Norcraft Companies Inc (NYSE:NCFT) is well positioned to experience accelerated EBITDA growth as it benefits from an improving housing market and leverages company-specific factors.
Specifically, its exposure to the dealer channel, which accounted for about 90 percent of 2012 revenues, represents a competitive advantage, given the higher margins normally associated with buyers in this channel and the relative "stickiness" of these relationships.
Based in Eagan, Minnesota, Norcraft Companies is a leading kitchen and bathroom cabinetry manufacturer primarily focused on the dealer channel. This offers advantages versus selling direct to builders or through home centers.
With estimated revenues of $340 million in 2013, Norcraft is the fifth largest US cabinet manufacturer. Reflecting its exposure to the dealer channel (it's the third largest player, with 7 percent of the market), more than 90 percent of sales are in the semi-custom segment.
UBS analyst David Goldberg believes profitability in this dealer channel has been among the best, driven primarily by product mix as dealers' sales tend to be concentrated in more complex, semi-custom cabinets.
Meanwhile, switching costs are high, reflecting the significant investment required. Demonstrating this, Norcraft's retention rate with "large" customers has been about 97 percent since 2011. Further, through June 2013, the company had been working with its top 50 customers for an average of 15 years.
The company could gain share and grow profitability as the housing recovery unfolds given its penetration in this channel (it's the third largest cabinet manufacturer to dealers) and its operational acumen.
Goldberg noted that benefits from recent investments should materialize in the up-cycle. The company recently converted a Canadian components facility to a full access cabinet line producer under the Urban Effects brand. Including this plant, capacity utilization is approximately 60%.
These significant investments ! should drive accelerated top-line growth as NCFT's sales force further penetrates existing accounts and develops new relationships and greater operating leverage.
Broad product offerings allow for flexibility. Although semi-custom cabinets represented about 91 percent of Norcraft's 2012 sales, the company offers a broad range of products differentiated by both design and price point.
Within the frame category, four brands are supported (including two lines within the Mid Continent Series). In the full access category, Norcraft supports two brands (including 2 lines within UltraCraft).
Further, about two-thirds of its business relates to repair and remodel demand, with the remainder from new construction. Finally, the company offers more than 600,000 door and finish combinations for use in kitchens and bathrooms.
Goldberg believes the market is the early innings of the housing recovery. Although a more restrictive mortgage market is likely to govern the amplitude of the improvements relative to the last cycle, he forecasts significant gains from current levels, albeit at a more moderate pace of growth.
Further, increased stability around home prices should help drive greater demand for repair and remodel projects, especially larger ones. As home prices stabilize, deferred repair and remodel should unfold, contributing to additional demand for building products.
Through the downturn, Norcraft has had success in improving its sales mix toward higher price products, which is contributing to margin expansion. Goldberg said although the company isn't focusing on the builder and home center channels today, supporting a broad product range gives it the opportunity to pursue these options should they choose to do so.
Year to date, building products stocks have risen an average of 25 percent, effectively in line with the S&P 500. On the positive side, investors are generally optimistic housing has bottomed, and the early stages of recovery are unfolding.
Goldber! g forecas! ts free cash generation of more than $21 million in 2014 and anticipates more significant levels in the future. In turn, the leverage to decline meaningfully over the next several years, bringing Norcraft in line with its peer average.
Moreover, while the pause in construction has negatively impacted the home-building stocks, shares of product companies have been more resilient, likely reflecting the diversified nature of their businesses and the better free cash flow dynamics. As such, Norcraft is well positioned to gain share and increase profitability as the housing recovery unfolds.
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