RBC Capital upgrades Brunswick Corp (NYSE:
BC) to Outperform from Sector Perform with a whopping $17 target (prev. $8).
With liquidity risks now behind it and dealer inventories coming in line, they view BC as a compelling three-year earnings recovery story. RBC's call requires only a 20% demand recovery over the next three years following peak-to-trough decline of nearly 60% since 2005. In the interim, they believe the rate of improvement in profitability and inventory metrics beginning in 2010 will provide reason for optimism, even if demand is slow to recover.
Industry conditions remain extremely tough, but a bottom could be approaching. The firm recently surveyed nearly 150 dealers. While tight credit continues to take its toll, industry demand appears to be stabilizing at a 135K run rate. Meanwhile, inventory levels are also clearly in much better shape, especially for Brunswick dealers.
Brunswick is on the cusp of a demand-agnostic earnings inflection. As the inventory de-stocking cycle runs its course, Brunswick's production should be significantly higher in 2010-2011, even if demand does not improve. With flat demand, they estimate that Brunswick's boat segment revenue will grow 65% and 35%, respectively, over the next two years
What Will Earnings Look Like As This Unfolds?
Given what they know about Brunswick's cost structure, the firm would expect high incremental margins as production comes back. The initial stages of recovery should be especially powerful, as higher sales levels should coincide with cost-reduction efforts coming to fruition.
Brunswick migrates toward 1:1 inventory replenishment, RBC believes the business can generate ~$200M of EBITDA in 2011 without any improvement in demand. Assuming demand ultimately recovers to 150K-200K units (vs. the prior cycle peak of over 300K), they estimate that BC would generate EBITDA of $240M-$620M.
BC shares have significant upside potential. RBC's $17 price target assumes industry demand recovers to the 150-175K range by 2012. They then apply an EV/EBITDA valuation range of 6-8x, discounted back two years at 15%.
The "Wholesale Bounce" Should Provide A Bridge To An Eventual Demand Recovery
RBC notes that typically, they are not big believers in investing around normalized earnings scenarios that can take years to play out. Such theses often prove fickle because few investors are truly committed to an investment horizon beyond 6-12 months. RBC's view in this particular case is different. Given the leverage in Brunswick's model, the rate of improvement in Brunswick's operating metrics should be palpable. A year from now, they suspect investors will see dramatic margin improvement (albeit from a very depressed base) coinciding with extremely favorable inventory metrics.
Notablecalls: This call should create some exitement among investor and inject fear into the short base.
Short interest stands at 12%+ and with the stock likely headed towards a new high shorts are less likely to fight the trend and cover.
The $17 price target seems to be the new Street high.
I see this one trading above $10 level today, with possibly $10.50 (if the market does not roll over)
