Brunswick Corporation (BC) Earnings Call Transcript & Summary

[Audio Gap] To have with us the senior management of Brunswick Corporation, including CEO, David Foulkes; CFO, Bill Metzger; and VP of Finance and Treasurer, Ryan Gwillim. Brunswick is the leader in the U.S. Marine space across both boats and engines as well as a very big P&A business, which I'm sure we'll hear more about later. We do have a short -- some slides that David wanted to go through before we begin the Q&A.

All right. Thank you very much, Joe. Hi, everybody. Hope you're having a great day. Thanks for joining us. Brunswick is a marine-focused enterprise. And last year, around this time, for the first time, we laid out our complete marine strategy. We did that again just a few weeks ago in Miami at our Investor Day, where we talked about how we're bringing the strategy to life and how we're evolving it. And now our plan is a 3-year plan that takes us from 2020 to 2022. So I am going to talk through some of the slides I used at the Investor Day to get us going on the background of the company, and then it will be great to have the conversation with Joe. Of all the slides that I put up, this is my favorite. I know you guys follow companies or invest in companies in a range of different industries and sectors. I'm guessing that nobody in any sector can put up a slide quite like this one. We are the real leaders in the recreational marine industry. We call it authentic leadership because there are so many proof points for it. We're the largest manufacturer of recreational boats. I think you know we have the lead in marine propulsion with our Mercury Marine business. We have the world's biggest marine Parts and Accessories business. And now as of the acquisition of Freedom Boat Club, we're the world's biggest boat club operator. So we are very proud of our innovation capabilities that lead the industry and also a nice portfolio of service businesses, particularly marine finance-related businesses. Just some of the proof points up there. There are about 10 million registered recreational boats in the U.S. Mercury Marine engines power about half of them. And that is the source of the incredible P&A annuity we have and for any particular boat, that annuity might be a 25-year annuity. We own 3 of the 4 most recognized boat brands in the U.S.: Boston Whaler, Sea Ray and Bayliner. When I made this slide, we had 210 Freedom Boat Club locations. I checked in yesterday, we have 221. So the business that we bought last year is expanding very nicely, and I'll talk about that in a little more. We also have 225 patents granted in the last 2 years. So the leadership we have, particularly in propulsion technology, we protect very closely with intellectual property protections. Although we're the leader in the industry, we do not in any way rest on our laurels. We're all -- everybody wakes up in Brunswick looking for the next opportunity to grow the business through various vectors. You might be familiar with this view of the U.S. boat market, which is the biggest in the world. There are about 200,000 new boats sold annually in the U.S. We win in that marketplace with our great Mercury Marine brands and our premium boat brands. So it gets sold into a boat park of about 10 million boats. We win in there because we have that tremendous legacy of Mercury Marine engines. We have the leading Parts and Accessories businesses, and we have the leading marine distribution businesses as well. About 50 million Americans classify themselves as fishermen or anglers. It's a huge population. And we lead with those people through our leading fishing boat brands and Mercury Marine again, which is the leading fishing-related engine. The big number on the page, 140 million people. That's the number of people who go boating every year in the U.S., about 40% of the entire population. They're obviously not all in their own boat because there are only 10 million or 12 million boats. They're on a family boat, a friend's boat, a rental boat, or more frequently now, a Freedom Boat Club boat. So the interest we have in shared access models and other models is, how do we connect with that 140 million people who go boating every year. 2019 was a pivotal year for us. We became a marine-focused enterprise, which meant we could really focus on our North Star and streamline our narrative. That's helpful internally, but I think very helpful for the analysts and investors who follow us. We undertook some strategic M&A to get there. We sold our Fitness businesses. We acquired Freedom Boat Club. We completed the integration of Power Products, which is a big set of marine P&A businesses. We have a new operating model that focuses us commercially on the vectors that we think are really important for our growth. And we have much clearer technology and ESG strategies, which I'll be happy to go into should you choose to take an interest in that area. So this is what we look like now as a company, 4 operating divisions: Mercury Marine; our new Advanced Systems Group, which contains all of our nonpropulsion technology and systems businesses; our Boat business, which is very streamlined now; and our Business Acceleration, which contains our subscription and service businesses like Freedom Boat Club. We also chose at the end of last year, beginning of this year to break ourselves out from an external reporting perspective into 3 segments. We had previously been 2. One of the main objectives there was to highlight the importance of our very noncyclical Parts and Accessories business. So this is an interesting view of Brunswick prefinancial crisis to now. You see on revenues, 56% of our revenue used to be from boats. Now it's 30%. And we're very evenly split on revenue between the 3 big divisions in our businesses. But the most important part of this slide is the lower part. If you look at overall earnings, our operating margins, they are incredibly improved. And half of them come from aftermarket parts and accessories, which makes our business much less cyclical than it ever used to be, even if people aren't buying so many new boats -- it isn't the case this year, the market looks pretty good. But if they weren't, that part of the business remains incredibly stable because they still use the boats they have. We did other things in 2019. A lot of new products, added capacity for engines and boats, rightsized our organization, took out about 10% of the salaried employees. And we executed on our plans flawlessly, including our capital strategy. If you look at where growth can come for us, we are about 30% of the global propulsion market. I think everybody who follows us knows we have great products and we're gaining share throughout that market in the U.S. and globally. The margins are very nice. We own about 25% of the global marine P&A market. Margins are extremely strong, plan to grow that organically and through acquisition. Our Boats, we're focusing on margin expansion with the objective of getting to about 11% at the end of this planning period. And then in the service businesses, we're looking at synergistic opportunities for the rest of our platform, like Freedom Boat Club. So we're a very small part of that market and it's a very big market. So lots of opportunities for us to grow. I'll skip some of these slides and say our 2022 targets represent significant improvements versus 2020, which is already going to be a great year for us. So you can see a strong margin improvement, strong earnings improvement. I'll go into the EPS a bit, but really strong cash flow improvement. We made in 2019 $250 million. We exited our pension plan, which will get us to the $325 million, but then our growth plans get us well into the $400 million of free cash flow, which generates a tremendous amount of optionality for us. Our capital strategy is very balanced between investing in growth, retaining a very strong balance sheet and returning money to our shareholders. Last year, we returned $400 million in share repurchases. So last slide. Through the planning period 2020 to 2022, we expect annualized EBIT growth of 11% to 14%. And on top of that, significant benefits from our capital strategy, giving us annualized average shareholder returns of 15% to 20%. I think a very compelling financial case, which, along with our unique platform makes us a great investment opportunity. So I will finish there and take some questions, Joe.

Thank you, David. Appreciate that. I guess, first, I wanted to walk through the last couple of years for Brunswick because it's been fairly transformative. You started out in mid-2018, you acquired Power Products. And for the benefit of those of us in the audience, explain to us, first, what Power Products does. And second, what advantage it gives you as a boat builder to own that business?

Right. So Power Products was an acquisition that we made in 2018 and completed the integration last year in 2019. It is a set of marine electrical and electronic control businesses. In fact, it's the biggest suite of them in the whole industry. It's a very strong margin business, 20% to 25% margin, so very nicely accretive to us. But from a strategic perspective, owning propulsion in a recreational boat is probably the thing you want to own most of all. But the next thing you want to own is the electrical distribution network inside the boat and then the control systems because everything in the boat hangs on that electrical distribution network. And Power Products brings with it a set of things like marine lithium ion batteries, chargers, inverters, all kinds of devices to hang on that electrical network. As a system though, the incredible thing that gives us is we can go to a boat builder, a boat OEM, we sell about 85% of our Mercury Marine engines to independent OEMs and we'll say, not only can you get the propulsion system from us, you can get every system on your boat from us and we'll design it for you. And if you think of what that sounds like to a boat OEM with typically limited numbers of people and sometimes limited expertise in some of the new technology areas, that means they can focus on the parts of the boat that differentiate them. It might be the whole design or the interior or the particular use case. And we're the only people in the industry that can deliver a fully integrated boat for them.

So if you fast forward 2019, you sold the Fitness business, effectively became a pure-play marine company. You acquired Freedom. First, on Freedom, how much of that acquisition was your bullishness on the boat club space? And how much of that was a source of demand for your boats, your engines, your P&A?

A little bit of both, as you quite -- you might have imagine. Certainly, the synergy case for us that -- Freedom has strong operating margins with no synergies. So they're accretive to our enterprise average margin with no synergies. But with the synergies, it's hugely -- the financial performance is huge for us. So Freedom has about 2,500 boats. They get turned over about once every 2 to 3 years, which means that 800 to 1,000 new boats go into Freedom every year. At the time we acquired them, none of those were Brunswick boats and none were Mercury engines. So you can imagine the synergies that we get from -- are really material from that. Strategically though, I think in every vertical, you see shared access models becoming increasingly important, non-ownership participation model. And the one that's really worked in marine is the club. Peer-to-peer is not quite so big as it is in some other verticals. But Freedom is, by far, the biggest asset of that type in the marine industry. It's 4x bigger than any other. So acquiring it is big for us from a financial perspective, big strategically. Just a couple of things about Freedom. We're at 221 clubs. We think market saturation is probably 1,500 clubs just in the U.S. 3x more women are members of Freedom Boat Clubs than our owners of registered recreational boats. 50% more people under 40 are members of Freedom Boat Club than owned recreational boats. So the faster we can grow those, the faster we can bring in a new demographic into boating. People do graduate, if you like, or progress from membership of Freedom to boat ownership. So that's interesting, but we're happy whether they're Freedom or whether they own one of our boats.

Or maybe if you just think about the recurring revenue opportunity, that replacement of boats as well as folks who are in clubs, that acts more like the aftermarket parts business does versus the new boat and engine sales. So it's adding to our recurring revenue.

It is, yes, that's right. I think 75% of total revenues from Freedom are recurring.

As a boat OEM, is the boat club concept good or bad for that business in the sense that does it take away from boat purchases? Or does it get more people into the sport?

Yes. So I think the latter clearly. We recently did a survey of Freedom Boat Club members, 92% were not intending to make a boat purchase. So 90-plus percent of Freedom boat members are new people in boating that would not have entered via the new boating path -- or new boat ownership path.

So shifting gears a little bit to the industry. Last year was a tale of 2 cities, if you will. The first half was a little choppy. I think in hindsight, it was pretty clear that was weather related. The second half was a little bit more stable. And as we enter 2020, we're trying to figure out which one is correct. Is it the first half or the second half more a better indication of where we are as an industry in terms of the health of the industry?

Yes. So I think a couple of things. At the back half of 2019, we took great pains to make sure that field inventory level weeks on hand were at appropriate levels. So we underproduced retail significantly at the back half of 2019 to get field inventory levels in a good place. So we're in a very solid position as we enter 2020. Our forecasts are based on a flat to slightly up market. That is a very pragmatic call. We just did not want to get into the business of forecasting the market. And so we said, yes, all of our plans, our 2020 plan, our 3-year plan is going to be based on flat to slightly up. I'd say that's a pragmatic call. The first few months of the year, I would say, have been more or less as we expected to slightly better. If you think about -- the first quarter is not a very big boat purchase quarter. It's really the second and third quarter. January and February, 40% of the first quarter, so March is the biggest portion. We're working our way through that. But I think boat shows have been good. Miami was very good for us. We had good share. Mercury had great share, Mercury had 45% of all the engines at Miami. And if you think we have 5 other major competitors, it is pretty decent. So we were very happy with that. So I'd say we go into 2020 with inventories really well positioned, modestly improved situation versus what we were planning, I would say, constructive situation; and good representation and good performance at early boat shows. So we're pretty pleased.

So we've heard from a couple of boat dealers this morning, and I asked the question to both of them. Given the disruption we saw in the stock market last week, any indication that you're seeing a weakening of demand or order cancellations, et cetera? Both of them said, no. So I ask you the same question. Was there any -- have you seen an early impact from what we saw last week in terms of demand?

No. No, we haven't. If you think about our boat portfolio as well, we love to talk about Boston Whaler and Sea Ray because they're very profitable companies and very exciting products. But our average customer earns $75,000 to $125,000 a year and buys a $40,000 boat. So that is not an average customer that is necessarily super impacted or sensitive to the stock market. I would say that our premium brands with Boston Whaler and Sea Ray, Boston Whaler in particular, is -- they have orders through the majority of the year already. So particularly the new models, that we introduced at the end of last year and early this year, our orders out into next year already. So it would take a big pullback to effect something like that.

And the Whaler that's outside, that's for sale?

Probably is somebody's Whaler, I think.

Okay. You mentioned inventories earlier. You guys did a great job, as you mentioned, in the second half of getting weeks on hand down to flat at year-end. And it sounds like you're in a good spot, I guess. Again, MarineMax and OneWater this morning, and they feel the same way that overall industry inventories are in a good place. There are pockets of excess, if you will. Are you guys seeing that as well? Or do you feel good about the entire portfolio as we head into 2020?

I think we feel good about the whole portfolio. I would say that premium fiberglass is lower on inventory than probably we'd ideally like to be. I would say that our pontoons are right on inventory. I think the broad market, we're seeing pontoon slightly elevated versus the average, but nothing that concerns us very much. If you think about weeks on hand, that's -- it's a good measure. The other measure is just units in the field and because sales were lower last year, the actual number of units in the field is significantly below where it was in 2018. So I think we're in a strong position from an inventory perspective.

Moving on to innovation. You guys are in a very unique position, I think, because you're a leader in boats, you're a leader in engines. Can you give us a sense for given where we've come recently in terms of the evolution of both boats and engines, bigger boats, more horsepower, outboard powered, et cetera, where do you see the innovation going over the next 2, 3, 4 years, both on the boat and propulsion side?

So I think the technology that has got good utility really sells in new boats. People are not afraid to pay for those kind of advanced features. So joystick control, autopilot, GPS station keeping, you probably never order a Boston -- a big Boston Whaler or Sea Ray without those features right now. They also protect us really against the used, preowned market or the used boat or preowned market, which is where those features are less available. So we have a strategy that we call ACES. It's a strategy that's pretty -- a framework that's similar to automotive. ACES: autonomy, connectivity, electrification and shared access. Autonomy and driver assistance for us is an extension of the kind of advanced docking capabilities that we've been progressing, essentially ease-of-use features. We sell -- all of our premium boats now are connected. So when you buy the boat, you get the app. It allows you to monitor it while you're away from the boat, for example. Electrification is tougher in marine. We're seeing some of it, but we introduced a new product called Fathom very recently, which essentially replaces the generator on most large boats with a large capacity lithium ion battery and electrical distribution network produced by one of our companies, Mastervolt. So we're seeing electrification, but not quite in the same way as in automotive. And then shared access, the S, is really Freedom Club model, those kind of things, more of a business model transformation than technology. So we think all of those factors as well as just quieter, lighter, more fuel-efficient engines are -- will continue to give us a lead, and you'll see some unbelievable new products from us in the next year or so.

And you've already started to see some of those technology features start to migrate down into the product line. So digital switching has been installed as a feature on pontoon boats. There's ways to migrate joystick control and docking technology down into additional product categories. So there's many ways this can play out.

Yes, absolutely.

And just in terms of the engine, I can remember when having 3 250-horsepower engines on the back of your boat was a big deal. Now it's not so much. Are you still seeing that trend toward more horsepower? Have you hit a wall in terms of horsepower? At some point, as you point out, the engines become too heavy on the transom. So are we at that point where you're not going to see that increase in horsepower going forward the way that you had the last few years?

I think when we brought out a 450-horsepower outboard engine in the middle of last year. 2 of the boats at the launch event had 6 of them on the back. They were 70-foot boats, which did 70 miles an hour. So I think transom horsepower is still continuing to increase. I think on an individual engine basis, higher horsepower is still going to increase. Certainly, having 6 engines on the back of your boat is, if you need it for horsepower, that's great. It's probably not the ideal scenario from a complexity perspective. So if you could get there with fewer engines, I think people would like that as well. So I think, yes, the trend is boats that used to get powered by twin inboard diesels, for example, from Caterpillar or Cummins or -- are now powered by 4, 5 or 6 outboard engines. They're on the back of the transom, that means all the space that used to be filled by those big diesel engines is now available as accommodation or for other purposes. So the utility that you get is incredible. And the engines are very efficient and reliable, easy to service. So I think the growth of outboard will continue and the growth of horsepower will continue.

In terms of capital allocation, David, one of your slides pointed out your 2022 targets. And if they're correct, you're going to be throwing off probably north of $1 billion in free cash over the next 3 years, including 2020. What do you do with that cash? I know you've done a good mix of buybacks, debt reduction, M&A. So how do we think about the uses of that cash over the next 3 years?

Well, I think progressively reducing our leverage over the next couple of years is the right thing for us to do. We're not leveraged up very much. We're about 1.6 or 1.7 gross leverage right now. But we're -- getting it down in the low 1s gives us a lot of optionality, as you pointed out. I think we have a lot of options. We've included M&A in our base case. We could do more M&A. Certainly, we're very cognizant of making sure that when our share price is right that we return money to shareholders. So I think we'll continue to balance our strategy between maintaining a very healthy balance sheet that protects us through any kind of macro issues, continuing to return money to shareholders and looking at strategic growth opportunities as well.

Is the M&A environment attractive at this point?

I'd say there's targets around for us to be interested in. Yes, certainly. Our focus will likely continue to be the annuity-type businesses, Parts and Accessories, some of the businesses like Freedom. I think we like the margins in those businesses. We like the continued reduction in cyclicality. We have about 1/4 of the marine P&A market right now. So plenty of room for us to look for other businesses.

We've got a couple of minutes left. I wanted to touch on one last topic. You mentioned ESG earlier in one of your slides. Maybe just give us a sense for the importance of ESG in your corporate strategy. What you've done to improve your ESG scores?

So maybe on the governance side, to start with, we recently declassified the Board. We also, when I took over as CEO at the beginning of 2019, separated the roles of Chairman and CEO. We have 3 female Board members, not where we want to be eventually but a start. So concrete moves, I think, in the right direction. Our scores for governance tend to be strong. So in terms of environment and social, for the first year this year, in fact, in March, we'll be publishing our first enterprise-wide sustainability report. Our biggest division, Mercury Marine, has been very strong in sustainability for a long time, 9 times award winners in Wisconsin for environmental leadership. We just haven't, while we had more of a portfolio mindset to our enterprise, expanded that, but now we are. And so we have, I think, a great plan. You'll see a really good report from us. That indicates a lot of progress already and plenty of room to progress further. So we have a much broader, I think, a more holistic view of that. It certainly is becoming an increasingly important part of our strategy overall. But to be honest, our employees really like it as well. I think everybody feels good if they're contributing to a sustainable business.

Great. I think we're just about out of time. I appreciate it, David. Thank you, Bill. Thank you, everybody, for joining us.

Thank you.

Have a great day.

Thank you all very much, indeed.