AFI - Armstrong Flooring

[stockspinoffinvesting]

Does anyone have an opinion on Armstrong Flooring (AFI)?

 

Here is the quick investment case: AFI sells flooring material which is benefiting from a strong housing market. AFI was spun out of Armstrong as it was underperforming with revenue and EBITDA flat to down over the past three years. Management of AFI has been working to turn the business around and it looks like its having success. In each of the past two quarters EBITDA has grown double digits. This is significant as EBITDA declined 2% in 2015.  While the flooring market has rebounded from its lows, it still remains 30% below peak levels of 2005. On the margin front, AFI has much room for improvement. AFI has EBITDA margins of ~6.0% but management is excellent and has a plan to get margins back to ~10% range. In addition, the stock trades at an EV/EBITDA multiple of 7.0x while peers trade at ~11.0x. Assuming revenue grows 5% in each of the next three years, EBITDA margins expand to 10% and AFI's valuation expands to 11.0x EBITDA, the stock will trade at ~$42 (it trades at $18 now). ValueAct (well regarding activist investor) owns 16% of the company and has a board seat. Raging Capital (hedge fund with ~20% annual returns since inception in 2006) also just announced it owns 6% of the company. Last point, the flooring market is consolidating. Mohawk Industries, the market leader, has spent $3.5bn on acquisitions and has historically acquired smaller competitors at an EV/Revenue multiple of 1.7x to 2.6x. AFI currently trades at 0.4x.

 

Here's my full write up:

http://stockspinoffinvesting.com/armstrong-flooring-stock-spinoff-with-138-upside/

 

[eclecticvalue]

I have read your thesis and it's good. If there are two activists on board I would think there will likely be an acquisition in the near future. And yes there has been trend that the housing market will pick back up.

[stockspinoffinvesting]

Thanks for your comment! Yes I agree. I think long-term it gets acquired. With spinoffs, usually they can't be acquired for 2 years post spin in order for the spinoff to retain its favorable tax treatment. This is the case for AFI. However, I think you are right that this company gets acquired once the two year period is over. This would be a win for the activists and management (they have options for 20% of the company).

[glorysk87]

Have started looking at this. Have a few questions.

 

First, it appears to be a very competitive and commoditized space.  What's Armstrong's competitive advantage? I've been reading through the spinoff documents, the presentations, the recent Q, etc, and I haven't really seen a solid competitive advantage. It appears the company is putting a lot of strategic value on the ability of LVT to drive revenue growth, but a quick look at most of their competitors (Mohawk especially) shows that they all produce and sell LVT products as well.

 

Second, why should we assume that the new management team will suddenly be able to restore the growth and margin profile of the business? They languished for years when part of AWI, so what's different now? I'm always wary of the old "we'll spin the company off and it will allow us to focus on restoring the business" pitch.  If the business itself was high quality, shouldn't it have performed well before the spin as well?

[stockspinoffinvesting]

Armstrong Flooring (AFI) recently was spun out of Armstrong Worldwide as the flooring business and was considered the bad business. Armstrong’s ceiling business was considered the good business.

 

Why is the flooring business considered the bad business?

 

Flooring revenue and EBITDA has trended flat to down over the past three years.  In addition, the margins in the flooring business are a lot lower than the margins in the ceiling business.  For instance, in 2015, the flooring business had an EBITDA margin of 6.0% while the ceiling business had a 23.5% EBITDA margin.

 

So why is it interesting now?

 

AFI’s business is benefitting from new management and its turnaround is well under way. Through Q3 2016, revenue has grown +2% (versus declines in 2015 and 2014) and EBITDA is up +27% (versus declines in 2015 and 2014). The strong EBITDA growth has been driven by margin expansion as EBITDA margin has expanded by 150bps to 7.6% through Q3 2016. Increased productivity and lower input costs are driving the margin expansion.

 

Meanwhile, AFI continues to benefit from a strong US housing market. The latest data point? October housing starts increased 26% y/y to 1.323mm but still remain below the long term average of 1.442mm, suggesting continued upside to the housing market.

 

If AFI continues to grow revenue and expand margins, its valuation should also increase and there is meaningful upside to the stock.

 

Here’s how I think about upside. Let’s assume, revenue grows 2% per year for the next three years. This would be inline with revenue growth year to date, but below management’s goal of +5% to +6%.  Let’s further assume that AFI can expand its EBITDA margin to 10%. This seems very reasonable if not conservative given progress to date. These assumptions result in 2019 EBITDA of $129mm. Applying a 9.0x multiple results in an enterprise value of $1.158bn. Backing out net debt and pension obligations results in an expected market cap of $1.104bn and a share price of ~$33. I also assume shares outstanding are 20% higher driven by stock option dilution.

 

One last point. The flooring market has been consolidating. Mohawk Industries, the market leader, has spent $3.5bn on acquisitions and has historically acquired smaller competitors at an EV/Revenue multiple of 1.7x to 2.6x. AFI currently trades at 0.5x.

 

ValueAct (well regarding activist investor) owns 16% of the company and has a board seat. Raging Capital (hedge fund with ~20% annual returns since inception in 2006) owns 6% of the company.

 

More detailed investment case: http://stockspinoffinvesting.com/armstrong-flooring-stock-spinoff-with-138-upside/

Analysis of most recent quarter: http://stockspinoffinvesting.com/armstrong-flooring-reports-q3-results/

 

[fareastwarriors]

AFI holders per Bloomberg.

[CorpRaider]

Added a bookmark for your blog.  Keep up the posting!

[stockspinoffinvesting]

thanks CorpRaider, will do!

[CorpRaider]

Really miss spinoffmonitor, has been out of commission for like a year.  Stockspinoffs has been kind of out of it lately too.  Sent them a message to remind them of some updates and got a respone so they are still alive.

[rukawa]

Armstrong Flooring is not really cheap based on current metrics. Their actual free cashflow is projected by management to be around 25 million for 2016. And their mcap is 513 million, which means they trade at 20x free cashflow. Doesn't seem like they got hit by the typical spinoff institutional selling..if anything the opposite their stock price has increased 50% since the spin.

 

I feel like here you are really betting on management and spinoff dynamics but there is no real margin of safety.

[InelegantInvestor]

Really miss spinoffmonitor, has been out of commission for like a year.  Stockspinoffs has been kind of out of it lately too.  Sent them a message to remind them of some updates and got a respone so they are still alive.

Stockspinoffs is alive, but we need to get our rate of posting back up. I think we will see more activity going forward.

[stockspinoffinvesting]

Armstrong Flooring is not really cheap based on current metrics. Their actual free cashflow is projected by management to be around 25 million for 2016. And their mcap is 513 million, which means they trade at 20x free cashflow. Doesn't seem like they got hit by the typical spinoff institutional selling..if anything the opposite their stock price has increased 50% since the spin.

 

I feel like here you are really betting on management and spinoff dynamics but there is no real margin of safety.

 

I agree that AFI is not that cheap on a current price to cash flow basis. However, I think it is cheap versus comps on a EV/EBITDA and EV/Revenue basis. Especially because current margins are so depressed. So if margins expand and valuation expands, you have a positive double whammy for the stock price.

 

Its also cheap looking at precedent transactions.It trades at 0.5x on an EV/Revenue basis and transactions in the space have taken place at 1.6x to 2.7x multiples. I think this is relevant because the market is consolidating and because 20% of spinoffs end up being acquired according to an Edge Consulting Study.

 

In turns of downside protection, AFI has no debt so if the turnaround fails or if the housing market turns, there is little risk of bankruptcy. In that scenario, I think an acquisition would probably make even more sense.

[InelegantInvestor]

AFI seemed reasonable when I wrote about it in March(http://www.stockspinoffs.com/2016/03/22/no-fooling-armstrong-world-industries-spinoff-armstrong-flooring-april-1/). It seems less interesting given the sharp run up.

[Ballinvarosig Investors]

Sorry to bump this 1.5 years later.

 

I set a reminder 2 years ago to review this company after the tax lock up upon the sale of the company expired. I think it's pretty clear that this hasn't played out for management as expected. Even adjusted EBITDA margins aren't at 10%, there is no growth, and the company has had to shutter some plants, resulting in costs of closure. The fact that the the incentive plan for the CEO hasn't been triggered at even the minimum should tell you it hasn't been plain sailing.

 

At the same thing, there does seem to be a chink of light on the horizon. Q4 was a bit better on the last comp. Management have talked about price increases being passed down, I would be reasonably hopeful that we should see top line growth for 2018. Management are suggesting adjusted EBITDA of $70-80m (seem realistic if price increases are being passed on), current EV is $390m. If management can hit their 2018 target, then I can see this going back up to about $17-18 a share in 6-9 months.

[Spekulatius]

I feel like some of the spinoffs are real turds nowadays. There is probably too much mo ey chasing opportunities within this category, but thwt is nothing that a decent marketcorrection can’t fix.Gor now, one is better off watching spinoffs are the Yan investing in them.