Brunswick Corporation (BC) Earnings Call Transcript & Summary

Okay. Good morning, everyone. Thank you for joining us for Day 2 of the 42nd Annual Raymond James Institutional Investors Conference. I'm Joe Altobello, equity research analyst here at Raymond James, covering the household, personal care and leisure sectors. Our next presentation of the day will be from Brunswick Corporation. As most of you probably know, Brunswick is a leader in the marine space across Propulsion, Boats, Parts and Accessories as well as Boat Clubs with its acquisition of Freedom a couple of years ago. Its portfolio includes some of the best-known boat brands in the world, such as Boston Whaler, Sea Ray, Bayliner, just to name a few, all powered by its high innovative Mercury engines. Very pleased to have with us today members of senior management, including CEO, David Foulkes; CFO, Ryan Gwillim; and Vice President, Investor Relations, Brent Dahl. Welcome to everybody. We should have some time at the end of our chat for audience questions as well, which you can submit electronically via OpenExchange through the chat icon in the upper left of your screen.

So with that behind us, I did want to start with -- our discussion from a big picture perspective. Back in late January, a little over a month ago, you provided guidance for the coming year with the underlying assumption that the U.S. marine industry would see unit growth in the low to mid-single digits on top of the double-digit growth that we experienced last year. The January SSI data looked pretty good, up double digits. So as we sit here today in early March, have you seen anything over the past few weeks that would make you more or less confident in that outlook for growth in '21? I think you guys are on mute. No, it looks like your mics are on mute, guys. There we go.

Here we go. I'm sorry about that. Good morning, Joe. Good morning, everybody. Apologies. I can't remember your question now, though, it's 30 seconds. So yes, I think we're building confidence in that outlook. I think, as you mentioned, January was strong, February has continued to be strong. I think there are a lot of momentum carried over from the back end of 2020. We're seeing that strength across our businesses. Certainly, on the Boat side, boat dealers are keen to build inventory quickly. They know how important that is. Similarly, in Engines and P&A., and then even in early membership sales for Freedom Boat Club, I think across all businesses, we're showing signs of another strong retail season. On the wholesale side, I think dealers and our other channel partners are recognizing the value of having as much inventory as possible, not being caught out as we enter the full season. As we mentioned earlier, our -- in some -- in our earnings call and earlier discussions, on the retail side, our production is sold out through about 85% of production slots for the year. And that's probably actually increased since I last took a look at it. So most of this year is fully accounted for. And of those boats, an unusually high number are also retail sold. So they'll be sold straight through the dealer, which means we'll have to go into another replenishment cycle. I think early season retail suggests that the pipeline situation is not going to get any better very quickly. And I think our objective this year is really to try and produce with balanced wholesale and retail. We do not believe we will make much improvement in the pipeline during this year. But what we are doing, as you know, is increasing some capacity. We're adding about 10% to our capacity. It should take us up over the next 2.5 years to about 44,000 units versus about 39,000 or 40,000 now. What that means is that the pipeline replenishment is likely to take, I would say, 3 years, including this year, to get us back to more normal levels, assuming retail behaves in a relatively predictable way. So I would say everything we've seen so far builds confidence in a strong retail season and good wholesale.

No. That's helpful. So moving on to another subject, supply chain. Just hoping to get an update on that. Have you seen any increased delays either suppliers providing parts or getting things through the West Coast ports, for example, which has become an issue for some companies. Have things gotten worse? And are you concerned that it might impact your plans for '21?

We're not concerned at the moment that it will impact our plans overall at a kind of aggregate level. Certainly, some of the things that you talked about are things that we're managing on a daily basis. If you think about -- I think about the supply chain situation, if you like, in 3 different layers. First of all, there's COVID. Our plants are producing extremely well. Our productivity is at least as good as it was pre-COVID. Some of our suppliers were not quite so efficient, I think, during the height of COVID. But as the case rates, particularly in the U.S., have come down, that situation has improved significantly. I do think overlaid on that, though, everybody is ramping up production as fast as they possibly can, and the supply base needs to keep up. And certainly, that is happening in more verticals than marine. So one of the things that really -- 2 things, I think, really help a company like us are scale. We tend to be the biggest, at least, marine customer for a lot of companies, so we tend to get to the front of the line. And then the diversity of our business. We may get something that is an issue, 1 day in 1 plant. But because of the breadth of our portfolio, it is never going to aggregate up to something that affects the full business. I'd say the third layer of things that we're managing right now is associated with the recent power outages in Texas and Northern Mexico. Our facilities are back up and running fine and have been for a couple of weeks now. But we do receive refined petroleum products and other chemicals from the Gulf Coast. And some of those facilities, when they go through a hard shutdown like that, take some time to come back fully online. So we are not experiencing any shortages right now. But those facilities will need to come back online in a predictable way. If they do, we'll be fine. If not, we might see some issues there. So far, we have not, though.

Okay. Great. Your Propulsion business has performed extremely well of late, largely through a combination of strong innovation that has enabled market share gains in saltwater, repower as well as international markets, along with your core freshwater markets, obviously. What specifically are you doing to gain market share in those particular areas that I mentioned, saltwater, repower and international? Does it require a different go-to-market strategy? Or is it basically just really out innovating the competition?

Well, I think the core of it is very similar across all of those kind of end markets and channels. We have the best product, and the new products that we're launching are making us even more differentiated. We have the best technology. We also are a very easy customer to do business with. We put a lot of it -- we make a lot of investments in engineering support, integration engineers that work with OEMs. We're certainly expanding our channel partnerships as we move forward internationally. And even domestically, we -- I think we have put in place about 100 new repower dealers just last year. Obviously, that volume and support is really important. And then as you know, we're expanding our OEM customer base dramatically. And to be honest, volume is coming our way in those end markets faster than we had anticipated. So the basics of best product, best technology, best support are still working. I think there are subtleties around the different end markets, but nothing -- if it's on a level playing field, we're always going to win with our product and technology, and we are winning. I would say a lot of the OEM wins that we saw have a saltwater component to them. And a lot of new builders that are entering the saltwater market are preferring Mercury over other alternatives. And so this demand is just coming at us very, very fast, which, of course, we appreciate, and we're really benefiting from the investments that we made in capacity over the last several years, which I think makes us able to serve all of those markets, at least, at the moment, better than our competition can.

What's the biggest pushback that you get typically from a dealer or a repower -- or from an OEM or a repower dealer?

0 pushback. We don't -- we really don't get any pushback. I think it'd have been great if more people could have been at the event where we launched the new 600 Verado, and maybe we'll talk about that in a bit more detail later, but we had people just clamoring to be at that event, who were not really even in consideration when we first organized the event. So I would say that there is -- our products are just creating tremendous pull, and pushback is something that we are definitely not seeing at all.

Good to hear. So you sort of answered this question, but I'll ask it anyway as a follow-up. What are you seeing from a competitive standpoint on the engine side? Is that innovation gap that you talked about that's benefited you for a while now. Is that expanding at this point?

It is expanding. It has expanded. I think the -- if you think about the -- I'll talk about the 600 a little bit more, but this -- we have the new 600 outboard. We have the next most powerful outboard, which is the 450VA. You have to go down to 425 before you see a competitor, and that is a product that I would not say is competitive with our product. The most powerful Suzuki is 350 horsepower, so half the power of the new 600. So I would say that we're continuing to significantly outpace the -- our competitors. I do -- when you look at the new 600 Verado, we did something really special there. We did not just build a bigger version of an existing outboard. We knew that we wanted something different. And so the feature content of that product is amazing. It's not just a V12. It has a steerable gear case. So the whole of the outboard doesn't move, just the gear case. First time an automatic transmission has ever been installed in an outboard. It has twin propellers. So that's in-built steering. So there's -- essentially, you just bolt it to the back of the boat. So we really thought that product through. And the combination of innovations is something that I don't think anybody else could have done. But certainly, nothing that anybody else is going to catch in the next, I don't know, 5 years. If you're a builder with large boats, and often that's a saltwater builder, I don't see how you can partner with anybody but Mercury right now. Why would you? We can fulfill your portfolio needs for every boat in -- that you have, and we have product that is just simply unavailable and will not be available from our competition. So I'm really excited about the most recent product. I think it separates us even more than we were separated before. You see builders building boats for that 600 Verado, they specifically worked with Mercury, and said, okay, we'll have the boat ready when you have the engine ready. What that means is that those folks are not designed to work with anybody else's engines, only designed to work with Mercury's engines. You're seeing now people with 70-foot boats that used to have inboard diesels in them, switching to outboard power because they get 20-feet more interior space that was occupied by those diesel engines. And now they just put outboards on the back. So I think that this is a big momentum shifter as outboards enter a whole new class of boats, larger boats, displacing diesels, displacing inboard engines. I just think there's still way to catch this right now.

And Joe, this isn't an accident. This isn't something we came up with overnight. And we are -- rough estimate, we spent $1.5 billion since 2008 on outboard engine design, R&D, CapEx and capacity. And each time we launch an engine family, that builds on what we learned from the previous one. And for a competitor to, a, have that amount of investment; and b, that much time, it's just not going to happen, as Dave said.

One, Joe, just to kind of dimension this against other verticals, 4x more people watched the launch video for the Verado 600 than watched Harley-Davidson's 21 Model Year online event. That is -- and if you -- sometimes, you were comparing ourselves with other things in the marine industry. But it's sometimes nice to pick your head up and understand how much interest a product like that is generating. We had articles, not just in Marine Press but in Robb Report, Car and Driver and Motor Trend. This was a product that was unique, and I think inspired a lot of people, not just within the marine industry but outside of it.

Got it. I want to turn to channel inventories. You ended 2020 with 40% fewer boats in the channel than the year before. You've been very clear that we're likely not to see a normalization until some time in 2022, which might be even later now. So on your last earnings call, you noted that you had enough manufacturing capacity to meet expected retail demand, and you mentioned this earlier this morning, this year of around 39,000 or 40,000 units, which implies you don't expect to make any progress in refilling the channel? Am I interpreting that correctly? Or do you expect to increase capacity above expected retail this year?

We're working as hard as we possibly can to get as many boats out as we can, and we announced the capacity actions. Those were kind of discrete actions that were important that we talked about because we wanted people to know that we will do everything we can to get as many boats out as possible at reasonable investment levels. We are taking many other actions across our plants to reorganize more efficiently, bringing in more workers, adding shifts. I think -- could we potentially outproduce that 39,000 or 40,000? Yes, we could, but it will probably be in 1,000 to 2,000 range at the maximum. So that 40% reduction in field inventories represents about 10,000 units. So even if we really stretch with expected retail, it's very difficult to see us making any significant inroads or progress in increasing pipelines this year. As we get more capacity online in '22 and '23, we'll certainly be chasing up that inventory to the appropriate levels, but I don't see it this year.

Okay. So if we look back historically, you typically ended the year at around 36 weeks of inventory in the field. You ended last year at just 19 weeks. I think at one point, you were down to 14 weeks in the channel. The conventional wisdom seems to be that we're unlikely to see 36 weeks, again. I think most people that we speak with feels like we're now at a lower level of -- a primary lower level of inventory, improving from here, obviously, but we're not going back to where we were in 2018 and 2019. What is the right number of weeks on hand that you think a normal year should end at? And can you get there by the end of '23?

Yes. No, I think there's a lot of discussion about what is the right level. And I think it's a good discussion to have. Certainly, we don't want excess inventory in the field. It's a bit of a moot point, to be honest, probably for the next couple of years. One of the things that it's important to consider is not just what inventory, but is it the right inventory. In that regard, we're using analytics and working much more closely now with our channel partners to help them understand what is selling, both in terms of models, option content, colors, so that what they stock is what they're going to sell, and we don't get slow-moving inventory. In that regard, I think we can optimize what inventory is out in the field. But the level you can get to depends a lot on the number of brands you have and the number of models in the brand inventory, if you like. If you look at Brunswick or our Boat Group, there's probably 600 different models across our 17 brands. If you want -- we have a large dealer body. If you want dealers to have a representative number of a particular model with a reasonable number of some premium content, some value content, there is just not a straightforward way of getting that number down too far. So I believe that we'll optimize it, and maybe that will be some weeks, but it isn't going to be 20 weeks or 25 weeks. We -- if we level load production, which is obviously how we'd optimally like to run our plants, we -- the 25 weeks, we cannot respond to any demand spikes. And so our dealers would be -- if there was a demand spike there, all of a sudden, they're out of inventory. So I think that we'll optimize it. We'll make sure it's the right inventory. Certainly, it may change by some weeks. I just don't see it shifting down very, very substantially.

Okay. Okay. Because I was doing some quick math. And it seems like based on your capacity, based on retail, assuming no big falloff in retail, it's going to be hard for you guys to get back north of 30 weeks probably until 2024, if my math is correct. Is that how you're thinking about it as well?

Well, obviously, I think we will be progressively evaluating the actions that we need to take. I think, clearly, there's a trade-off here. We do not want to lose market share in the areas that are important to us. Our premium brands, Boston Whaler, Sea Ray, Lund, we want to protect market share. If we don't have enough capacity, that obviously becomes a risk. And I think, right now, there might be some effects on -- supply-driven effects on market share as opposed to situation previously where market share was mainly based on demand. So we need to just make sure that we're careful with our investment. We don't over-capacitize. But as we understand how retail develops, we will take additional actions as necessary to protect the market share in the brands where we are particularly focused.

Since you mentioned market share, I'll go there next. Your Boat segment, even though 2020 was a very strong year, didn't seem to gain much market share last year. Was that just a lack of availability in terms of the channel that held you back?

Yes. I think availability was a factor certainly for our premium brands, like Boston Whaler and Sea Ray. Our field inventory was down in single-digit weeks. I would say, though, if you look at last year, we gained share in Aluminum Fish. We gained share -- Sea Ray gained share. Boston Whalers' large boats gained share. Interestingly, we gained -- I think we're the fastest-growing wake sports brands that we have now and have been for the last 2 years. I think we've been up like 60%. Now we're a small -- we're starting small. But in some key areas that are important to us, we gained share as much as our production would really allow us to, I think. And one of the things I think we've been very clear on is operating margins in the Boat segment are a priority for us, along with market share in our premium brands. We are not going to go chasing share with price and discount anywhere, but particularly not just to gain additional units of Aluminum Fish boats. That's not what the operating priorities of PBG are.

So you're gaining share in the areas that you want to gain share, effectively?

Yes, we are. And I think we're gaining share with a great new product. We've been going through a huge refresh cycle with Boston Whaler, and we'll continue to do that, introduced 4 or 5 new models just in the last year. One of the things -- one of the impacts that has is it does slow us down a bit. As you're doing a model changeover on a production line, the efficiency of the production line goes down a bit. So that tends to hold us back a bit as we're going through the model change. One of the advantages of reopening our Palm Coast facility for Boston Whaler is that we'll be able to introduce new models on a new production line. And so we'll improve the overall efficiency of Boston Whaler and lose fewer units during the model transition. The more aggressive you get with new product introductions, obviously, that's very supportive of market share, and Boston Whaler has grown tremendously. But you do lose some efficiency as you transition an old model out and a new model in. And that additional plant capacity will allow us to do that much more efficiently. I think, obviously, the -- we just launched the new Sea Ray 370. It was extremely successful, was sold out through December already. One of the interesting things about that boat is not just the great reception that the design and styling of functionality guard, but it's Sea Ray's highest margin boat. So the play that worked so well for us with Mercury, which was every new product that we bring in, we bring in at a higher margin than the last one, both from a cost perspective, and to some extent, what we can price. That playbook is going to be playing out in our Boat group now with all of the new models being launched at significantly expanded margins than the one they are in place. So that new model introduction excites the marketplace, brings in new buyers, but simultaneously, allows us to further drive our Boat group margins in the right direction.

Got it. So with new channel inventories of boats, that's getting a lot of attention, obviously, you're also under-inventory on the Engine side. And I know you increased capacity a couple of years ago, you talked about that earlier. But can you talk about what you're doing to alleviate that lack of inventory? And what the opportunity is for this year and next, for example, to rebuild that channel?

Yes. We're doing a lot of things, really. Certainly, there are -- we introduced a lot of additional capacity, and there are other things that we can do that require less investment, but just help us to operate more efficiently. And we're doing that continuously, rearranging things inside the plant, moving less value-add activities like storage and distribution out of our main production facilities and allowing us most place for production. So you will continue to see that. We're obviously continuing to evaluate incremental capacity. I would say that market share is coming to Mercury faster than we'd anticipated. So we're constantly looking at what is the next most efficient thing for us to do. Sometimes, that's things that we need to do. Sometimes, that's things that the supply base needs to do. We certainly are anxious to maintain Mercury's momentum. And so far, we have been able to keep up with demand. As you say, though, the inventory build is not going as fast as we might have anticipated. So we're continually looking at what we need to do to, product line by product line, make sure that happens. When we introduced a new product, though, like the 600, it comes with a new production line, new capacity. And so one of the most efficient ways for us to introduce small capacity is when we launch new product. We're already making a lot of investments when we do that. So adding capacity is very efficient as we introduce new products, and we certainly will be continuing to introduce new products.

And Joe, just -- I just want to be very clear. We do not believe we are losing sales or share or anything on the Engine side due to lack of capacity or availability to get engines into the market. There have been commentary about OEMs not receiving engines. We do not believe they are our customers. We are servicing our customers and getting the engines that we need. And that is the benefit of spending the extra money in 2018 and 2019 to increase capacity at a time where it was maybe a bit -- was a bit foresight. And then we're glad we did because now we're using that, and frankly, taking advantage at times when our competition is not able to at times.

Okay. Thanks for clearing that up. As we think about margins, and you touched on this a little bit earlier, the most significant near-term opportunity does appear to be in your Boat segment with a goal of getting the double-digit margins -- segment margins by 2022. Can you help us understand what's driving that? And how would you gauge the opportunities from a margin perspective in Propulsion and P&A as well?

Well, I think we have margin opportunities across our business -- across our businesses that we're continuing to go after. Obviously, demand and absorption are really helping us right now across all of our businesses, and that's very helpful. But there are some very deliberate actions as well. If I look at Mercury, the level of automation that we put in every time we introduce a new product is higher and higher, which certainly helps. Our ability to source differently really helps. On the Boat side, our March on -- operating margins continues to be very strong, and that's a combination of a number of actions, SG&A reduction, plants, efficiencies. And we were operating about 9, 10 plants now versus the 29 that we did previously. So every plant is running more at capacity with more absorption. We're introducing a lot more automation where it makes sense in our boat plants as well. It's not always as straightforward. But we have plenty of opportunity. I remember saying a while ago that if every boat plant that we have was operating at the efficiency of our best boat plant, we would be getting towards that 10%. And that is what is happening as we share best practices, as we introduce more capable personnel, our operating is just getting better and better. And then as we introduce new products, we introduce new products with better gross margins. And so we're -- that is another impact. So we are, certainly, well on track to our double-digit margins in the Boat business, and that is plan -- where we currently plan to exit this year.

And in terms of P&A and Propulsion, do you see additional upside from here significantly?

Yes. I mean, as you know, both of their operating leverage -- their incrementals are higher than their margins are today. I'd say in P&A, it's more of a steady march. When your segment business operating margins are around 20%, a couple of 10, 20, 30 basis points a year really starts to add up, especially given the steady aftermarket annuity-based nature of that business. So I think that's -- we'll continue to create new products on the P&A side that add content, add value to the customer, and obviously, those generally come with a little bit stronger margin. And then on the Propulsion side, I think, Dave said it best. I mean every engine launch that we've made has been incremental from a margin standpoint. We not only are able to take a little bit of price, but the main item is taking cost out from the engine family replaced, whether it's fewer materials or less manufacturing, touches. And then we've been -- we have a really nice expanding average on that, Joe. So I think there's still room to run. And I think our guidance for the year has shown that, and we don't believe it's going to stop anytime soon.

Okay. Great. You've talked about your ACES strategy in the past, with the E standing for electrification. Thus far, we haven't really seen electric engines, at least on the marine side, gain much attention or market share. What do you think is holding it back? What's been the -- maybe the technological issue with electric engines?

Well, still the only really material market for electric engines at the moment is Europe on regulated lakes. You'll see some around in kind of light commercial operation, but not many in kind of the general recreational space and some of that is just physics. It just doesn't take much power to push a light-duty vehicle, whether it's a passenger car or some like commercial vehicle along a road, and then they have brakes to recover energy. It takes more power to push a boat through water, and boats, obviously, don't have brakes. And they need to float. So 1,000-pound battery packs. If you think about -- if you put a 1,000-pound battery pack in a boat, that is 5 fewer people that you can carry in that boat. So there are just some things around boating that make implementation of electrification more difficult. I think -- we think about the products a lot when we think about electrification, but there's obviously the infrastructure implications as well. I think we're, on a light-duty vehicle basis, just kind of coming to terms of what the infrastructure implications would be of light-duty electrification. But if you think about people in marinas with no power or in taking long journeys to places that don't have readily available power, I think the -- we have a more -- a longer path to alternative energy. What that means, though, is that there's still this important market around smaller boats that don't have such big range requirements and have more predictable duty cycles and can plug-in or also have portable batteries. We believe that's an important market. We expect to be a leader in that marketplace. We also recognize that there will be some kind of leading-edge customers who may want an electric alternative or electric option so we expect to and will be offering that option. But I think we just need to be realistic about the difference between a light-duty passenger vehicle or car and what its requirements are and the requirements for a boat. The physics are just different. I would say there are other verticals that are in similar situations. If you think about aviation, for example, in aviation, the power requirements the higher, the weight impacts are higher, and the path to alternative propulsion will be longer. I would think of marine more in that context. So what's been really important for us is we have leading electrical options where customers are likely to choose those options. We expect to do that, but also that we continue to make our conventional products as efficient as we possibly can. And the big -- one of the big stories around the Verado 600 is not just that it has 600 horsepower. It's that if you replace two 300-horsepower outboards with one of our 600s, it's 20% more fuel efficient. And that's because of the combination of technologies that I mentioned earlier, the automatic transmission, the dual prop system and the advanced controls that 600 operates, what we call a lean bird strategy, which means it operates at a more -- with more efficient specific fuel consumption. So we need to make sure that we're continuing to move fuel economy on our conventional engines in the right direction, which obviously reduces CO2 emissions and we have the leading available electric solutions where those are required in the market or where customers are potentially choosing them as an option. So we have been hiring a lot of electrification talent, making significant investments in an electric product. I mean you will see over the next couple of years significant product in that space from us. I would just say that, that is -- I do not expect the progress of electrification in marine to be as rapid as it is in light-duty transportation.

Got it. And one last question before we wrap it up here, it looks like we're almost out of time, a couple of years ago, I mentioned this earlier, but you acquired Freedom Boat Club. It's an attractive stand-alone business, but it also provides a lot of synergies for brands like Boats, Engines and P&A as the fleet turns over every 3 years or so. So I'm curious how do you see that business? Is it a steady stand-alone business? Is it a way to drive demand for your Boat business? Is it a way to convert club members into boat owners? Or is it all of the above?

Yes. I think it is all of the above. But in terms of kind of prioritizing that, it's a rapidly growing business, and we see it continuing to grow very rapidly. The core operating margins of the business are consistent with our enterprise margins. But if you look at the synergies that are unbelievable, we just -- that is Freedom Boat have either delivered or ordered more than 1,000 boats from Brunswick, and even more, Mercury engines. So that is an appreciable source of volume as that fleet continues to expand. We will be expanding rapidly in the U.S., and you'll hear some more announcements for us, promise, in the not too distant future in regards to that. You'll also be hearing more in the not too distant future about our expansion plans in Europe, which are taking shape very nicely. We think a Freedom model or a model very similar to Freedom is equally applicable in other geographic regions. So we think it's a growth play. We think the synergies are unbelievable. We think we're attracting a different demographic, more women, more minorities, younger people than we do with our new boat. Certainly, if people leave Freedom to buy a boat, we want them to buy one of our brands. And we'll be putting in place programs to us incentivize that. Obviously, they have experience with our brands. They're more likely to buy our brands, but we'll be doing something more specific about that as well. But it really -- that is not the primary purpose of -- it's not a funnel. It's not its primary purpose. It's an adjacent business with incredible synergies that's attracting customers that we would never have attracted to new boat ownership. When we surveyed the population of Freedom members, only about 5% have ever even been in the market for a new boat. So think of this as an incredible synergistic growth opportunity for our core businesses.

Got it. Well, I think we're about out of time. David, Ryan, Brent, thank you for your time today. Great to see you, and thanks, everybody, for listening, and enjoy the rest of the conference.

Thanks so much, Joe, and thanks, everybody, for listening as well. Appreciate it.