I've been curious about U.S. home appliance manufacturer Whirlpool (NYSE:WHR) for some time now; unfortunately standing on the sidelines while the stock soared immediately after the fourth quarter earnings. Although this company does have legitimately worrisome issues with margins, free cash flow conversion and foreign competition, skeptics may find that there's quite a bit more here than they assume.
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Fourth Quarter Results Lukewarm
Whirlpool had something of a good news/bad news release for the fourth quarter. Reported revenue fell 3% (or 2% in constant currency terms) and that wasn't great. Although North America eeked out a 1% sales gain, results were weaker than expected in Latin America and Europe (down 1 and 7%, respectively, in constant currency). Curiously, shipments were remarkably consistent across Whirlpool's major segments - down 3% in North America and 4% in both Europe and Latin America.
To management's credit, expense control was quite good. Gross margin did improve more than a point, and operating income declined just 3% - keeping the operating margin constant despite the potential deleverage that often goes with lower sales. On a geographical basis, the earnings picture was chaotic - strong growth in North America, a lot of weakness in Latin America and ongoing malaise in Europe. (For related reading, see Zooming In On Net Operating Income.)
Guidance Hits the Spin Cycle
Against a backdrop of so-so reports from companies like Electrolux and General Electric (NYSE:GE), Whirlpool pretty much stunned the Street with its guidance. The company expects low single-digit shipment growth around the world (except Europe, where they look for single-digit declines), and ongoing margin improvements. So strong are the improvements that the midpoint of guidance was basically one-third higher than what the Street had modeled.
There are a couple of points to consider, though. First, there aren't many analysts following Whirlpool anymore, so surprises have to be kept in that context. Second, management's guidance for free cash flow next year wasn't especially strong, and was below the very view published estimates I could find. For those investors who prioritize free cash flow, that's a concern.
The Battle Against the Koreans Heats up
One of the major issues that Whirlpool has had for some time now is the ongoing growth of imports in the U.S. appliance market, particularly appliances from Samsung and LG. Whirlpool has been alleging for some time, though, that these companies are not playing fair - grabbing share with price cuts that amount to dumping. The Federal Trade Commission found Whirlpool's prior filing on refrigerators compelling enough to implement a 15% tariff, and Whirlpool has since filed a motion on washers as well. In addition to price competition, there have also been IP entanglements, and Whirlpool has successfully pursued some patent litigation against LG.
Waiting for the Domestic Recovery
Appliance sales do correlate to some extent with housing sales and overall consumer confidence. Not surprisingly, while housing sales (and auto sales) have been so weak in recent years, so too have North American appliance sales.
Sooner or later, the thinking goes, this has to turn around. Sooner or later old machines break down and it's just not viable to go without a refrigerator or stove (and many people would add a washing machine to that list). A similar argument can be made for other housing-related stories like Armstrong (NYSE:AWI), Mohawk (NYSE:MHK) and Ethan Allen (NYSE:ETH), and it's worth noting that those stocks have been much stronger over the last year or two.
Risks and Opportunities
The U.S. appliance retail market is extremely concentrated, with half of all sales occurring through Sears (Nasdaq:SHLD) and Lowe's (NYSE:LOW) and nearly two-thirds of sales through Home Depot (NYSE:HD) is added to the mix. With Sears apparently in trouble, that could create some exposure risk for Whirlpool.
Still, what many people forget is that Whirlpool actually has a strong, growing emerging market business. Whirlpool is the No. 1 appliance maker in Brazil (about 40% share) and the No. 2 maker in India (25% share). That says something to me not only about the company's marketing and design capabilities, but also its manufacturing - it's not as though a U.S. company can capture so much share in emerging markets without a competitive cost structure.
The Bottom Line
I have to say that Whirlpool's relatively low margins and low returns on capital concern me, as does the very low free cash flow conversion. For this stock to work over the long haul, those numbers just have to improve. (For related reading, see Free Cash Flow: Free, But Not Always Easy.)
Still, I'm intrigued. The company is doing OK despite many years of a very tough U.S. market, and now a weakening Europe as well. I like the domestic rebound potential as well as the emerging market growth angle, and the company's margin progress this quarter (and projected into next year) is quite encouraging.
Right now, I think Whirlpool's stock is worth something in the high $70's - undervalued enough to be tempting, but not enough for me to buy. Should the stock retreat a bit, though, or the company starts showing improving free cash flow conversion, I'd have to revisit the question of when to buy.
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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.
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