We recently researched Reliance Worldwide Corporation (ASX:RWC) in The Dynamic Investor after the release of FY23 results in August. The result was broadly in line with consensus estimates. However, a cautious outlook issued by management has continued to weigh on the shares. Are we now at a point where this is starting to be factored into the share price, or is RWC more likely to be a value trap?
About Reliance Worldwide Corporation
Reliance Worldwide Corporation is a global designer, manufacturer and supplier of premium-branded water flow and control products. These products are typically used by end-users such as plumbers/contractors. These end customers purchase RWC’s products through a number of distributors.
The Company holds the leading market position in a number of product categories. In addition, it introduced a full range of Push-To-Connect (PTC) fittings to the US plumbing industry, through its premium SharkBite brand in 2004. PTC fittings allow lengths of pipe to be connected through a rapid push-on connection mechanism, without the need for soldering, clamps/rings, glue or tools.
Key Fundamental Drivers
Demand Environment Remains Weak
While RWC did not provide quantitative guidance for FY24, it noted that global economic conditions are expected to remain challenging.
In the Americas segment, the Company is seeing a slowing in major remodels. This is consistent with feedback from large retailers and industry sources that bath and kitchen remodels are being deferred. Remodelling activity is expected to decline by mid-single digits (in nominal $ terms) in FY24, according to the Leading Indicator of Remodeling Activity. The lower turnover of existing housing stock, which was a headwind in FY23, is expected to persist in FY24.
The Company also remains cautious about the outlook on market conditions in UK/Europe. In the UK, the group is cautious on both the new construction and repair and maintenance markets. The UK plumbing market had outperformed the broader UK Repair, Maintenance, and Improvement (RMI) sector from September 2022 to March 2023. However, this market is now underperforming. In addition, lead indicators for the RMI sector (such as house prices) appear to be decelerating into FY24.
Flat Outlook for EBITDA Margin
RWC’s EBITDA margin guidance for FY24 was slightly below expectations. This likely reflects ongoing inventory reduction and the associated impact on manufacturing overhead recovery.
Overall, we model a flat EBITDA margin outlook out to FY26, as there are both positive and negative influences on EBITDA margin over FY24-26. Positively, Automation should assist RWC’s manufacturing cost footprint over the short-to-medium term. In addition, there has been some easing in freight and copper off recent highs. Negatively, any margin benefit from lower input costs is likely to be shared with the powerful US retail channel. Secondly, the outlook for RWC’s end-markets remains challenging. This calls into question whether RWC can continue to implement the quantum of price increases recently passed through (~7-8%) over FY24/25.
Improved Cash Conversion to Lower Gearing
Gearing (on a net debt to EBITDA basis) as at 30 June 2023 declined to 1.7x, from 2.1x as at 31 December 2022. The gearing level is now towards the bottom end of the target range of 1.5-2.5x. An improvement in operating cashflow (+110%) and strong cash conversion (107%) allowed the Company to repay debt.
The Company is aiming to reduce inventories further. This is likely to contribute to margin pressure, as manufacturing is transferred from Australia to the US. However, it is likely to lead to further improvement in cash conversion and therefore, lower gearing.
The de-rating in RWC shares now sees the shares trading on a 1-year forward P/E multiple of ~13x. While this multiple remains below historical levels, we remain cautious. In particular:
i.RWC is rolling out new products to support a recovery in sales growth in US. However, the revenue and margin upside from recent product launches and ongoing operational efficiencies are considered to be more medium-to-longer term benefits. While this would ordinarily provide valuation support for the shares, a weakening demand outlook across all operating segments is likely to remain the key focus for investors over the short term.
ii.Consensus EPS forecasts for FY24 have been downgraded, with potential for the softer FY24 outlook to spill over into FY25.
iii.The unwinding of still-elevated levels of inventory in the retail channel presents a risk to forward sales growth. In context, over ~50%+ of RWC’s American sales come from Home Depot and Lowe’s.
At the June peak, RWC was sold of sharply before easing back towards $3.80. It then tried to rally again to retest that old peak in August, but once again if fell sharply and it has struggled ever since. We can now see RWC forming lower highs and lower lows. This means that RWC is at risk of falling further. The next level down is $3.40, which means investors looking to buy into RWC can wait for cheaper levels.
Michael Gable is managing director of Fairmont Equities.