Masco's Profit Margins Have Outperformed Our Expectations

Sector Director

Brian Bernard

Revenue segments as reported by the company.

Plumbing Products

Decorative Architectural Products

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We think Masco’s financial performance over the past decade has been as much of a self-help story as a story of improving end markets. Masco almost entirely refreshed its senior executive management team in 2014. Since then, it has taken significant measures to build a stronger and more consistent business model. The firm divested its most cyclical and least profitable businesses (it spun off its installation business, now named TopBuild, to shareholders in 2015 and sold its windows and cabinetry businesses in 2019 and 2020, respectively). Management also executed significant cost-reduction initiatives and shored up the firm's balance sheet. 

In our view, Masco's sale of its windows and cabinetry businesses was a positive development for the firm because we had long viewed its plumbing and decorative architectural businesses as the firm's crown jewels and key drivers of the company's valuation, while Masco's cabinetry and windows businesses were often laggards that had been a drag on margins and returns on invested capital. 

Repair and remodel, or R&R, spending, and to a much lesser extent, new residential construction, are major drivers of Masco’s financial performance. After divesting its installation, windows, and cabinetry businesses, the firm's overall exposure to the R&R market is 89% of sales.

R&R spending surged during the pandemic, but we don't expect a dramatic downturn in home improvement projects, although the amount spent per project will likely moderate over the near term resulting in modestly lower R&R spending. Historically, project incidence has been relative stable, but average project expenditure is more sensitive to macroeconomic conditions. We project owner-occupied improvement spending will decrease about 4.5% year over year in 2023 amid a weakening housing backdrop and a challenging prior-year sales comparison. Nevertheless, we continue to see a 5% long-term growth trajectory for R&R spending. We expect the repair and remodel market will benefit from several long-term secular tailwinds related to aging housing stock, favorable demographics, and increased acceptance of smart home and energy-efficient products and solutions.

Business Strategy & Outlook

Over the past two decades, Masco's plumbing and decorative architectural segments have comfortably outearned the firm's cost of capital and have each generated most of the firm's economic profits. We believe Masco's plumbing and architectural coatings-related intangible assets and the firm's relatively low-cost Behr distribution and sales platform will support excess returns for at least the next 20 years, supporting a wide moat.

We believe the Delta and Hansgrohe brand names yield pricing power relative to lower-end brands and imports, which support the segment's high-teens operating margins. Over the past decade, plumbing margins have benefited from the segment's ability to persistently generate favorable price/cost spreads (that is, increasing prices more than input cost inflation). Delta products, which are known for pleasing aesthetics, innovation, and quality, focus on mid- to mid-high-end price points. Based on our analysis, Delta’s average price point is below luxury suppliers Kohler and Grohe, slightly below Fortune Brands’ Moen, and well above American Standard and other lower-end brands. Hansgrohe is sold in more than 140 countries including the U.S. In the U.S., Hansgrohe is seen as a premium brand, with an average price point more in line with Kohler and Grohe. 

While there are examples of foreign competition taking share from incumbent plumbing fixture manufacturers in our coverage (new entrants such as Spain's Roca brand are taking market share from Australia-based GWA Group), we don't see increased imports as a material threat to Masco's core plumbing brands. There has been established foreign competition in the U.S. plumbing fixtures market for some time, and Masco has clearly held its own. Since the U.S. housing recovery began in earnest in 2010, Masco's organic plumbing sales have grown faster than the U.S. repair and remodel market and adjusted operating margin expanded more than 500 basis points to over 18%.

The decorative architectural segment, which mostly consists of the Behr paint and primer brand, has been Masco’s most profitable and highest-returning business. Behr paint is currently a leading brand in the U.S. do-it-yourself coatings market, with approximately 30% share, and the brand has been making inroads in the larger professional market, where it has roughly 10% market share. We think two main factors drive Behr’s strong financial performance. First, we think the Behr brand has built considerable brand equity, which drives repeat business and yields pricing power; second, Behr’s exclusive relationship with Home Depot, the largest home improvement retailer in the world, supports Behr's intangible assets and provides a cost advantage relative to Behr's main competitors, Sherwin-Williams, Benjamin Moore, and PPG, which rely on a more cost-intensive sales channel.

Because of its exclusive relationship with Home Depot, Behr has been able to expand market share without having to make costly investments in company-owned store space like Sherwin-Williams. Furthermore, we think Behr enjoys relatively low logistics costs because it has built its manufacturing and distribution facilities around a national home improvement behemoth with its own world-class distribution network. As such, Masco's decorative architectural segment generates much higher margins and ROICs than industry leader Sherwin-Williams, even with the segment's lower-margin hardware and lighting businesses, which accounts for approximately 25% of segment sales, and its far smaller scale (we estimate Masco's coatings business is one ninth the size of Sherwin-Williams). 

We think Behr and Home Depot have a symbiotic relationship that has strengthened over the years as both parties work collaboratively to expand the brand and take share from competing paint brands across the DIY and professional markets. Furthermore, we think Masco has parlayed this long-standing and successful partnership to increase the penetration rate of other products at Home Depot (for example's Masco's Liberty shower door program win at Home Depot, which was announced in 2016).

Masco is exposed to some environmental, social, and governance risks, including environmental and social impact of the firm's products and services and carbon emissions from the firm's operations. However, we don't believe these risks could result in material value destruction.

Masco's failure to keep pace with global green building standards and demand trends could result in reputational risk and lost market share, but we see a low probability of this risk materializing. Masco has a long history of developing innovative and environmentally friendly products, and a significant amount of revenue is tied to green products (for example, 86% of Behr product sales and 73% of Delta product sales in 2019). We expect the firm's product leadership and its commitment to environmentally friendly products will continue. Some of Masco's operations could face stringent carbon regulations, but we think the firm's regulatory risk is manageable and likely not material. Furthermore, the company has been making investments to reduce its carbon emissions.

Wide

Economic Moat

Masco

Masco Corp. engages in the design, manufacture, marketing, and distribution of branded home improvement and building products. It operates through the following business segments: Plumbing Products and Decorative Architectural Products. The Plumbing Products segment includes faucets, plumbing fittings and valves, showerheads and hand showers, bathtubs and shower enclosures, toilets, spas, and exercise pools. The Decorative Architectural Products segment offers paints and coating products, and cabinet, door, window, and other hardware. The company was founded by Alex Manoogian in 1929 and is headquartered in Livonia, MI.

Earnings data Q3 2023

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Masco Corp. engages in the business of designing, manufacturing, and distribution of branded home improvement and building products. It operates under the Plumbing Products and Decorative Architectural Products segments. The Plumbing Products segment includes faucets, showerheads, handheld showers, valves, bath hardware and accessories, bathing units, shower bases and enclosures, shower drains, steam shower systems, sinks, kitchen accessories, and toilets. The Decorative Architectural Products segment focuses on architectural coatings, including paints, primers, specialty coatings, stains and waterproofing products, and paint applicators and accessories. The company was founded by Alex Manoogian in 1929 and is headquartered in Livonia, MI.

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