Morningstar | Fortune Brands Blames Moderating Demand and Hurricane for 3Q Miss but Doesn't See Imminent Downturn
Shares of narrow-moat-rated Fortune Brands Home & Security traded sharply down Oct. 26 in reaction to disappointing third-quarter financial results. Revenue grew 2.4% year over year to $1.38 billion, which missed the consensus estimate by $56 million, and adjusted earnings per share of $0.93 missed the $1.04 consensus estimate. Fortune Brands added $0.24 related to restructuring and asset-impairment charges back to its $0.69 third-quarter GAAP EPS. Management said results were hurt by slowing home products demand and Hurricane Florence, which disrupted Fortune Brands' plumbing and cabinets businesses. Management estimates that had Hurricane Florence not interrupted operations, consolidated revenue would've grown 4% year over year and adjusted EPS would've been $0.07 higher.While management acknowledged moderating demand for its products during the quarter, it doesn't expect a housing downturn or recession in 2019. We too expect increased new residential construction next year. Still, we did temper our growth projections to better reflect our moderated 10-year forecast for housing starts as well as repair and remodel spending that may not grow at the magnitude we had envisioned over the next decade. Considering recent margin performance, we also moderated our midcycle operating margin assumption to 14% from 14.4%. These adjustments caused our fair value estimate to decline 8% to $60 per share.
Fortune Brands' newly formed door and security segment posted the strongest revenue growth (up 8% year over year), followed by plumbing (up 5%). The cabinets segment reported a 2% decline in sales. Segment adjusted operating margins, which exclude restructuring and asset-impairment charges, were down across the board. Adjusted margins for both doors and security and plumbing were down 190 basis points year over year to 20.3% and 16.1%, respectively, and cabinets' adjusted operating margin contracted 50 basis points to 10.8%.
Excluding lost shipping days caused by Hurricane Florence, management estimates that plumbing's revenue would've grown 9% (versus 5% reported) and plumbing's adjusted operating margin would've been 21.8% (versus 20.3% reported). The cabinets business was also negatively affected by the hurricane. Excluding the hurricane impact, management estimates cabinets' adjusted operating margin would've been 11% (versus 10.8% reported).
As a consequence of third-quarter results that underperformed internal expectations, as well as management's more conservative outlook for the remainder of the year, management cut its guidance for 2018 sales growth, adjusted EPS, and free cash flow. Management now expects full-year revenue growth of 5%-6% (versus 6%-7% previously), adjusted EPS of $3.41-$3.49 (versus $3.62-$3.72 previously), and $460 million of free cash flow (versus $500 million-$525 million previously).
Fortune Brands Home & Security is a holding company. Through its subsidiaries, the company provides home and security products. The company's segments are: Cabinets, which manufactures cabinetry and vanities, for the kitchen, bath and other parts of the home; Plumbing, which manufactures or assembles and sells faucets, accessories, kitchen sinks and waste disposals; and Doors and Security, which manufactures and sells fiberglass and steel entry door systems, composite decking and railing, and urethane millwork, as well as manufactures, sources and distributes locks, safety and security devices, and electronic security products and fire resistant safes, security containers and commercial cabinets.
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