(MAS) Masco Retains Underperform

We reiterate our Underperform recommendation on Masco Corporation (MAS), which manufactures, sells, and installs home improvement and building products.

The company earns 75-80% of revenues from the operations in North America, primarily in the U.S., while its international operations are located principally in Belgium, China, Denmark, Germany, the Netherlands, and the U.K. The company’s principal customer Home Depot, buys approximately 20%-30% of its production.

Masco recently reported its fiscal first quarter results delivering a loss of 5 cents per share in stark contrast to a profit of $0.03 per share during the year-earlier quarter. The company’s loss was broader than the Zacks Consensus Estimate of a loss of 3 cents. It was attributed to poor North American sales during the quarter, partially due to expiration of home buyer tax credit in mid-2010.

Net sales, which were in line with the Zacks Consensus Estimate fell 4% to $1.77 billion. Except Plumbing Products and Other Specialty Products segment, all the company’s segments reported a decline in revenues. Operating profit (adjusted) went down significantly to $53 million from $93 million in the first quarter of 2010.

North American sales dipped 7% to $1.33 billion while international sales rose 4% to $439 million. In local currencies, international sales increased 5% from the first quarter of 2010.  Segmentwise, sales in the Cabinets and Related Products segment fell 24% to $307 million; Installation and Other Services slipped 7% to $254 million and Decorative Architectural Products declined 4% to $375 million. Meanwhile, sales in Plumbing Products and Other Specialty Products rose 7% to $710 million and 2% to $126 million, respectively.

The following factors lead to an “Underperform” recommendation of Masco, nearly half of Masco’s revenues are related to new home sales. Falling home prices have made buyers reluctant to spend money on home investment projects. This has reduced Masco’s sales, which fell by almost 4% in the last quarter. Consequently, this will not only exert negative pressure on the company’s inventories and product prices but also affect margins.

Rising prices of raw materials are also impacting the company’s margins. Most of Masco’s products are made with the use of particle board, copper, brass, titanium dioxide and resins. Prices of each of these materials have risen steadily, driven by the global supply-demand process, certain feedstock restrictions and the price spread between crude oil and natural gas.

Masco has a significant exposure to its two principal customers: The Home Depot (HD) and Lowe’s Companies (LOW). However, these companies are not very dependent on Masco’s products. For instance, although Home Depot, the largest customer of the company, contributed almost 26% to Masco’s revenues in 2010, Masco’s products contributed only 10% of Home Depot’s sales.

Moreover, Masco’s Decorative Architectural Products segment sells its Behr Premium Plus brand paint exclusively through Home Depot. Therefore, the products under this brand are subject to Home Depot’s pricing power.

Besides, currency fluctuation has been hurting Masco due to its widespread global operations and raw material base in international locations. In order to mitigate this impact, the company has entered into certain foreign currency exchange contracts and foreign currency forward contracts. However, the company recorded a $4 million loss from its exchange contracts during the first quarter of the current fiscal.

Moreover, Masco operates in highly competitive markets worldwide. The company’s competitors include Benjamin Moore, Glidden, Olympic, The Sherwin-Williams Company (SHW), The Valspar Corporation (VAL) and Zinsser. This highly competitive scenario is aggravated by the economic downturn, adversely affecting prices and inhibiting growth opportunities.

Even in the coming quarters Masco’s earnings and sales are expected to continue to be hampered by the slowdown in new home construction, particularly after the expiration of federal tax credit toward home buyers. However, the company expects the second half of 2011 to be stronger than the first half. Masco currently retains a Zacks #4 Rank (short-term Strong ‘Sell’ recommendation.

Headquartered in Taylor, Michigan, Masco Corporation manufactures, sells, and installs home improvement and building products. Approximately 75%-80% of the company’s sales are generated from operations in North America, primarily in the U.S. International operations are located principally in Belgium, China, Denmark, Germany, the Netherlands, and the U.K.

The company’s principal customer Home Depot, buys approximately 20%-30% of its production. Masco operates five business segments: Plumbing Products, Cabinets and Related Products, Installation and Other Services, Decorative Architectural Products, and Other Specialty Products.

HOME DEPOT (HD): Free Stock Analysis Report

LOWES COS (LOW): Free Stock Analysis Report

MASCO (MAS): Free Stock Analysis Report

SHERWIN WILLIAM (SHW): Free Stock Analysis Report

VALSPAR CORP (VAL): Free Stock Analysis Report

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