Before the open this morning, two home construction and
remodeling companies reported disappointing fourth quarter results, furthering
concerns of a slowdown in the housing sector. Specifically, Tile Shop (TTS 6.23, -1.22, -16.37%)
reported a loss per share of ($0.02), slightly missing the ($0.01) consensus,
while Masonite International (DOOR 58.09, +0.52, +0.90%) generated EPS of $0.68, also missing expectations, which had called
for earnings per share of $0.71.
What's especially notable, though, is that these are not the first two housing related companies to issue soft financial results and/or guidance recently; taken together, this trend has left investors feeling a bit skittish about macroeconomic conditions in general. However, it is also very notable that there seems to be a consensus forming among housing-related executives that the worst is over now in terms of market declines.
Barrage of Soft Housing Market Data Points
For instance, back on January 15, paint and coatings company Sherwin-Williams (SHW) issued downside FY18 EPS guidance ($18.53 vs. prior outlook of $19.05-$19.20), citing weak sales growth in its North American stores in October and November for softness. The company ultimately reported Q4 results that were generally in-line with its lowered expectations, but it then also issued downside FY19 EPS guidance.
Elsewhere on January 15, Floor & Decor (FND) commented at an investors conference that the "housing market is a bit mixed versus what it has been, which could put some challenges on its hard surface line." FND is slated to issue its Q4 results on Thursday before the market opens.
Fast forward to February 7, when Mohawk (MHK), a peer flooring product company, cautioned that macroeconomic conditions around the world -- including some housing markets that are under pressure -- could weight on its results. Consequently, the company issued downside guidance for 1Q19, seeing EPS of $2.02-$2.12 vs. the $2.29 consensus.
Thus, even before TTS and DOOR's downside reports, there was clearly plenty of evidence indicating that conditions for the housing market, builders, and home remodeling companies had deteriorated in the fourth quarter. Weakening housing data, including a 5.5% dip in new housing starts in October and November, really foretold the story for these companies and their upcoming earnings reports.
A few headwinds have been facing the housing market recently, such as tight supply, un-affordability in certain coastal cities, and most notably, the rise in interest rates that occurred in Q4. But, as we discuss in more detail below, encouraging commentary from various management teams suggests that the market may have bottomed out. While no one is predicting a booming market this year, there does seem to be a consensus that conditions have stabilized and that fundamentals overall still look favorable.
Closer Look at TTS & DOOR's Quarterly Results
TTS reported a Q4 loss of ($0.02), missing estimates by a penny, with revenue up about 6.7% year/year to $83.9 mln, virtually in-line with the consensus. While the company did modestly miss on the bottom line, there are a few positive takeaways from the report. First, the quarter followed up on recent revenue growth trends; year/year growth has tracked higher over the past few quarters -- albeit, modestly -- going from (1.1)% in 1Q18 to 3.8% in 2Q18, 5.7% in Q3, and finally to 6.7% this quarter. Similarly, the company’s same store sales growth has improved sequentially for four straight quarters, coming in at a healthy +5% in Q4, driven by a strong increase in average ticket.
Additionally, its gross margin expanded nicely to 70.3% from 66.8% in the year ago quarter. In fact, TTS has now generated gross margin of 70% or better in four straight quarters. That is especially impressive when considering that many companies have seen their margins pressured due to rising raw material and labor costs.
TTS’ margins have been boosted by the company’s addition of over 2,000 new products; the company is beginning to see a meaningful contribution from those, and particularly from its higher priced stone category. This has been helpful as far as product mix is concerned.
On top of this, the company is shifting some of its product sourcing away from China in order to avoid the trade tariffs, switching to other geographies such as Turkey, India, and South America. These margin-boosting initiatives, combined with the better top-line growth, led to a 140% surge in Adj. EBITDA to $8.7 mln.
In short, TTS' quarterly results were actually pretty solid in our view, considering the challenging environment. The fact that the stock is trading lower by 15% today has a lot to do with the fact that shares had soared by nearly 40% since late December, setting up a "sell-the-news" type of reaction.
As for DOOR, it reported EPS of $0.68 vs. the $0.71 expectation with revenue up 3.9% to $528.4 mln, in-line with the consensus. However, unlike TTS, many of its other key metrics also showed some degradation. For example, gross margin fell to 18.0% compared to 19.7% in the year ago period, and Adjusted EBITDA decreased by 10% to $57 mln. Also, its revenue growth rate has been going the wrong way, from 9% in Q2 to 7.5% last quarter and then 3.9% this quarter.
During its earnings call this morning, management stated that the gross margin and EBITDA declines were both due to the same two issues: higher material costs (+5% in the quarter) and an abrupt slowing of orders, primarily in the month of December. Specifically, its North American residential business experienced a 3% dip in net sales as it saw much lighter-than-anticipated volumes.
Furthermore, the company was expecting to see a bump in December from pre-buying activity ahead of some price increases that were set to hit in January, but that did not come to fruition. These price increases came too late in the quarter to have a beneficial impact in the quarter -- although the company does project that they will help to offset cost pressures this year.
Similar to TTS, the company is implementing some cost-saving actions to help offset rising commodity prices and market softness -- including also looking at other sourcing options outside of China. From the end of Q3, DOOR has reduced company-wide headcount by 3% while also cutting U.S. overtime hours by over 20%. DOOR has also made investments to increase throughput at its plant in Monterrey, Mexico that have more than doubled that site's capacity, allowing it to more cost effectively service demand across North America.
In its earnings press release, TTS guided for FY19 gross margin of 69-70% and reaffirmed its long-term targets for Adj. EBITDA margin of 20% or more and pre-tax return on capital employed of 20% or greater. Meanwhile, DOOR issued in-line guidance for FY19, projecting EPS of $3.60-$4.40 vs. the $4.24 consensus on revenue of $2.24-$2.28 bln vs. the $2.28 bln estimate.
This in-line guidance, along with some encouraging commentary during the company’s earnings call, seems to have alleviated investors' concerns as the stock is currently trading modestly higher. The company stated that it still believes there are healthy fundamentals in the U.S. housing market and that there has been a rebound since December’s lows.
Looking ahead, the company is anticipating a relatively flat environment for housing this year -- coming off of a very strong 2018 -- which is a little more cautious than what real estate brokerage company Redfin (RDFN) just expressed during its earnings call. It commented that the housing market is getting stronger, as interest rates have eased, and that it believes the supply of homes for sale will increase, providing buyers with more options, but not at a rate that will cause prices to drop too sharply.
TTS agreed that the current housing market is mixed but reminded investors that it has always been strong in the remodeling space and that whenever the housing market dips, some customers turn to investing in and upgrading their homes, rather than trying to sell them. With repair and remodel spending expected to continue to grow in 2019, the company is confident that it can weather any type of downturn in the new housing market.
- OUR VIEW
- LEARNING CENTER