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Fortune Brands (FBIN) Research Report: Q1 CY2024 Update


Full Report / June 07, 2024

Home and security products company Fortune Brands (NYSE:FBIN) reported Q1 CY2024 results exceeding Wall Street analysts' expectations, with revenue up 6.7% year on year to $1.11 billion. It made a non-GAAP profit of $0.83 per share, improving from its profit of $0.69 per share in the same quarter last year.

Fortune Brands (FBIN) Q1 CY2024 Highlights:

  • Revenue: $1.11 billion vs analyst estimates of $1.08 billion (2.7% beat)
  • EPS (non-GAAP): $0.83 vs analyst estimates of $0.75 (10.7% beat)
  • Gross Margin (GAAP): 43.9%, up from 39.3% in the same quarter last year
  • Free Cash Flow was -$135.9 million, down from $139.4 million in the previous quarter
  • Organic Revenue fell 2.2% year on year
  • (-7.3% in the same quarter last year)
  • Market Capitalization: $8.34 billion

Targeting a wide customer base of residential and commercial customers, Fortune Brands (NYSE:FBIN) makes plumbing, security, and outdoor living products.

The company offers solutions in home and lifestyle products to builders and home homeowners. Its products solve challenges related to home security, water management, and outdoor living and provide customers with reliable and efficient solutions for modern living.

It offers a wide range of products, including smart home security systems, advanced water filtration systems, stylish outdoor living solutions, and premium door hardware. In addition, the company provides installation, maintenance, and repair services.

Fortune Brands Innovations generates revenue primarily through the sale of its innovative products and associated services. Its business model revolves around manufacturing, distribution, and service provision, with product sales accounting for the majority of its revenue. While the division may offer maintenance contracts and replacement parts, recurring revenue is not the primary focus of its business model.

Home Construction Materials

Traditionally, home construction materials companies have built economic moats with expertise in specialized areas, brand recognition, and strong relationships with contractors. More recently, advances to address labor availability and job site productivity have spurred innovation that is driving incremental demand. However, these companies are at the whim of residential 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 home construction materials companies.

Other companies providing similar products include Honeywell (NYSE: HON), Masco (NYSE: MAS), and privately held company Kholer.

Sales Growth

A company’s long-term performance can give signals about its business quality. Even a bad business can shine for one or two quarters, but a top-tier one tends to grow for years. Fortune Brands struggled to generate demand over the last five years as its sales dropped by 3.3% annually, setting a rough starting point for our quality assessment. Fortune Brands Total Revenue

Long-term growth is the most important, but within industrials, a half-decade historical view may miss new industry trends or demand cycles. Fortune Brands's annualized revenue declines of 13.5% over the last two years suggest its recent demand was even weaker than before. Fortune Brands isn't alone in its struggles as the Home Construction Materials industry experienced a cyclical downturn, with many businesses seeing lower sales at this time.

Fortune Brands 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, Fortune Brands's organic revenue averaged 3.8% year-on-year declines. Because this number is better than its revenue growth, we can see that some mixture of foreign exchange rates and divestitures dampened its top-line performance. Fortune Brands Year-On-Year Organic Revenue Growth

This quarter, Fortune Brands reported solid year-on-year revenue growth of 6.7%, and its $1.11 billion of revenue outperformed Wall Street's estimates by 2.7%. Looking ahead, Wall Street expects sales to grow 4.2% over the next 12 months, a deceleration from this quarter.

Gross Margin & Pricing Power

In the industrials sector, a company's gross profit margin is a critical metric to track because it sheds light on its pricing power, complexity of products, and ability to procure raw materials, equipment, and labor.

Fortune Brands'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 38.5% gross margin over the last five years. That means Fortune Brands only had to pay its suppliers $61.46 for every $100 in revenue to provide its products and services.

Fortune Brands Gross Margin

Fortune Brands produced a 43.9% gross profit margin in Q1, marking a 4.7 percentage point increase from 39.3% in the same quarter last year. Zooming out, Fortune Brands's margin has trended up over the last 12 months, increasing by 2.3 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

Fortune Brands has been an efficient company over the last five years. It demonstrated it can be one of the more profitable businesses in the industrials sector, boasting an average operating margin of 14.1%. 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, Fortune Brands's annual operating margin rose by 1.3 percentage points over the last five years, showing its efficiency has improved.

Fortune Brands Operating Margin (GAAP)

In Q1, Fortune Brands generated an operating profit margin of 14%, up 1.3 percentage points year on year. Since its gross margin expanded more than its operating margin, we can infer that leverage on its cost of sales was the main driver behind the recently higher efficiency.

EPS

Analyzing long-term revenue trends tells us about a company's historical growth, but the long-term change in its earnings per share (EPS) points to the profitability of that growth–for example, a company could inflate its sales through excessive spending on advertising and promotions.

Fortune Brands's EPS grew at an unimpressive 4.1% compounded annual growth rate over the last five years. On the bright side, this performance was higher than its 3.3% annualized revenue declines and tells us management adapted its cost structure in response to a challenging demand environment.

Fortune Brands EPS (Adjusted)

We can take a deeper look into Fortune Brands's earnings to better understand the drivers of its performance. As we mentioned earlier, Fortune Brands's operating margin expanded by 1.3 percentage points over the last five years. On top of that, its share count shrank by 10.5%. These are positive signs for shareholders because improving profitability and share buybacks turbocharge EPS growth relative to revenue growth.

Like with revenue, we also analyze EPS over a shorter period to see if we are missing a change in the business. For Fortune Brands, its two-year annual EPS declines of 15.7% mark a reversal from its five-year trend. These results were bad no matter how you slice the data.

In Q1, Fortune Brands reported EPS at $0.83, up from $0.69 in the same quarter last year. This print beat analysts' estimates by 10.7%. Over the next 12 months, Wall Street expects Fortune Brands to grow its earnings. Analysts are projecting its EPS of $4.04 in the last year to climb by 9.7% to $4.43.

Cash Is King

Although earnings are undoubtedly valuable for assessing company performance, we believe cash is king because you can't use accounting profits to pay the bills.

Fortune Brands has shown robust cash profitability, giving it an edge over its competitors and the option to reinvest or return capital to investors. The company's free cash flow margin averaged 9.9% over the last five years, quite impressive for an industrials business.

Taking a step back, we can see that Fortune Brands's margin expanded by 3.5 percentage points during that time. This is encouraging and shows the company is heading in the right direction.

Fortune Brands Free Cash Flow Margin

Fortune Brands burned through $135.9 million of cash in Q1, equivalent to a negative 12.2% margin. The company's quarterly cash flow turned negative after being positive in the same quarter last year, but we wouldn't read too much into it because working capital needs can be seasonal and cause short-term swings.

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 Fortune Brands hasn't been the highest-quality company lately because of its poor revenue and EPS performance, it historically found a few growth initiatives that worked. Its five-year average ROIC was 13.3%, higher than most industrials businesses.

Fortune Brands Return On Invested Capital

Balance Sheet Risk

Debt is a tool that can boost company returns but presents risks if used irresponsibly.

Fortune Brands reported $359.7 million of cash and $3.04 billion 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 $940.4 million of EBITDA over the last 12 months, we view Fortune Brands's 2.9x net-debt-to-EBITDA ratio as safe. We also see its $45.4 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 Fortune Brands's Q1 Results

We were impressed by how significantly Fortune Brands blew past analysts' organic revenue expectations this quarter. We were also excited its revenue outperformed Wall Street's estimates. Zooming out, we think this was an impressive quarter that should delight shareholders. The stock is flat after reporting and currently trades at $66.67 per share.

Is Now The Time?

Fortune Brands 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 Fortune Brands, we'll be watching from the sidelines. Its revenue has declined over the last five years, but at least growth is expected to increase in the short term. And while its rising cash profitability gives it more optionality, the downside is its organic revenue has been disappointing. On top of that, its unimpressive EPS growth over the last five years shows it's failed to produce meaningful profits for shareholders.

Fortune Brands's price-to-earnings ratio based on the next 12 months is 15.1x. While one can find things to like about Fortune Brands and its valuation is reasonable, we think there are better opportunities elsewhere in the market.

Wall Street analysts covering the company had a one-year price target of $86.40 right before these results (compared to the current share price of $66.67). Readers should still exercise caution as analysts tend to be overly optimistic. The firms they work for, often big banks, have relationships with companies that extend into fundraising, M&A advisory, and other lucrative business lines. As a result, they typically hesitate to say bad things for fear they will lose out on other business. We at StockStory do not suffer from such conflicts of interest, so we’ll always tell it like it is.

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