American Woodmark (AMWD) is set to report second quarter results on November 24th. Last quarter, the company posted solid results beating both top and bottomline estimates. However, management’s commentary surrounding margins disappointed investors and the stock saw a brief correction. I argued in a previous article that the factors impacting margins like volume deleverage, Covid-19 related safety measures, labor retention, and investment in certain product related initiatives were short term in nature; and investors should focus on the significant momentum in the U.S. housing market which bode well for the company’s results in the second half of this fiscal year as well as FY2022.

The end markets have continued to improve since the end of the last quarter and the margin comparisons are also getting easier in the back half of this fiscal year. I believe the company’s guidance and performance over the next few quarters can act as a catalyst for the stock and the sell-side numbers can get revised upwards.

American Woodmark’s derives ~40% of its sales from new construction end market while ~60% of its sales is from repair and remodel business. Most of the investors following housing stocks know that the new housing demand is has been very strong over the last couple of months. Single family housing starts have increased 14% in August, 23% in September and 32% in October (see table below).

Source: Census.gov historical data

Kitchen cabinets are usually fitted towards the end of housing construction process. There is normally a 60 to 90 day lag between a new housing unit getting started and kitchen cabinet sales happening for that unit. So, the strong starts activity we have seen over the recent months will start reflecting in American Woodmark’s revenues in the third quarter.

Further, I believe this strong activity we are seeing in the housing market will continue in the near to medium term. I have explained in a previous article that there has been a significant under build in the housing market over the last decade and new housing starts need to remain at elevated levels for next several years to compensate for it. My analysis indicated that housing starts will likely continue to move higher from these levels. Recent commentary from home builders about there order trends have also been very encouraging. Last quarter, DR Horton (DHI) reported more than 80% yoy growth in net new orders in the while Meritage Homes (MTH) reported more than 70% yoy growth. The story is same across the board with almost every homebuilder seeing significant new order growth. Net new orders are a leading indicator for housing starts and there is a very good visibility and momentum in this market.

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Overall, I believe the end market demand growth for American Woodmark’s new housing related business can be in low 20s (yoy % growth) in back half of this year. Since, the company has a history of gaining market share and posting above market growth in its new construction business, I believe this business can grow its revenues in mid 20s (yoy % growth) in the back half of this year.

Remodeling business is a bit difficult to model as it has shorter lead times, but I am expecting a sequential improvement. While the company’s in-stock and stock business have performed well in the recent quarters, around half of the company’s remodeling business is stock plus, custom and semi-custom cabinets that has seen a decline. Buying these stock plus, custom and semi-custom cabinets involves some level of interaction with the company’s design teams and covid-19 related fear impacted this business severely in the early months of pandemic. So, this category performed poorly versus other home improvement and remodeling categories.

This is somewhat similar to what happened with KB Home (KBH) (see my article on KB Home here). Since KB Home primarily sell build-to-order customized homes and its sales process involves relatively higher personal interaction, its business saw a sharper downturn and slower recovery during the recent crisis. However, last quarter KB Home reported that its business has seen significant sequential improvement and its net orders were up ~32% in the first three weeks of September.

I believe directionally American Woodmark’s made-to-order (custom, semi-custom and stock plus business) is also likely seeing similar trends. Further vaccine availability early next year will provide a significant boost to this business. On its last earnings call, management said that they saw meaningful improvement in made-to-order business as the quarter progressed. While they didn’t provide the exact numbers, I believe the company’s remodeling sales can turn positive by the third quarter of this fiscal year.

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If we assume ~25% growth in new residential construction business (40% of the revenue) and flat to slightly positive result from remodeling business (60% of the business), the company can easily post double digit growth in the back half of this year.

The current sell-side consensus estimates (see table below) are implying mid-single growth in the back half and I believe they will likely get revised upwards.

Table: Consensus estimates for quarterly revenues

Revenues

Q1

Q2

Q3

Q4

FY 2020 actual

427

428

396

399

FY 2021 estimates (Note Q1 is actual)

390

448

419

422

yoy growth

-8.72%

4.68%

5.75%

5.65%

Source: Company filing, consensus estimates

In addition to good topline growth prospects, the company’s margin comparisons are also getting easier in the back half of this fiscal year. The company’s margins in the second half of the last year were impacted by disruptions in particleboard supply. Since then, new supply has come up in the market and pricing is favorable. So, the company has easier comparisons (see table below).

Table: American Woodmark’s quarterly EBITDA margins

Adjusted EBITDA margins

Q1

Q2

Q3

Q4

FY 2019

15.90%

14.30%

13.60%

15.70%

FY 2020

16.30%

14.70%

12.70%

13.40%

FY 2021

14.60%

~100 bps decline*

easy comparisons

* During last earnings call management indicated that they expect margins to decline ~100 bps in Q2

Also, some of the short-term costs from the company’s investment in technology, product refreshes, and labor retention will decrease in the back half of this year versus the first half; and the company will benefit from volume leverage. So, I believe we can see a year over year increase in margins in the second half of the current fiscal.

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With double digit revenue growth and margin improvement, the company can post significantly better results in Q3 this year than last year. I expect upward revision in consensus estimates to continue for the company in the near term.

The stock was trading at a 52-week high of ~$117 around Q3 end last year. If the company is going to post a significantly better performance in the third quarter of this year, why shouldn’t stock trade higher? So, I believe we can see $117 plus levels over the next couple of quarters.

Disclosure: I am/we are long AMWD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I have sold out of the money put options of American Woodmark.



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