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Today, June 30, 2021, we are adding MasterCraft Boat Holdings, Inc. (MCFT) to and dropping MDC Partners Inc. (MDCA) from the Forbes Investor Master Buy List.
The desire to safely spend time with loved ones in the early days of COVID-19 led to a boon in demand for numerous outdoor activities allowing for easy adherence to the social distancing and quarantine measures put in place. A big beneficiary of this has been leading powerboat maker MasterCraft Boat Holdings, which saw the steep initial dry-up in demand caused by the pandemic quickly give way to record sales in the U.S. As a result, its stock skyrocketed 58% in 2020 and another 35% through the first five-and-a-half months of the current year.
Since then, however, MCFT’s shares have retreated over 23% on concerns that the gradual return to normal life as more people get vaccinated will put an end to the boating party. But with data suggesting that the company’s addressable market has been permanently increased by secular changes brought on by the pandemic such as the huge increase in the number of people working from home, we think this momentum in demand can endure. Indeed, with many of its offerings already sold out through the end of next year, MCFT appears in excellent position to continue enjoying meaningful growth for the foreseeable future. That’s why we’re not surprised by the company’s recent announcement to buy back up to $50 million of its stock following this dip and think those who do the same will be happy they did.
WHAT THEY DO:
MCFT is a leading innovator, designer, manufacturer and marketer of recreational powerboats. Through its MasterCraft, NauticStar and Crest Marine brands, the company has leading market share positions in three of the fastest growing segments of the powerboat industry—performance sport, outboard saltwater fishing, and pontoon boats—and continues to increase its presence in the large, growing luxury day boat segment with its newest modern luxury Aviara vessels. In addition, it also offers various accessories like trailers and aftermarket parts.
MCFT’s MasterCraft-branded portfolio (67% of Q3 net sales) consists of its ProStar, XStar, XSeries, XTSeries and NXT boats designed for the highest levels of performance, styling, and enjoyment of both recreational and competitive activities like water skiing, wakeboarding, wake surfing and general boating. It also includes the company’s new Aviara-branded AV32, AV36 and AV40 models designed to meet the exacting specifications of consumers seeking the ultimate luxury recreational day boat experience. MasterCraft and Aviara boats retail for about $75,000-190,000 and $345,000-670,000, respectively, and averaged $106,000 in Q3. MCFT’s NauticStar-branded lineup (12% of Q3 net sales) is comprised of high-quality outboard bay boats, deck boats and offshore center console boats that are designed for a variety of uses, including recreational and competitive sport fishing in both freshwater lakes and saltwater, and general recreational enjoyment. The average sales price (ASP) of NauticStar’s boats was $42,000 in Q3. Lastly, its Crest Marine banner (21% of Q3 net sales) is one of the top producers of innovative, high-quality pontoon boats, which range from 20 to 29 feet in size and also averaged $42,000 last quarter.
HOW THEY’VE DONE:
Fiscal 2021 Q3 net sales of $147.9 million were up 44.2% from the COVID-impacted prior-year period. Higher sales volume of 32.0% and 58.6% coupled with price increases of 7.1% and 7.7% drove 41.0% and 69.9% surges in MasterCraft and Crest Marine segment sales to $99.4 million and $30.4 million. MCFT’s NauticStar segment wasn’t far behind, with sales climbing 27.5% to $18.0 million as a 36.1% jump in volume easily offset a 6.7% drop in ASP. Further aided by less dealer incentives, favorable overhead absorption, and lower selling and marketing costs, the adjusted operating margin (excludes share-based compensation and other special items) expanded 559 basis points to 16.63%. Together with a decline in interest expense, this led to a more than doubling in adjusted net income to $19.1 million or $1.01 per share.
WHY TO BUY:
Like most areas of the economy, the boating industry was initially walloped by the arrival of the coronavirus at the beginning of 2020. Indeed, with the pandemic gathering steam, MCFT started pulling back its production rate in early March of last year and had completely suspended production by the end of the month on the anticipation of a dramatic drop in retail demand. As a precautionary measure, it also followed other companies in drawing down its entire $35.0 million revolving credit facility in order to shore up its liquidity during this uncertain time. Not surprisingly, these drastic actions contributed to MCFT finishing its last fiscal year (which ended June 30, 2020) with an unprecedented 58% drop in sales and suffering its first quarterly net loss (in Q4) since going public in mid-2015.
But with boating emerging as one of the few fun and family-friendly recreations that could be safely enjoyed outdoors even in the midst of the raging global pandemic, MCFT’s fortunes quickly turned. Thanks to this heightened interest in boating, fiscal 2021 (which started last July and ends today) has been a banner year for MCFT so far, with the company enjoying record profitability in each of the first three quarters. In fact, in just Q3 alone MCFT sold 2,098 boats—the most in the company’s history. Together with higher overall pricing, net sales for the quarter came in $9.0 million above analyst expectations to an all-time high of $147.9 million. And with MCFT also doing a tremendous job of minimizing the disruptions to its own operations from several supply chain issues that have been impacting the boating industry—including a resin shortfall, the power outages caused by the ice storms in South Texas, and container shortages and shipments from overseas—adjusted earnings per share for the period topped $1 for the first time and beat the consensus forecast by an impressive 31 cents.
What’s more, the strong cash flow generation that this favorable operating environment has also led to provided MCFT with enough confidence in its financial position to fully repay the $35.0 million borrowed on its revolver just two quarters later and further reduce its debt load by $13.8 million to $91.9 million while still boosting its cash balance by $23.5 million from pre-pandemic levels to $29.0 million. As a result, the company’s net debt actually improved by $37.3 million to just $62.9 million over this span.
Based on these strong year-to-date results, the company’s robust order book across its brands, historically low dealer inventories and its rising production rates, MCFT was optimistic enough heading into the summer selling season to raise its full-year guidance for the third time in as many quarters. Specifically, despite assuming continued inefficiencies in its production as it navigates through supply chain disruptions, it now expects to end fiscal 2021 with net sales growth approaching 40% and adjusted earnings per share growth up in the high 120% range year-over-year versus its prior view for top-line growth in the mid-to-high 30% range and a doubling in the bottom line from last year’s levels. This implies a near tripling in sales from last year’s COVID-19 diminished Q4 and is even more than 12% higher than fiscal 2019 Q4 levels. And the bottom-line is set to shine even brighter, with MCFT’s guidance indicating adjusted earnings of about 71 cents per share to close out fiscal 2021, which is well above the 62-cent profit analysts were anticipating and a dramatic improvement from the 10 cents it lost in Q4 of 2020.
Yet while this record-setting performance and continued favorable outlook initially drove MCFT’s stock up nearly 16% over the next four trading days to as high as $33.63, it’s given all of it back and more since, falling roughly 23% as it’s been sucked down with shares of other boat makers in what appears to be a broader industry sell-off over growing concern that the good times won’t last and people’s interests will shift away from boating as life continues to move past the pandemic.
While we agree that there will eventually be some kind of regression to the norm in terms of historical behavior, there are also good reasons to believe overall demand will continue to trend above pre-pandemic levels going forward. In particular, the sharp rise in the number of people choosing to work remotely is providing more freedom for many to flock to areas where they can enjoy the outdoors and have proximity to water as evidenced by the significant increases in prices for rural and waterfront properties compared to properties in urban areas recently. Furthermore, according to data from the National Marine Manufacturers Association (NMMA)—which represents North American recreational boat, engine and marine accessory manufacturers—three of the new powerboat categories that drove record retail unit sales in calendar 2020 were personal watercraft (up about 8%) like Jet Skis, Sea Doos and WaveRunners; wake boats (up about 20%) for wakesurfing, skiing and wakeboarding; and freshwater fishing and pontoon boats (up about 12%). Due to their accessible entry-level price points, these boats are often considered a gateway to boat ownership. In other words, while some of those who purchased boats in the past year may ultimately decide it’s not for them, we think the rise in the pool of people who have been introduced to and have enjoyed this leisure activity over this span has materially increased as well, which could lead to more of them wanting to upgrade to bigger and more expensive models in the future.
Backing up this view are the strong retail demand trends that MCFT has continued to see across its brands, which had the company entering the current quarter with a record wholesale backlog. This includes an order book for its MasterCraft brand that is completely sold out through the rest of 2021, a commitment from MarineMax (the largest marine dealership in the U.S.) to take all the Aviara boats MCFT can produce over the next twelve months, and additional dealer commitments for model year 2022 that have already exceeded the company’s own aggressive expectations. And this is occurring at a time where dealer inventories remain historically low and are not expected to return to optimal levels until sometime in calendar 2023.
As a result, MCFT finds itself in the fortuitous position that every boat it makes over the next year-and-a-half is already as good as sold and will require it to give very few, if any, incentives to dealers. And to help get the most from this favorable market environment, the company recently completed the relocation of all Aviara manufacturing to its new Merritt Island facility in Florida. This not only provides additional capacity to support the growth in this new brand anticipated in the years ahead, but also frees up much needed capacity for its MasterCraft brand in the old facility, which MCFT is already busy putting to good use. Indeed, with each of its facilities currently running at record production rates and continuing to aggressively ramp production to meet this enduring retail demand, we think the company is poised to close out fiscal 2021 in style and drive meaningful growth into fiscal 2022 and beyond. This is why we view the steep sell-off in the stock from its post-earnings high in early May as way too premature. Apparently, so does MCFT itself, which yesterday announced a new share repurchase authorization to buyback up to $50 million (or roughly 10% of its common stock at the current price) over the next three years. We think you’d do well to follow this lead.
MDCA was a very disappointing selection, losing about 19% of its value in the three years and three months it spent on the Forbes Investor Master Buy List. By comparison, the S&P 500 gained more than 60% during that span.
Despite the high hopes we had when the stock was initially recommended, it found itself down more than 30% just six weeks later following a very disappointing Q1 report on May 10, 2018 and has never recovered. In fact, it continued to trend lower and was trading at roughly $2.50 before the pandemic-fueled market sell-off sent it spiraling to a low of just $1.01 on April 3, 2020.
It was still trading close to this level when Stagwell Media—for which MDCA’s CEO, Mark Penn, is also the president and managing partner, and which already owned roughly 19% of the company through a $100 million investment made in March 2019—proposed a merger between the two firms highlighting the value-creating merits of such a transaction that sent it up 78% on June 26, 2020. While MDCA’s shares had dipped back down to $1.61 by the end of September, the signing of a preliminary, non-binding agreement in principle for this business combination in early October 2020 shot the stock back above $2 before the official announcement of a definitive agreement to merge with Stagwell (with MDCA and Stagwell shareholders initially expected to own 26% and 74% of the newly-formed firm) in late December had them ending 2020 at their highest level in more than two years.
Further bolstered by the favorable full-year guidance provided by both MDCA and Stagwell Media earlier this year, the stock had climbed another 80% from the end of 2020 ahead of the Q1 announcements by these companies on May 5. Fortunately, these results proved quite favorable with MDCA’s net revenue in the quarter decreasing just 1.4% from the prior year to $270.7 million and net income growing to a record $9.5 million (versus just $1.8 million in Q1 2020) thanks to the ongoing operational recovery from the pandemic lows and aggressive cost actions. Similarly, strong double-digit growth in nearly all its non-COVID-19 impacted segments, such as digital marketing, helped Stagwell Media’s Q1 net revenue and adjusted EBITDA grow 4.8% and 10.2% to $158.1 million and $23.8 million, respectively.
These operating results, combined with the reiteration of their full-year outlooks, increased our confidence in MDCA’s ability to deliver on its post-merger targets for achieving pro forma revenue and adjusted EBITDA run rates in excess of $2 billion and $350 million this year and annual organic revenue growth of at least 5% over the longer term. This had us optimistic that MDCA’s stock would see additional gains as a result. That also initially proved true with shares rising another 14% to a closing high of $5.62 on June 14.
However, as we wrote in our June 16 update, the stock began selling off two days later on news that Indaba Capital, MDCA’s largest shareholder, informed the Special Committee that it believed the terms of the current agreement, which Stagwell actually sweetened by increasing the ownership by MDCA’s shareholders in the combined firm, still did not properly value the company and that they will vote no to the merger. Yet as we wrote then, failure to consummate this deal would likely tank MDCA’s stock. Thus, despite all of Indaba’s rhetoric, we felt they would ultimately decide to vote in favor of the deal too. What’s more, while it may be MDCA’s single largest shareholder, Indaba Capital’s equity stake of 11.9% at that time was still small enough that as long as other large shareholders were on board, the deal was likely to get approval. That was especially true when you considered insiders who will vote in favor own 21% of MDCA and that discussions Stagwell has had with its other major shareholders indicated they are likely to vote yes to the revised proposal once the Special Committee assesses and approves it.
That said, Indaba Capital has continued its campaign of dissent and reiterated their frustration over Mark Penn’s unwillingness to engage with them regarding the matter in a press release posted earlier this week. It also indicated that Indaba Capital now owns about 15% of MDCA’s total shares outstanding, implying they have continued to increase their stake to make it more difficult to obtain the votes needed to pass the merger agreement in its current form. And with MDCA having scheduled the formal voting on this revised proposal for July 19, we would not be surprised if Indaba Capital continues to ratchet up its pressure until then.
While we still think there’s a better chance that the merger will successfully obtain shareholder approval than not, the risk of the latter was easier to bear when it drove MDCA’s stock down below $5 last week. However, with it having rebounded from this dip and now trading back to the level it was at before Indaba Capital committed to voting no to the deal, that’s no longer the case in our view. What’s more, given such a run-up ahead of this merger, it could take a few quarters of actually delivering on its post-merger expectations to drive the next leg up in the stock. Thus, we believe this is a good time to cut your losses on MDCA and move on to investment opportunities with greater certainty in its near-term prospects.
NOTE: After today’s moves, the total number of stocks on the Forbes Investor Master Buy List remains unchanged at 23.
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