Fleetwood: Result 2017

After flirting with a turnaround for a few reporting periods, Fleetwood went all the way this time, releasing a terrific full-year result. This was the best result from the business since the halcyon days of the mining boom.

Revenue was up just 16%, but it meant a transformation in earnings before interest and tax (EBIT), which rose to $14.6m against last year's loss of $2m.

To understand what happened you have to drill into the divisional data, which we've split out in Table 1. The modular accommodation business, which manufactures buildings for housing and education sectors, has performed superbly.

Revenue from the division rose by 23% which, along with a restructure of the loss-making west coast business, improved margins from 2.5% in the prior period to 8.6% last year. That was enough to turn a divisional profit of $3.6m to a profit of $15.2m.

The accommodation business has certainly improved in recent years as the industry has consolidated and larger, contracted orders have been won. Sales to the resources sector have evaporated but have been replaced by more stable sales to the education and affordable housing sectors. Resources once completely dominated the business, it now accounts for about 10% of revenue.

This is a better business than it used to be and we think current margins are about right.

Margin improvement hasn't come because of price rises or from large revenue lifts; they have come from operating efficiencies and, in particular, from eliminating losses from the west coast business. At 8%, they aren't embarrassingly large either.

RVs still turning

We've been hoping for an elimination of losses from the RV business for some time. That didn't happen last year but the loss did narrow and a turnaround in the division appears to be underway.

For the first time in years, Fleetwood's RV brands, Coromal and Windsor, gained market share. Factory orders have increased hugely and revenue leapt more than 50% for the year.

Unlike making cars which are assembled by robots, it takes plenty of labour to make and customize RVs. Higher revenue has required an expanded workforce which, being new, isn't as productive as more experienced workers.

Margins from the division haven't yet picked up to reflect higher revenue but, as workers become more productive, we think the RV business should be able to generate a profit in the next two years.

That may not sound like a big deal, but stripping RV losses from the result would increase EBIT by 50%. It would make a huge difference to the value of the business.

The accessories business remains the weakest part of Fleetwood and should be sold. Revenue has risen commendably but, despite restructuring and factory efficiency gains, profits and returns on capital are woeful.

Village people

Villages remains pleasingly profitable despite a 13% fall in revenue. There is some uncertainty about future utilisation. Rio Tinto is the most important customer at Searipple and leases about half the village. A change to their arrangement could change profitability for the segment although we note that costs can be scaled down to generate a profit even with low utilisation rates.

Searipple has been aided by village closures. In 2012, Searipple accounted for 20% of village rooms in Karratha; it now accounts for 50% as competitors have gone bust. This should help protect margins to some extent.

The company has announced its first meaningful dividend in some time, at 5 cents per share. This was no surprise. Activist investors have piled onto the register and demanded higher dividends.

Higher cash returns

That does appear a sensible demand as Fleetwood is now generating decent results and sits on a franking balance to support up to $1 a share in fully franked dividends.

Higher cash returns are likely. Fleetwood could sell a division and payout a large, fully franked lump sum or start paying consistently higher dividends. Either way, more cash to shareholders is a near certainty.

The notable wart on an otherwise excellent result was operating cash flow, which lagged EBIT at just $6m. In our last review we posited that poor cash conversion was now the norm at Fleetwood as its business moved from village revenue to more capital intensive accommodation revenue. That is undoubtedly true and Fleetwood will never again replicate cash flow of previous years as working capital needs increase.

Case closed?

Despite that, the improvement has been commendable. The business remains debt free and trades on an enterprise value to earnings before interest, tax, depreciation and amortisation (EV/EBITDA) multiple of less than nine.

That doesn't sound especially cheap for this type of business but, add back losses from RVs and that multiple lowers to 6. We still think there is latent revenue potential from accommodation and a sale of the accessories business will unlock more value still. It is unlikely the RV business will sit in Fleetwood's stable as a zero profit earner. It will either contribute profit or it will be sold.

Our investment case has worked out well and we are close to the exits but there are a few reasons to maintain exposure. Those with larger portfolio allocations should consider trimming, but our recommendation remains HOLD. 

Note: The Intelligent Investor Growth Portfolio owns shares in Fleetwood. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.

Disclosure: The author owns shares in Fleetwood.