Wednesday, December 7, 2016

A current AIM holding: Briggs & Stratton (BGG) by Sarah Hillegass. "Is BGG stuck in low gear?"


Briggs & Stratton Corporation (BGG, $20.65): “A Stalling Engine of Slow Growth”

By: Sarah Hillegass, AIM Student at Marquette University

 Image result for briggs and stratton logo

Disclosure: The AIM Equity Fund currently holds this position. This article was written by myself, and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.

Summary

·         Briggs & Stratton (NYSE: BGG), headquartered in Wauwatosa, WI, manufactures equipment and engines for manufacturers (OEM’s) in the lawn and garden equipment and engine powered equipment industries. BGG has two segments: Engines (60% sales) and Products (40%).

·         The Engines segment has improved profitability by shifting to a more commercial sales approach, rather than residential. This market is highly reliant upon new home sales.

·         The Products segment has faced severe headwinds in sales of snow throwers due to less inclement weather, which has decreased profitability. New debt and poor international expansion has put extra pressure on financial performance.

·         BGG has climbed steadily over the last month from $18 to almost $21. Around $20, many insiders sold BGG in large volumes. This signals that the stock may be overvalued.

·         After holding BGG for nearly two years, it is in the same position now as when it was added to our portfolio. Therefore, I would recommend a SELL for BGG. While it is a great business, there is not enough growth/value to contribute to our portfolio performance.


Key Points: In late October, Briggs & Stratton released their first quarter report for fiscal year 2017 for the months of July through September 2016. While reporting typical negative first quarter earnings, BGG slightly beat consensus expectations. However there appear to be minimal bright spots for BGG in the near future. BGG’s two operating segments, Engines segment (60% sales) and Products segment (40%), both face lackluster end markets. BGG’s business is highly cyclical to weather and the housing market. Therefore without major initiatives in place, BGG will perform according to macro influences.


The primary bright spot shines through in the Engines segment with regards to the lawn and garden equipment industry. The industry constitutes 87% of the Engines segment sales. BGG is focused on transforming sales into more commercial markets than residential markets. This would help improve margins and create more stability to BGG’s business. The beneficial impact in gross margins for the segment increased from 15.8% in 1Q16 to 20.1% in 1Q17. However, BGG’s sales to the industry are still primarily for residential applications. As presented at the Baird Global Industrials Conference on November 8, home ownership is at lows not seen since the 1960’s, with more adults renting apartments instead of buying homes. This hurts BGG’s potential market, since mower sales are highly correlated with new home sales. Outside of the Engines segment, the parts distribution channel has the potential to become more efficient with BGG’s increased stake in Power Distributors, LLC. This will help streamline domestic products distributions to support power equipment customers. Additionally, Hurricane Matthew sales of generators may impact sales for 2Q17, but management has no estimates to quantify that.


However, BGG faces many hurdles in the short term to overcome. The Products segment as a whole has faced significant headwinds in sales and gross margins. With less inclement winter weather, there have been fewer snow thrower sales. This decreased margins by 290 basis points to 15.2%. Additionally, revenue recognition was changed for engine shipments to overseas customers starting in 1Q17. Previously, revenue was not booked until the customer received the engine shipments, which meant potential deferrals because of in-transit shipments. Now, revenue is booked when the engines are delivered to a carrier. This adjustment increased the amount of sales to report for the engines segment in 1Q17, but on an adjusted basis compared to last year’s numbers, 1Q17 sales were down by nearly $14 million. This decline was due to less demand from equipment manufacturers as production moved closer to season to lower operating costs.


Outside of the two operating segments, BGG faces financial concerns. In 1Q17, BGG called on $50 million from a revolver. This increased BGG’s short-term debt obligations. Cash went from $90 million in 4Q16 to $40 million by 1Q17. Additionally, the total debt to capital ratio increased from 31% to 37% in the same timeframe. This is higher than it has been over the last three years. While management’s intentions are to expend geographically, acquire companies, and return cash to shareholders, the results have not helped performance. The international expansion has not grown, with exposure of 27% of sales in 2010, and only 28% in 2016. The acquisitions BGG wants to participate in would deplete cash farther and push the debt ratio higher. Finally, with few initiatives in place to improve business operations, BGG’s EPS will primarily grow due to share repurchases that were expanded by $50 million in April 2016.


What has the stock done lately?

BGG has climbed from a low of $18 to a high around $21 over the course of the last month. This increase was primarily driven by better than expected 1Q17 results and forecasts. However, trading at a P/E multiple of 30x, BGG appears significantly overvalued. Also, management has been selling shares in the open market. In an 8-K filing on November 14, BGG’s CEO, Todd Teske, announced he plans to sell 150,000 shares of his nearly 400,000 shares. Additionally, Senior Vice President, William Reitman, sold 15,000 of his 80,000 shares at the end of October.

 Source: FactSet

Past Year Performance: Over the last twelve months, BGG’s total return was approximately 22%. BGG traded at a low of $15 and a high of $24. Over the same timespan, the RUSSELL 2000 index’s total return was roughly 17%. Therefore, over the past year, BGG has performed relatively well, with the stock price appreciating nearly 11%. However, more than double the amount of shares that were bought of BGG were sold from insiders.  



Source: FactSet

My Takeaway: From what is disclosed in public reports, I believe that BGG is not in a great position to grow and provide returns to shareholders over the coming year. Due to the macro cyclicality of the industry, BGG has to have efficient, lien operations to remain profitable. The lackluster sales in either segment mixed with a weaker balance sheet make for a riskier investment. I would recommend selling a position in BGG. While BGG is a great business with an essential product, the stock is in the same position as two years ago when it was added to our portfolio. If the balance sheet improves, complemented by stronger organic growth, it may be a great investment.

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