Brunswick Stock: No Confidence On Near-Term Performance (Upgrade To Hold) (NYSE:BC)

Investment summary

My previous investment thought for Brunswick Corporation (NYSE:BC) (published on 14^th May) was a sell rating because I believed the business would miss its FY24 EPS guidance, which will cause valuation to derate sharply. I have shifting my rating from sell to hold as I am very uncertain about how the demand environment will be in the near term.

2Q24 results update

Released on the last week of July (25^th), 2Q24 result was a disaster. Total sales fell by 15% to $1.44 billion, coming below management’s own guidance and consensus estimate of $1.55 billion, driven by Boat segment decline of 23% and Propulsion segment decline of 21%. Sharp revenue decline led to strong decremental margins, which drove adj EBIT margin down by 130bps y/y, resulting in adj EPS of $1.80.

Demand was weak as expected

2Q24 results came in just as expected, where weak demand caused poor margins and EPS performance. The latest industry data points to a continuous poor demand backdrop; hence, looking ahead, I still think demand is going to stay weak.

In the Boat segment, trends exiting the quarter did not bode well for 3Q24. Despite being the peak marine selling season (June and July), June SSI main powerboat retail was down 20% y/y, decelerating from -10% in May and ~1% growth in April. The underlying weakness was especially concerning, as management noted that the high interest rate environment continued to place increased pressure on consumer budgets and discretionary spending. This means that until rates are cut meaningfullydemand is unlikely to come back to a normalized level. On top of that, boat prices remained at high levels (vs. pre-covid), and I expect this to remain as a demand headwind. Indeed, management has revised their FY24 growth expectation for this segment to be down by 20% vs. a -10% growth guide previously. This tells us that July showed no signs of improvement (management has 1 month of data already). They even went one step further to mention that further reductions in production levels are expected to match current end-demand levels, which clearly shows how bad underlying demand is.

Moving up the value chain, dealer ordering patterns also paint a negative demand outlook. Given the marine selling season, I would’ve expected ordering patterns to improve in 2Q24 since dealers need to load up inventories before they can sell in June/July. This did not happen. As per the call, management noted that dealers continue to exhibit caution with conservative ordering patterns (even new models were not seeing strong ordering trends). This basically aligns with my previous view that high rates are impacting dealers’ ability to fund their purchases and floor plans. Given that end-to-end retail demand is weak (as mentioned above), my belief is that ordering patterns are unlikely to recover anytime soon.

The other big part of the business – Propulsion – also does not have a positive growth outlook. Propulsion (2Q24 revenue down 21% y/y) is unlikely to see growth recovery as boat dealers continued to exhibit conservative wholesale ordering patterns. A good leading indicator of demand is that partner OEMs have lowered production outlooks, which is a reflection of the weakening marine retail sales backdrop. The management tone during the call was also very negative, as they noted this pattern is unlikely to change significantly through the remainder of this season. FY24 revenue guidance for this segment was heavily revised downward from a -6% y/y decline to a -24% y/y decline.

In turn, this is causing OEMs to maintain lower boat production rates through the main selling season, with impacts to Propulsion and Navico Group OEM orders.

OEMs and channel partners continue to moderate production levels to adjust to the environment and in the absence of external stimulus, we do not now foresee this pattern changing significantly through the remainder of the season. 2Q24 earnings transcript

Near-term performance remains uncertain

Consequently, management revised their FY24 EPS guidance down from $7-$8 to $5-$5.50, a major revision. This has certainly reset expectations by a big margin, now implying an EPS decline of ~41% vs. FY23. However, I think the bigger implication from this guidance is that it increases the uncertainty of the timing of recovery. Be reminded that June/July is BC’s peak selling season, and with rates still higher, near-term demand is unlikely to see any positive traction. Despite that, the stock is now trading at 12x forward PE, which indicates that the market is pricing in a recovery next year.

Given the current demand backdrop, high rates, and poor growth-leading indicators (OEM and dealers’ ordering patterns), I believe the near-term performance is still very uncertain, and I am not confident enough to assume a recovery next year until I see serious proof of demand recovery.

The stock could move both ways from here:

1. Bull case: The upcoming rate cut could ignite consumer demand recovery, which drives more dealer orders. When there are signs of this happening, the stock is likely to trade further upwards as the market price in the start of a new growth cycle. Valuation could move up to ~15x forward PE (high end of historical training range) from the current 12x.
2. Bear case: 2H24 shows no signs of improvement, which will force consensus and the market to taper their FY25 EPS outlook, leading to downward revisions and multiples trading back to 9x.

With little visibility into the near term, I am shifting my rating from sell to hold as I sit this one out.

Conclusion

My view for BC is a hold rating. 2Q24 results were disappointing as expected, indicating a weak demand environment. Management’s cautious outlook and revised guidance further highlight the uncertainty in near-term performance. While expectations have been largely reset (EPS revised sharply downwards), further downside is possible if demand weakness persists. On the flipside, if the upcoming rate cut ignites a strong consumer demand recovery, the stock could rerate higher. My view is that until clearer signs of a recovery emerge, it is better to take a cautious approach.