.

MBC believes that the Supreme Cabinetry acquisition will be accretive to its adjusted diluted EPS run rate by July 2025. MBC plans to finance the acquisition with a combination of cash on hand and tapping its existing credit facilities.^[6]

Factoring in $28 million of run-rate synergies (to be fully achieved by the end of year 3), as well as $25 million in net present value of Supreme Cabinetry’s cash tax attributes, MBC is acquiring Supreme at a purchase price-to-adjusted EBITDA multiple of 5.9x adjusted EBITDA^[7], a significant discount to MBC’s enterprise value (EV)-to-adjusted EBITDA ratio of about 7.5x. Ignoring any potential Supreme Cabinetry growth opportunities, if Supreme Cabinetry’s cash flow stream were simply to be valued at MBC’s EV-to-adjusted EBITDA multiple, that alone would add about $1.10, or 6%, to MBC’s share price.

MBC’s Risks are Manageable, in Our Opinion

While MBC has the highest market share in the cabinet industry, it does face risks. For example, many companies produce cabinets, and the business has few barriers to entry. Furthermore, since participants can offer similar products to MBC’s cabinets, MBC can sometimes face significant price competition. In our view, MBC’s large size in the industry and its reputation for high-quality work offset many of these concerns, particularly given the stock’s heavily discounted valuation.

MBC Has Posted Strong Results Since it Was Spun off, Yet It Trades at a Large Discount to the S&P500

Reflecting what could be a conservative revenue forecast, MBC expects its 2024 adjusted diluted EPS and its adjusted EBITDA (excluding any contribution from Supreme Cabinetry) to be $1.40-$1.60 and $370-$400 million, respectively. The midpoints of both ranges are up from $1.40 and $383.4 million, respectively, in 2023. The company likewise projects that its 2024 adjusted EBITDA margin will edge higher to 14.0%-14.5% from 14.1% in 2023.^[8]

MBC’s free cash flow should be around $200 million in 2024^[9], which suggests the company’s free cash flow yield is a robust 10%. MBC management’s 2024 free cash flow guidance is quite impressive, but such a level would still be down from $348 million in 2023. The company’s free cash flow benefited in 2023 from the unwind of a large, planned inventory build-up in 2022. Indeed, inventory drawdowns added $124 million to MBC’s cash flow in 2023.

Investors have ascribed giant valuation discounts to MBC because of a misperception of the risks the company faces in a housing market downturn. Quite remarkably, MBC’s P/E and EV-to-EBITDA ratios based on 2024 projections are only about 11.7x and 7.5x, each of which represent roughly 50% discounts to the S&P 500 Index.

Perhaps such enormous discounts would be merited if the data supported such caution, but full year 2023 and 1Q 2024 results clearly suggest otherwise. More specifically, MBC’s revenue dropped 16.8% in 2023 and 5.7% in 1Q 2024 as rising interest rates caused existing homeowners to back away from or postpone R&R cabinet projects and some prospective home buyers to cancel or delay purchase decisions. Nevertheless, MBC’s gross profit declined only 4.1% in full year 2023 and was flat in 1Q 2024, and its diluted EPS improved during both periods ($1.40 in 2023 versus $1.20 in 2023, and $0.29 in 1Q 2024 compared with $0.28 in 1Q 2023).

Few companies in any industry have a sufficiently flexible cost structure to offset such revenue reductions and post higher EPS results. Perhaps equally important: if the cabinet environment is turning higher, as we believe, MBC’s lean cost structure could allow it to post better earnings results than most analysts expect.

Another element which could boost investor enthusiasm for MBC: the long-awaited and much-anticipated commencement of interest rate reductions by the Fed. Such an action would be welcomed in many corners of the economy, none more so than the housing sector. In turn, many investors may conclude that a boost to the housing market would almost certainly lead to higher demand for kitchen and bathroom cabinets.

If MBC were to post better-than-expected earnings and/or investors were to adopt a more constructive view of the company’s prospects, MBC shares could be revalued sharply higher. Indeed, each one multiple point increase in MBC’s P/E and EV-to-EBITDA ratios would translate into an MBC stock price increase of about $1.50, or around 9%, and $3.00, or about 17%, respectively.