Fortune Brands (NYSE:FO) announced third-quarter earnings last week that weren't as bad as feared, as the company is seeing more stable trends in two cyclical business segments tied to the housing and golfing industries. The third sells alcohol and wine and is holding up as it should in a difficult consumer climate, and it makes one wonder if its value is fully being realized as it is tied to businesses with extremely low investment appeal and murky long-term trends.
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Third-Quarter Decline
FO's third-quarter sales fell 10.6% to $1.72 billion on flat trends in the spirits business and trends that management characterized as moderating in the golf and home products segments. More specifically, spirits sales eked out a 0.1% top-line gain to account for 37% of sales as higher sales from the Jim Beam and Canadian Club brand names offset weakness in other names. Home and hardware continue to account for the bulk of sales (46.7%) and fell a dramatic 17.9% to mirror the struggles at rival Masco (NYSE:MAS) that posted a 23% fall in sales during its most recent quarter and is set to announce third-quarter results this week. Golf also struggled, experiencing a 9.5% decline to account for 16.2% of the quarterly sales.
All three segments posted substantial profit declines, with golf falling further into the red by recording an operating loss of $21.4 million. Home and hardware dropped 26.2% to $70.8 million to log an 8.8% operating margin. Spirit profit declines were again more moderate, falling 3.3% to $145.4 million, but accounted for 71.1% of total quarterly operating income.
Total operating income fell 19.7% to $204.5 million and reported net income fell 63.1% to $124.1 million as last year's quarter contained a sizable one time gain. Earnings per diluted share fell a similar amount, declining 62.9% to 82 cents. Quarterly free cash flow fell less dramatically, dropping 35.8% to $326.3 million, or $2.14 per share.
Earnings Guidance
Fortune Brand's free cash flow generation demonstrates the capital-generating capabilities of its business model. For the full year it projects free cash between $2.47 and $2.70 per diluted share and earnings of $2.10 - $2.30 per share. Management upped its earnings guidance as it is seeing "continued stability of our spirits business and signs of stabilization in new-home construction." Whirlpool (NYSE:WHR) and Black & Decker (NYSE:BDK) also recently confirmed that household spending trends are stabilizing by raised forward guidance. (To learn more about free cash flow, see our article, Free Cash Flow: The Best Fundamental Indicator.)
Shaky Outlook
However, Fortune expects consumers to continue to hold off on bigger ticket home improvement activities for at least another year. The golf business is also weakly positioned as the sport is arguably on a secular decline as the number of available golfers is decreasing over time as outdoor activities continue to give way to indoor ones. Rival Callaway Golf (NYSE:ELY) also pointed to lower near-term trends as consumers cut back on golf and other discretionary products and services.
Bottom Line
Given the lack of visibility in these segments and much lower profitability, management should consider freeing the more stable and lucrative spirit business to enhance shareholder value, especially considering there is little to be gained in terms of synergies from keeping three unrelated businesses under one corporate umbrella.
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