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Armstrong World (AWI) Research Report: Q1 CY2024 Update


Full Report / June 06, 2024

Ceiling and wall solutions company Armstrong World Industries (NYSE:AWI) reported Q1 CY2024 results topping analysts' expectations, with revenue up 5.2% year on year to $326.3 million. The company's full-year revenue guidance of $1.42 billion at the midpoint also came in 4.7% above analysts' estimates. It made a non-GAAP profit of $1.36 per share, improving from its profit of $1.04 per share in the same quarter last year.

Armstrong World (AWI) Q1 CY2024 Highlights:

  • Revenue: $326.3 million vs analyst estimates of $319.4 million (2.1% beat)
  • EPS (non-GAAP): $1.36 vs analyst estimates of $1.23 (10.4% beat)
  • The company lifted its revenue guidance for the full year from $1.36 billion to $1.42 billion at the midpoint, a 4.4% increase
  • EBITDA Guidance for the full year is $475 million at the midpoint, above analyst estimates of $462 million
  • Gross Margin (GAAP): 38.1%, up from 36.1% in the same quarter last year
  • Free Cash Flow of $27.98 million, down 58.8% from the previous quarter
  • Organic Revenue rose 4.3% year on year
  • (8% in the same quarter last year)
  • Market Capitalization: $5.06 billion

Started as a two-man shop dating back to the 1860s, Armstrong (NYSE:AWI) provides ceiling and wall products to commercial and residential spaces.

The company makes ceilings and walls that improve the aesthetic and acoustic environment of interiors for businesses and homeowners. Its products help its customers build spaces that are visually appealing and functionally superior, promoting comfort and productivity.

The company offers a diverse range of ceiling and wall solutions, including mineral fiber, fiberglass, and metal ceiling tiles, along with suspension systems and walls. These products cater to various settings, from commercial buildings to residential homes, providing options for sound absorption, durability, and design flexibility.

It earns revenue primarily through the sale of its ceiling and wall products to contractors, builders, and architects for both new construction and renovation projects. The large majority of its net sales are to distributors, with large home centers like the Home Depot coming in second. Sales directly to customers and retailers make up the remaining small portion of its revenue.

Building Materials

Traditionally, building materials companies have built competitive advantages with economies of scale, brand recognition, and strong relationships with builders and contractors. More recently, advances to address labor availability and job site productivity have spurred innovation. Additionally, companies in the space that can produce more energy-efficient materials have opportunities to take share. However, these companies are at the whim of construction volumes, which tend to be cyclical and can be impacted heavily by economic factors such as interest rates. Additionally, the costs of raw materials can be driven by a myriad of worldwide factors and greatly influence the profitability of building materials companies.

Competitors offering wall and ceiling solutions include Saint-Goabin (EPA:SGO.PA) and private companies Hunter Douglas and USG Corporation.

Sales Growth

Examining a company's long-term performance can provide clues about its business quality. Any business can put up a good quarter or two, but the best consistently grow over the long haul. Over the last five years, Armstrong World grew its sales at a weak 5.8% compounded annual growth rate. This shows it couldn't expand its business in any major way. Armstrong World Total Revenue

We at StockStory place the most emphasis on long-term growth, but within industrials, a stretched historical view may miss cycles, industry trends, or a company capitalizing on new catalysts such as a contract win or a successful product line. Armstrong World's annualized revenue growth of 7.4% over the last two years is above its five-year trend, but we were still disappointed by the results.

Armstrong World also reports organic revenue, which strips out currency fluctuations and one-time events like acquisitions because they don't accurately reflect the company's demand. Over the last two years, Armstrong World's organic revenue averaged 6.4% year-on-year growth. Because this number aligns with its revenue growth, we can see the company's core operations drove most of its performance. Armstrong World Year-On-Year Organic Revenue Growth

This quarter, Armstrong World reported solid year-on-year revenue growth of 5.2%, and its $326.3 million of revenue outperformed Wall Street's estimates by 2.1%. Looking ahead, Wall Street expects sales to grow 4.1% over the next 12 months, a deceleration from this quarter.

Gross Margin & Pricing Power

Cost of sales for an industrials business is usually comprised of the direct labor, raw materials, and supplies needed to offer a product or service. These costs can be impacted by inflation and supply chain dynamics.

Armstrong World's unit economics are great compared to the broader industrials sector and signal it doesn’t sell a commodity but instead enjoys product differentiation through quality or brand. As you can see below, it's averaged an impressive 37.1% gross margin over the last five years. That means Armstrong World only had to pay its suppliers $62.89 for every $100 in revenue to provide its products and services.

Armstrong World Gross Margin

Armstrong World produced a 38.1% gross profit margin in Q1, marking a 2 percentage point increase from 36.1% in the same quarter last year. Zooming out, Armstrong World's margin has trended up over the last 12 months, increasing by 2.4 percentage points year on year. If this trend continues, it could suggest better unit economics and more leverage on the fixed portion of its cost of goods sold.

Operating Margin

Operating margin is a key measure of profitability. Think of it as net income–the bottom line–excluding the impact of taxes and interest on debt, which are less connected to business fundamentals.

Armstrong World has been a well-oiled machine over the last five years. It demonstrated elite profitability for an industrials business, boasting an average operating margin of 25.7%. This isn't surprising as its high gross margin gives it a favorable starting point for ultimate operating profitability.

Analyzing the trend in its profitability, Armstrong World's annual operating margin decreased by 6.5 percentage points over the last five years. Even though it's already high, shareholders will want to see Armstrong World grow its margin in the coming years.

Armstrong World Operating Margin (GAAP)

In Q1, Armstrong World generated an operating profit margin of 26.4%, up 3.8 percentage points year on year. This increase was encouraging, and since the company's operating margin rose more than its gross margin, we can infer it was recently more efficient with its general expenses like sales, marketing, and administrative overhead.

EPS

We track the long-term growth in earnings per share (EPS) for the same reason as long-term revenue growth. Compared to revenue, however, EPS highlights whether a company's growth was profitable.

Armstrong World's unimpressive 6.1% annual EPS growth over the last five years aligns with its revenue performance. On the bright side, this tells us its incremental sales were profitable.

Armstrong World EPS (Adjusted)

Like with revenue, we also analyze EPS over a more recent period because it can give insight into an emerging theme or development for the business. Armstrong World's two-year annual EPS growth of 14.9% topped its 7.4% two-year revenue growth.

In Q1, Armstrong World reported EPS at $1.36, up from $1.04 in the same quarter last year. This print beat analysts' estimates by 10.4%. Over the next 12 months, Wall Street expects Armstrong World to grow its earnings. Analysts are projecting its EPS of $5.31 in the last year to climb by 10.5% to $5.87.

Cash Is King

If you've followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can't use accounting profits to pay the bills.

Armstrong World has shown terrific cash profitability, enabling it to reinvest, return capital to investors, and stay ahead of the competition while maintaining a cash cushion. The company's free cash flow margin has been among the best in the industrials sector, averaging 20% over the last five years.

Taking a step back, we can see that Armstrong World's margin dropped by 5.9 percentage points during that time. Armstrong World's historical free cash flow profile was attractive, but shareholders are surely hoping for its trend to reverse.

Armstrong World Free Cash Flow Margin

Armstrong World's free cash flow clocked in at $27.98 million in Q1, equivalent to a 8.6% margin. The company's margin regressed as it was 1.1 percentage points lower than in the same quarter last year.

Return on Invested Capital (ROIC)

EPS and free cash flow tell us whether a company was profitable while growing its revenue. But was its growth capital-efficient? A company’s ROIC explains this by showing how much operating profit a company makes compared to how much money it has raised (debt and equity).

Although Armstrong World hasn't been the highest-quality company lately, it historically found a few growth initiatives that worked out wonderfully. Its five-year average ROIC was 25.3%, splendid for an industrials business.

Armstrong World Return On Invested Capital

The trend in its ROIC, however, is often what surprises the market and moves the stock price. Unfortunately, Armstrong World's ROIC averaged 6 percentage point decreases each year over the last few years. We like what management has done in the past but are concerned its ROIC is declining, perhaps a symptom of fewer profitable business opportunities.

Balance Sheet Risk

As long-term investors, the risk we care most about is the permanent loss of capital. This can happen when a company goes bankrupt or raises money from a disadvantaged position and is separate from short-term stock price volatility, which we are much less bothered by.

Armstrong World reported $69.6 million of cash and $581.4 million of debt on its balance sheet in the most recent quarter. As investors in high-quality companies, we primarily focus on two things: 1) that a company's debt level isn't too high and 2) that its interest payments are not excessively burdening the business.

With $445 million of EBITDA over the last 12 months, we view Armstrong World's 1.2x net-debt-to-EBITDA ratio as safe. We also see its $14.1 million of annual interest expenses as appropriate. The company's profits give it plenty of breathing room, allowing it to continue investing in new initiatives.

Key Takeaways from Armstrong World's Q1 Results

We were impressed by Armstrong World's optimistic full-year revenue guidance, which blew past analysts' expectations. We were also excited its operating margin outperformed Wall Street's estimates. Zooming out, we think this was a great quarter that shareholders will appreciate. The stock is flat after reporting and currently trades at $115.93 per share.

Is Now The Time?

Armstrong World may have had a good quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.

We appreciate companies solving complex business problems, but in the case of Armstrong World, we'll be watching from the sidelines. Its revenue growth has been uninspiring over the last five years. And while its powerful free cash flow generation enables it to stay ahead of the competition through consistent reinvestment of profits, the downside is its diminishing returns show its profitable business opportunities are shrinking. On top of that, its operating margin decline shows the business has become less efficient.

Armstrong World's price-to-earnings ratio based on the next 12 months is 19.7x. While one can find things to like about Armstrong World, we think there are better opportunities elsewhere in the market. We don't see many reasons to get involved at the moment.

Wall Street analysts covering the company had a one-year price target of $119.68 right before these results (compared to the current share price of $115.93).

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