Morningstar - Fall 2019 - 68

Investors

Both of these companies have narrow moats
and proven pricing power, so I'm pretty confident
that they can push through.
Lallos: Your report notes that one advantage for Masco

compared with Fortune is that it has less exposure
to cyclical areas.

Bernard: Masco has cabinets and windows;
Fortune Brands has cabinets and doors.
These are big-ticket items that, unless you have
some kind of disaster, you can push off.
If you're concerned we are going to eventually hit
a recession, you'd want to be less exposed
to that. Those businesses for Fortune Brands are
more than 50%, whereas it's much less for
Masco. And Masco is doing a strategic review
right now of their cabinetry and window
businesses. They very well might get rid of them,
in which case they would be mostly focused
on plumbing fixtures and paint.

partnership with Home Depot HD yields
a cost advantage.
Some might say having only one customer is a big
risk, but they've been with Home Depot since
Home Depot had only two stores. I don't think this
partnership's going anywhere. Home Depot
likes having this highly rated captive brand. In some
surveys, it's rated better than Sherwin-Williams.
It is much less expensive for Masco to sell through
Home Depot than it would be to sell out of
individual stores like Sherwin-Williams. It's an
estimate, because I'm looking at segment
performance, but comparing Behr to SherwinWilliams, Behr has much better ROICs.
Historically, professional painters have liked the
Sherwin-Williams model. They can build
relationships with the store owners and get pricing

I can't think of one homebuilder that
has not in some way, shape, or form shifted their
strategy to go after a lower price point.
Brian Bernard

Plumbing is a low-ticket item. Paint, too. Even
if you're a little concerned about job prospects or
home prices, are you going to say, "Oh, I
can't afford $100 to replace a faucet or get some
paint"? Some people might, but smaller, doit-yourself projects are less likely to be deferred
during times of economic uncertainty than biggerticket remodels. That's why I like Masco.
Compared to Fortune Brands, certainly, there's
less risk there.
Behr Paint is a big plus for Masco. It enjoys strong
brand recognition. They're going against
Sherwin-Williams SHW, but Behr's exclusive

Morningstar Fall 2019

that they might not be able to get through a Home
Depot, which has more control. Nonetheless,
Masco is making a push to go after the pro. And
here, too, they don't have to spend as much.
They do have some Masco employees in the store,
but Home Depot does a pretty good job of
making Behr stand out.
Then again, when you have just one customer,
they must be pushing back on pricing. I'm
sure Home Depot does to some extent; Masco is
very guarded on this. But operating margins in that
segment of the business are around 19%; it's
the most profitable. Those are very good margins.

Lallos: To round back: Your housing outlook is
not as positive as it was-but it is still pretty positive.
Are there differences between the Morningstar view
and what other analysts are seeing?

Bernard: One thing that differentiates us is that
it's rare to find someone willing to put out a
10-year forecast. For the two- to three-year outlook,
we check with Fannie Mae, Freddie Mac, and
National Association of Home Builders, which are
obviously good sources for forecasts. I would
say we're slightly more bullish than those three
given our expectation for a better-than-expected
spring selling season and modestly higher
demand over the remainder of 2019 compared to
the second half of 2018.

Longer term-and I've seen only a couple
of sources that look out 10 years-I'd say that the
consensus case is that starts will be range-bound
around 1.2 to 1.3 million units, which is more
like our bear case. But we see it going up above
1.4 million. That's still bullish. That's an
outlook that would still be good for all the stocks
we've talked about.
Lallos: What is it about Morningstar's approach that
emboldens you to look out 10 years?

Bernard: We built a fundamental model that's
driven by a robust set of supply and demand data,
but we also have a group of experts covering
related industries that meet regularly to discuss
housing trends and manage our forecast.
I cover the homebuilders, and I lead our analysis
of housing-related macroeconomic data. Then we
have Charles Gross covering wood product
companies. We have Kevin Brown looking at
apartment REITs, Jaime Katz on home furnishings,
and Eric Compton on the banks. We take all
these views, along with our in-depth data analysis,
to come up with a reasonable outlook.

However, housing demand is notoriously difficult
to forecast. We do have a bull case, with starts
peaking near 1.6 million in 2025, as well as a bear
case (starts languishing around 1.2 to 1.3 million
over the next decade). Because housing data is
so regional, and we're putting together a national
view, we think this is a reasonable range. But
overall, I feel good about where our forecast is. K
Laura Lallos is managing editor of Morningstar magazine.

Morningstar - Fall 2019

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