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Fortune Brands' Segmental Opportunities Solid, Costs a Drag

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We issued an updated research report on Fortune Brands Home & Security, Inc. (FBHS - Free Report) on Jun 12.

This security and safety service provider currently carries a Zacks Rank #3 (Hold). Its market capitalization is approximately $8.4 billion.

Let’s delve deeper and discuss the company’s potential growth drivers and possible headwinds.

Factors Aiding Fortune Brands

Favorable Operating Conditions: We believe that security and safety service provider companies are poised to benefit from the strengthening of U.S. economy and healthy growth prospects of the global market. Considering the domestic housing market, increase in housing starts, as well as higher demand for repair and remodeling activities, will spur demand for Fortune Brands’ products.

For 2018, the company anticipates home products market in the United States to grow 5-7% while the global market is expected to increase 5-6%.

To leverage gains from such favorable operating conditions, the company has been diligently working toward solidifying its product portfolio. The addition of brands like Shaws of England and Victoria + Albert to the Global Plumbing Group in 2017 is worth mentioning here. These assets are anticipated to generate combined revenues of $45 million annually for the company.

Reward for Shareholders: Fortune Brands ardently believes in rewarding shareholders handsomely, especially through dividend payments and share buybacks. Over the last five years, the company’s annual dividend payment has grown from 30 cents in 2013 to 72 cents in 2017. After an 11% hike in the quarterly dividend rate announced in December 2017, the company’s annual dividend rate now stands at 80 cents.

Also, in April 2018, share buyback program of $150 million was authorized by the board of directors. This program has two-year validly and shares can be repurchased in the open market or through privately negotiated transactions. This, along with $160 million left from the earlier $250-million program — which was authorized in December 2017 and is slated to expire on Dec 8, 2019 — allows the company to repurchase up to $310 million of its common shares.

Growth Projections: Solidifying business of Global Plumbing Group, favorable pricing and its cost actions, as well as ongoing share buybacks, will benefit Fortune Brands in 2018. The company anticipates sales to grow by 6-7% in the year. Earnings per share (before charges/gains) are predicted to be $3.58-$3.70, higher than $3.54-$3.66 expected earlier. The mid-point of the revised forecast is well above the year-ago earnings of $3.08.

Also, Plumbing, Doors and Security segments are anticipated to flourish in the year. For the Doors segment, sales are projected to increase in low-double digits, better than high-single digit to low-double digits expected earlier, on the back of the expansion in retail business. For the Security segment, sales are predicted to increase in mid-single digit while for the Plumbing segment sales will likely grow in the low-double digits versus high-single digit expected earlier.

Factors Working Against Fortune Brands

Poor Share Price Performance and Valuation, Lower Earnings Estimates: In the first quarter of 2018, Fortune Brands reported weaker-than-expected results with earnings of 56 cents per share, lagging the Zacks Consensus Estimate of 59 cents by 5.08%. Also, net sales missed estimates by 0.4%. Revenues from the Cabinets segment were weak in the reported quarter, declining 3% year over year. For 2018, the company has lowered its sales growth projection for the Cabinets segment. It is now anticipating growth in the low-single-digit range versus mid-single digit predicted earlier.

In the past three months, the company’s shares have declined 7.6% versus 6.6% decrease recorded by the industry. Also, on a P/E (TTM basis), the stock looks overvalued compared with the industry, based on respective tallies of 18.6x and 15.6x in the past three months.

Moreover, earnings estimates on the company have been revised downward in the last 60 days. The Zacks Consensus Estimate is currently pegged at $1.04 for the second quarter of 2018, representing a decline of 3.7% from its 60-day-ago tally. Also, the impact of three upward revisions in earnings estimates for 2018 was offset by two downward revisions, keeping estimates stable at $3.63 per share.

Rising Costs & Expenses Raise Concerns: Fortune Brands is dealing with adverse impacts of rising costs and operating expenses. Notably, the company’s cost of sales in the last five years (2013-2017) grew at 6.8% (CAGR) while its operating expenses went up 4.7%. The trajectory continued in the first quarter of 2018 as well, with the cost of sales and operating expenses increasing 5.5% and 8.1% from their respective tallies in the year-ago comparable quarter. We believe that unwarranted rise in costs and expenses will prove detrimental to the company’s margins and profitability.

Long-Term Debt: Fortune Brands is a highly leveraged company. In the last five years (2013-2017), the company’s long-term debt soared 33.9% (CAGR) while grew roughly 2% sequentially to approximately $1.5 billion at the end of first-quarter 2018. Also, the company’s total debt/total equity has increased from 13.2% in 2013 to 58% in 2017. It stood at 80.1% at the end of first-quarter 2018. We believe, if unchecked, high-debt levels can inflate the company’s financial obligations and put pressure on margins.

Stocks to Consider

Some better-ranked stocks in the industry are Axon Enterprise, Inc. (AAXN - Free Report) , MSA Safety Incorporated (MSA - Free Report) and Johnson Controls International plc (JCI - Free Report) . While both Axon Enterprise and MSA Safety sport a Zacks Rank #1 (Strong Buy), Johnson Controls International carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks Rank #1 stocks here.

In the past 60 days, earnings estimates for each of these stocks have improved for the current year and the next year. Also, average positive earnings surprise for the last four quarters was 330% for Axon Enterprise, 16.35% for MSA Safety and 1.95% for Johnson Controls International.

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