Summary
I am positive on Fortune Brands Innovations (NYSE:FBIN). My summarized thesis is that the FBIN growth outlook seems positive in its key market (the US), as the macro situation is likely to get better. Moreover, growth could be structurally higher in the near-to-medium term as it leverages its partnership strategy to grow its digital product sales. As such, FBIN deserves to trade at a premium for its history.
Company overview
FBIN is a home goods retailer that sells a wide assortment of items, including plumbing, door systems, security, kitchen cabinetry, kitchen sinks, and related items. Revenue is split into three segments: Water Innovations [WI] (57% of FY23 revenue); Outdoors (27%); and Security (16%). However, on an adj EBIT basis, Water Innovations occupies a higher weight of 79%, followed by Outdoors at 23% and Security at 18% (corporate is loss-making, so the total of these three is >100%). The business has its main operations in the US, where it derives 80% of its total revenue.
Earnings results update
In the latest quarter (2Q24) reported last week, FBIN grew sales by 6.6% to $1.24 billion, positive growth across all three segments. WI grew 6.9%; Outdoors grew 3.7%; and Security grew 11.7%. Margins performed positively as well, with adj EBIT margin improving by 40bps y/y to 17.4% on a blended basis, driven by expansion in WI (10bps y/y expansion to 23.3%) and Security (330bps y/y expansion to 18.9%), but offset by minor compression in Outdoors (margin fell by 10bps y/y to 16.3%). This ultimately drove strong net earnings growth of ~31%, coupled with share buybacks; reported EPS grew at ~33%.
Demand outlook
It was a very strong quarter for FBIN and one that got me excited about the upcoming performance, especially considering that the US macro seems to be getting better. Just yesterday, the Fed sent another strong message that they were going to cut rates soon. This is marvelous for FBIN as it reduces mortgage rates, which is positive for home demand. This means demand opportunities as new home construction drives up demand for outdoor and plumbing products. While management is guiding US repair and remodel volumes to contract by 3-4% y/y, from the prior expectation of a 2–4% decline, I see the potential for upside if the Fed really cuts rates. Lower mortgage rates will likely drive up inventories of existing homes, which should translate into an increase in existing home sales (given the undersupply situation), and this should drive up more volumes for FBIN.
The main growth catalyst for FBIN is its digital product sales, which is guided to grow by more than 3x over the next 4 to 5 years, from the current ~$300 million to >$1 billion by 2030. The main product driving this growth in the WI segment is FBIN’s Flo by Moen product – detects inline water leaks and allows for valve shutoff. While this seems like a simple product, the cost savings could be huge (from spending on repairing parts of the home that are damaged). Hence, I expect strong adoption ahead, especially with the strong partnerships that FBIN has already established. One example is the national agreement that FBIN has announced with Farmers insurance, where policyholders can save on insurance premiums upon installation. This is one of several partnerships with major insurance companies. In addition, FBIN and the California Water Efficiency Partnership announced a partnership in June, which will raise awareness among local governments and citizens and pave the way for product rebates from the state. It should take some time for these partnerships to ramp up to full capacity, as such, FY25 is likely to be the year where FBIN reaps the full benefit.
Within the security segment, there are also new partnerships that are very promising. Firstly, FBIN announced a minority investment and partnership with Value Hybrid, which should open up cross-selling opportunities for FBIN’s Master Lock’s business, which has a large installed base. Basically, because a large portion of the installed base is still using mechanical systems (the Master Lock brand has literally >100 years of history), there is a lot of room to convert into connected systems. Additionally, FBIN also announced a new partnership with ADT, in which its Yale Assure 2 collection will be the preferred smart lock for ADT customers. Given that ADT’s is the best home security system provider in the US, this should contribute meaningfully to FBIN P&L.
Mentioned in the 2Q24 earnings call: we are excited to announce that we recently entered into a new partnership with ADT. Under this agreement, the Yale Assure Lock 2 collection will be the preferred smart lock for ADT customers across the country.
Source: Author’s calculation
As such, I am very excited about this digital product sales opportunity. Assuming that the $300 million will grow linearly to $1 billion in 2030, it implies a growth rate of ~40% in 2025, or a $117 million revenue contribution. This translates to about 240 bps of growth in FY25 (vs. FY24 revenue guide of $4.79 billion). Top that off with FBIN normalizing the growth of mid-single-digits pre-covid (FY16-FY19 average revenue growth was ~6%), growth could sustain high single-digits over the near-to-mid-term.
Valuation
Source: Author’s calculation
I believe FBIN is worth 17% more than the current share price. My target price is based on FY26 $654 million in adj net income and a forward PE multiple of 18x.
Earnings bridge: High single-digit revenue growth (as I noted above) with modest earnings margin expansion should result in FBIN achieving $654 million in adj. net income in FY26. As FBIN scales bigger, especially with its partnership strategy that can scale volume at a rapid pace, I would expect FBIN to benefit from fixed-cost leverage. The business has historically shown its ability to capture such incremental margins (adj net margin has improved from 7.2% 10 years ago in FY14 to 10.8% in FY23).
Valuation justification: With growth now expected to be structurally higher than in the past over the medium term, I believe FBIN should trade at a premium to its historical valuation range. Removing the COVID period drawn down, the FBIN long-term average (10-year) is around ~16.5x. I assumed FBIN to trade at the +1 standard deviation range for the near term (18x).
Investment Risk
China is not a meaningful part of FBIN business, but because of the macro-dynamics, where the consumer spending environment is poor, it has resulted in a huge growth decline—2Q24 China sales fell by 35%. The market is also expected to be down 15–20%. The sizeable decline, if it persists, will impact FBIN headline growth, which is not a good thing for stock sentiment.
Conclusion
My positive view on FBIN is because of its positive growth outlook, which stems from an improving macro backdrop and FBIN’s partnership strategy to drive digital product sales. This improved growth should also be accompanied by margin expansion as FBIN captures incremental margin from fixed-cost leverage. This performance dynamic should warrant the FBIN to trade at a premium to its own history.
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