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Morningstar | Fortune Brands Posts Solid 2Q Results Amid Cost Headwinds; Doors and Security Businesses to Merge

While Fortune Brands' second-quarter sales and adjusted EPS both narrowly missed consensus estimates, we thought the narrow-moat home products company reported solid results, especially considering the firm had to grapple with rising input costs across its four business lines and restructuring activity within its cabinets business. Management maintained its full-year sales outlook of 6% to 7% top-line growth in 2018 and raised its adjusted EPS guidance to $3.62 to $3.72 from $3.58 to $3.70 previously. The increased EPS guidance is the result of share repurchases. Year to date, Fortune Brands has spent over $600 million to repurchase 10 million shares, and the firm has an additional $500 million authorized. We've maintained our $66 per share fair value estimate.

Doors was the fastest-growing business and the only segment to expand adjusted operating margin during the quarter. Door sales grew a robust 20% year over year, and adjusted operating margin expanded 60 basis points to 17.5% driven by strong operating leverage. Plumbing revenue grew 11% (9% organic), and while the segment's adjusted operating margin contracted 240 basis points to 20.9%, year-to-date plumbing profitability is about in line with last year's performance and is tracking toward management's target operating margin of 21%. The cabinets business is in the midst of restructuring as management repositions the business to better serve higher-growth end markets. Cabinet sales declined 2% year over year, and adjusted operating margin contracted 90 basis points to 12.7%. Security sales grew about 3%, and the segment's adjusted operating margin declined 140 basis points to 13.6% due to higher metal costs. Management expects these cost headwinds to abate in the second half of 2018 as pricing actions take hold.

Beginning in the third quarter, the doors and security businesses will combine into one segment, which will represent roughly 20% of Fortune Brands' revenue and segment operating income.

The president of Therma-Tru Doors, Brett Finley, will head the newly formed doors and security segment. We think this combination makes sense strategically, and a streamlined cost structure should result in better operating leverage going forward.