JELD-WEN Struggling Now; Demand Could Erode Further Next Year

The manufactured building materials sector has admittedly seen some poor performers over the last two years despite strong residential and non-residential activity, but JELD-WEN (NYSE:JELD) (“Jeld-Wen”) nevertheless stands out with particularly poor performances on growth, margins, returns (ROIC, et al), and share price performance. Double-digit price increases haven’t been enough to offset steep cost inflation, and now the company is going into a period where underlying demand could well be noticeably weaker. On top of all that, whenever the company names its next permanent CEO, that will be the fourth such appointment in nine years – not a mark of stability.

When shares of a company like Jeld-Wen look cheap, it’s fair to ask yourself whether you’re underestimating just how tough things really or whether the market has overreacted and left the stock for dead. In many cases the answer can be “both”, and that could be the case here. I don’t feel like forward revenue growth of 3% to 4% and free cash flow margins in the 3% to 4% range are especially aggressive assumptions, but if pricing normalizes, they could well prove too aggressive and whatever undervaluation I see here could vanish quickly.

Meeting Lowered Q3 Expectations, But Lowering The Bar Again

Although Jeld-Wen did technically surpass expectations with third quarter results, those expectations were significantly reduced after the disappointing results of the second quarter (following another disappointing quarter for Q1’22), and management once again lowered expectations. Input cost inflation remains the prime culprit for the underwhelming results, but now weaker retail demand is moving into the picture as well.

Revenue rose 13%, or 18% in organic terms, in the third quarter, beating expectations by about 6%. Growth was fueled by strong pricing – up 15% – and okay volumes that grew 3%. The North America business was the strongest by far, with 17% pricing growth and 6% volume growth, while European revenue rose 10% (price up 13%), and Australasian revenue rose 14% (price up 10%).

Pricing has started to outpace cost inflation, driving 90bp of sequential gross margin improvement, but gross margin was still down 50bp to 19.4%. EBITDA rose 18%, beating by 7%, with margin up 40bp yoy and down 50bp to 9%. Looking at the segments, North American EBITDA rose 37% with margin up 120bp yoy and 150bp qoq to 12.6%, but that’s still below the 13.9% of Q3’2020. EBITDA in the Europe segment fell 24% (margin down 150bp to 5.9%) on worsening cost pressures, and profits in Australasia rose more than 13%, with margin up 90bp to 12.8%. Adjusted operating income rose 7%, with margin down 20bp to 4.5%.

For a little added perspective, looking at Q3 results in terms of analyst expectations at the time of the Q2 earnings announcement, revenue beat by close to 4%, but EBITDA missed by 15%.

The issue is very much cost inflation and management’s ability (or lack thereof) to offset those pressures with pricing and productivity. Management guided the next quarter’s EBITDA down 7% at the midpoint, citing those issues, and announcing a more comprehensive review of the organization (likely meaning firings) and the supply chain.

Conditions Could Get Worse From Here

While this quarter did see pricing outpace inflation, that may be the end of the good news for some time, as there is emerging weakness in the company’s end-markets. Unlike a business like Beacon (BECN), doors and windows are more driven by new-build (around 45% of demand) and the repair/remodel leans more heavily toward remodel. Given the surge in remodeling seen during the pandemic period, I don’t think remodeling is going to be a particularly strong driver.

Looking at new-builds, while I’m bullish on housing long-term (including multifamily), I think housing starts will decline next year with a peak-to-trough move of around 10%. Jeld-Wen management has already talked about signs of weakness in the retail channel (Home Depot (HD) is a major customer), and now the company is also reporting weaker orders in the traditional channel – bad not only for underlying demand, but also for the company’s mix (Home Depot and other retails skew to lower-margin products).

If housing demand does decline, it will be due in part to affordability, and that leads me to question whether or not the market will accept and absorb meaningful further price increases. Meanwhile, many suppliers across the value chain are talking tough about maintaining pricing and that today’s prices are the “new normal”. I am deeply skeptical of that, but if there is to be a correction in pricing, it will take time and Jeld-Wen could be in an unenviable price/cost squeeze again in 2023.

The aforementioned commentary covers North America. I don’t have (or make) detailed forecasts for Jeld-Wen’s European markets (about 25% to 30% of the business), but based on the commentary and feedback from multiple multi-industrial CEOs during this earnings season, it does sound as though conditions in Europe are even weaker. The details will almost certainly be different, but I don’t see Europe being a positive offset to the weakness I expect in Jeld-Wen’s North American business in 2023.

Self-help can offset this, and management is saying the right things about reexamining the business. The company has already talked about closing higher-cost factories in the U.S. and UK and relocating production to lower-cost areas, and I like the company’s pledge to assess the profitability and growth potential of the business across products, facilities, and geographies. It may well be the case that there’s potential here to boost margin by culling lower-margin products and/or consolidating production to more efficient facilities. Again, though, it’s a question of degree and timing – these moves can be help, and maybe help quite a bit over time, but “over time” doesn’t satisfy Wall Street’s notoriously short-term mindset.

More Turbulence At The Top

Earlier this year, shortly after the second quarter earnings release, the CEO unexpectedly resigned. This follows in the wake of the resignation of the CFO earlier this year, and means that the company’s top principal officers, and the architects of the 2025 targets (6% to 8% organic revenue growth from 2021 to 2025, mid-teens EBITDA margin, etc.) are now gone.

Jeld-Wen didn’t exactly knock it out of the park during CEO Michel’s tenure, with low single-digit revenue growth, no real progress on EBITDA margin, and not much progress on FCF generation, but the next CEO will be the fourth CEO in nine years. That’s abnormal and investors should wonder why this is the case. Is the company fundamentally weaker or more troubled than it appears? Are there just no real opportunities to drive improved performance? Is the board unreasonable and/or difficult to work with? I don’t have an answer, but I don’t like the turnover.

The Outlook

I believe Jeld-Wen could see a double-digit contraction in revenue next year, but that’s not the average expectation of sell-side analysts at this point. I’m definitely more bearish on construction (resi and non-resi) than many analysts for ’23, and I think there could still be some negative revisions. Perhaps not surprisingly, I don’t see Jeld-Wen hitting their prior 2025 revenue target, and I’m only looking for about 2% to 4% long-term revenue growth (2% with a 2021 starting point, 3.7% with a 2023 starting point), as I do think deflation is an underrated risk.

I do think margins will likely be weak again in FY’23, but I see improvement in FY’24 and I’m expecting FCF margins to improve over time into the 4%’s, a significant uptick from the trailing 10-year weighted average of around 2.3%. This will drive double-digit adjusted FCF growth if the company can achieve this.

EBITDA-based valuation is a little tricky now, as I don’t think historical average multiples are as useful at this point in the cycle (with revenue about to contract again). Based on margins and returns, I think a 7x multiple is fair, but I’m using it with my ’24 EBITDA estimate, as I think ’23 EBITDA is too much of a trough number in my model to give a fair sense of value.

The Bottom Line

Jeld-Wen shares look as though they should trade closer to $11-$12 today, which is okay upside now. As I said in the open, I think I’m using conservative (if not harsh) assumptions, but clearly the Street is even more negative on this name now. While I can see the appeal to value-hunters, I’d be careful here at least until the Street more broadly accepts the idea of weaker end-market construction demand in FY’23.