Buy Fortune Brands Stock. A Spinoff Will Boost Value. – Barron's





Fortune Brands Home & Security

is a leader in home remodeling, selling everything from cabinets to storm doors and plumbing. Now, it’s remodeling itself by spinning off its largest division into a stand-alone company that could draw in new investors and make the stock sparkle.

Fortune (ticker: FBHS) is no stranger to spinoffs. The company was born from a spinoff a little over a decade ago, when it was part of a conglomerate that also sold Jim Beam liquors and Titleist golf balls. That spin was extremely successful, as Fortune Brands has grown earnings per share at a 24% compound annual growth rate since then, versus 7% for the


S&P 500.

“Given our history, we know how to do these and we do them well,” says CEO Nicholas Fink.

Lately, Fortune stock has sold off along with other housing-related names, on fears that interest-rate hikes will sink its business. Shares are down 32% this year, to a recent $72.98.

Fortune now owns well-known home brands like Moen plumbing fixtures, Master Lock, and Omega cabinets. The next spinoff, which is likely to happen in 2023, involves splitting the company’s cabinetry division into a publicly traded company owned by Fortune shareholders. Fortune now gets about 40% of its revenue, or about $3 billion a year, from sales of cabinets.

The business rationale for the split is that the capital can be more efficiently allocated if the cabinet division—which has a different growth trajectory than Fortune’s other divisions—operates independently. The cabinets business is likely to grow in conjunction with the housing market, giving it a cyclical trading pattern that’s vulnerable to downturns. In 2021, cabinets sales grew 16%, slower than Fortune’s other divisions.

But the spinoff is also about the shareholder base. “Investors have wanted them to spin it off for a while,” says Baird analyst Timothy Wojs. “I think the cabinet business is a good business, but investors tend to spend an inordinate amount of time [evaluating it].” Wojs believes that the focus on cabinets ends up pulling down the valuation of the rest of the company.

The company’s other divisions have potential for more organic growth, with or without a major boost from housing. In 2021, its plumbing brands (now called “water innovations”) saw 25% sales growth. Outdoors and security brands increased sales by 44%. Fortune’s products in those areas are innovative and fetch higher prices. A plumbing system that’s just pipes isn’t worth a premium. One that can monitor the entire house for leaks or pump out water for a baby’s bottle at the perfect temperature is worth quite a bit more.

Other companies in those faster-growing areas tend to trade at higher valuations. Home-security company




Assa Abloy

(ASAZY), for instance, trades at 14 times enterprise value to Ebitda (earnings before interest, taxes, depreciation, and amortization), while water company




Xylem

(XYL) goes for 20 times EV/Ebitda. Fortune Brands, however, trades for just under 10 times, near a five-year low.

“There’s a tension there in the portfolio that was maybe preventing investors from being able to see that full potential, when you have something that is just a different strategy sitting in the same portfolio,” Fink says.

Based on a sum-of-the-parts analysis and 2023 earnings estimates, Wojs figures that cabinets would fetch a multiple of seven times Ebitda, while the water business would go for 12 times, and other divisions would receive elevated multiples. Stitched back together with more appropriate valuations, the company’s parts could be worth $92 per share, up from a recent $73, Wojs estimates.

Getting to that higher valuation will mean persevering through some tricky times. Fortune sources materials from around the world, and has dealt with some of the same supply-chain and inflation-related issues that have hurt other companies. Those problems caused its operating margin to fall to 13% in the first quarter, from 14.8% a year earlier.

But Fink says those pressures are starting to wane, and that the company has been able to pass along cost increases to consumers. In the coming quarter, the bulk of those price hikes should hit Fortune’s bottom line just as some of the supply-chain problems are diminishing. “We expect operating margin to expand sequentially across the balance of the year,” Fink said on Fortune’s latest earnings call.

The broader housing market has been slowing as mortgage rates rise above 5% and some buyers get turned off by high prices. The bigger problem is that there aren’t enough homes for sale—a near-term pressure for Fortune that’s likely to become a longer-term opportunity.

The housing market is severely undersupplied, with only two months worth of existing homes for sale, less than half the inventory needed to keep the market in balance. To achieve that balance, developers will have to build more units.

The combination of economics and pandemic-related lifestyle changes also mean that homeowners have greater incentives to renovate. An increasing portion of Americans’ net worth is in their homes, making them even more interested in upgrading than they were before the pandemic. “It’s a place for living and entertaining and teaching and working,” Fink says.

As Fortune Brands reorganizes, it’s also a good place for investing.

Write to Avi Salzman at avi.salzman@barrons.com



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