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Morningstar | It Was a Shaky 1Q for Masco, but Management Maintains Full-Year Guidance; We Maintain Our $44 FVE

Masco's stock traded down 6% on April 25 after the narrow-moat-rated home products firm reported first-quarter results that missed consensus estimates and fell short of the high bar set by peer Fortune Brands, which reported 6% sales growth, an 80-basis-point adjusted operating margin expansion, and 13% adjusted EPS growth.

Masco's sales fell 1% year over year to $1.9 billion, which missed the consensus estimate by 4%. Excluding the Kichler acquisition and foreign currency translation, sales declined 2%. Masco's adjusted operating margin eroded 90 basis points to 12.1%, and its adjusted EPS declined 2% to $0.44, which missed consensus by $0.03. Management attributed Masco's weaker-than-expected sales performance to slower end market demand, channel inventory destocking, some customer prebuying activity in the fourth quarter, and two weeks of lost orders in the windows segment due to the implementation of its enterprise resource planning system. Lower volumes across the plumbing, decorative architectural, and windows segments dragged down consolidated profit margin.

However, sales picked up in March and April, and management maintained its full-year guidance of 3% to 5% sales growth (excluding currency translation) and adjusted EPS growth of 4% to 12%. We expect sales growth to come in closer to the lower end of management's guidance and EPS growth near the midpoint of the range. We've maintained our $44 per share fair value estimate, as the unfavorable valuation effect from tempering our 2019 sales growth and operating margin assumptions was offset by the time value of money since our last update.

Masco's cabinetry segment was the bright spot in the quarter. Segment sales were up over 9% as the repair and remodel end market grew in the high single digits and the new residential construction business grew in the low double digits. The segment's adjusted operating margin expanded 650 basis points to 9.3%, mainly due to operating leverage and increased pricing.

Plumbing revenue fell 3% year over year but was about flat excluding unfavorable foreign currency translation. After also adjusting for prebuying activity, we estimate that plumbing sales were up about 2% year over year. Segment adjusted operating margin contracted 60 basis points to 16.3%, due to lower volume and unfavorable mix.

Decorative architectural revenue rose 5% because of the Kichler acquisition but was down 7% on an organic basis. Segment sales were negatively affected by sales pulled forward into the fourth quarter of 2018, customer destocking, and generally softer do-it-yourself paint demand, which was down by low double digits. However, the Behr pro paint initiative grew at a low-single-digit pace during the quarter. Decorative adjusted operating margin fell 290 basis points to 14.3% due to lower volume, the contribution from Kichler, and pro paint-related investment spending.

Windows and other specialty products segment sales fell 16% year over year due to the aforementioned ERP implementation and soft sales in the United Kingdom. The segment reported a $3 million (adjusted) loss during the quarter.

Masco took a $16 million impairment charge related to the partial write-down of the Kichler trade name ($9 million) and the write-off of the U.K. window group's goodwill balance ($7 million). While the U.K. write-off was not surprising given persistent weak performance, we were a bit surprised by the Kichler write-down, given this business' relatively short time under Masco ownership. However, trade name impairment tests are based on and are sensitive to sales projections. Kichler's sales so far have been weaker than management had expected, which caused the write-down. However, we don't see this noncash charge as an indictment on the Kichler acquisition, like a discounted cash flow-based goodwill impairment would be.