Whirlpool’s Future Looks Bright
For business analysts, there are many ways to find investment opportunities. It is common for investors to look to history as a guide for fundamental assumptions, and potential opportunities exist when one believes the future of a company will differ from its past. It is our opinion that Whirlpool Corp. (WHR) is one such opportunity. Whirlpool’s acquisition of Maytag may have been poorly-timed, but the company executed the integration well and is applying its learnings in Europe, which now positions the company and its shareholders to benefit as volumes improve.
In 2006, Whirlpool acquired Maytag to leverage its existing scale as a global manufacturer and distributor and to utilize Whirlpool’s new innovations across an additional brand. The Maytag acquisition was a smart, long-term, strategic decision. Unfortunately for Whirlpool, the timing was very poor since 2005 marked the cyclical peak for domestic appliance volumes1. As illustrated in the chart below, from 2006 to 2012, industry volumes declined 25%, causing significant expense deleveraging and margin compression for Whirlpool. The issue was compounded by the bloated overhead from the Maytag acquisition. Additionally, this significant volume decline also occurred concurrent with an inflated raw material environment, which added to the margin pressures.
Margin Improvement and Overhead Reductions
In the decade prior to the Maytag acquisition, Whirlpool did a decent job combating raw material inflation. In North America, it maintained average gross margins in the low 20% range and average operating margins over 10%. However, in the five years following the acquisition, due to the aforementioned factors, gross margins hovered in the low-double digits, nearly 1,000 basis points below normal levels. Operating margins were also well below normal levels, averaging 4.2% during this time.
Following the Maytag acquisition, Whirlpool had 50 business facilities and 79 million square feet of company space. By 2014, Whirlpool had rationalized this large footprint, reducing the number of business facilities by 32% and the square footage of company space by 22%. In addition, the company has improved its product margin mix by focusing on higher margin tangential businesses and non-original equipment manufacturing, and it expanded distribution with broad floor representation across all major appliance retailers. As a result of these changes, Whirlpool’s North American operating margins have rebounded back to the low double-digit average, all while industry volumes remain 15% below the 2005 high water mark.
Opportunity to Exceed Prior Peak Margins
Many investors seem anchored to the previous cycle’s peak margin as a reference for the earnings power of Whirlpool’s North American region. We would contend that in this case, history is not the best guide. In contrast to 2005, Whirlpool has garnered a larger volume share, enhanced the margin mix of its products, and rationalized its manufacturing base. It is also operating in a more benign raw material environment. For these reasons, we believe that as the domestic appliance industry continues to recover, we will not only see similar earnings power to the Whirlpool of old, but will also witness a margin recovery that exceeds the previous peak. Furthermore, the typical life of an appliance is 8-12 years and 2015 marks the midpoint of this range relative to the last cycle. We believe increased volumes are forthcoming in the U.S., and with Whirlpool’s scale and efficiency, it is well positioned to take advantage of accelerating demand growth.
Applying Lessons Learned to Indesit
After the decline of the U.S. appliance market in 2006-2008, the industry saw a significant slowdown across all developed markets due to the ensuing financial crisis. Whirlpool’s European revenues declined nearly 30% from 2008 to 2012, and it saw operating margins slump from the mid-single digits to negative. This time, Whirlpool took advantage of the environment. While Europe continued to bump along the bottom of the cycle, Whirlpool acquired European appliance manufacturer Indesit, which more than doubled its business in that region.
Similar to the Maytag acquisition, Whirlpool and Indesit had significant overlap in their manufacturing footprints and distribution networks. Due to both companies’ substantial presence, the combined entity is now the largest European appliance manufacturer by volume with leading market share in the United Kingdom, France, Russia and Italy. We believe Whirlpool should realize significant margin expansion from rationalizing its manufacturing footprint, as well as additional expense leverage due to greater economies of scale. Critically, with the successful combination of Maytag, Whirlpool already has a roadmap to follow while it integrates Indesit’s operations. Thus, while any acquisition comes with risks, Whirlpool has already proven its ability to integrate a large business. When a recovery finally takes hold in Europe, Whirlpool will again be positioned to take advantage.
North America and Europe now represent nearly three quarters of Whirlpool’s business. Its other regions consist of Latin America (primarily Brazil) and Asia (mainly China and India). In each of these regions, Whirlpool maintains a strong, if not market-leading, position. These developing economies may face their own economic challenges in the short-term, but we believe the long-term opportunity of increased appliance penetration (see chart below) outweighs the inherent volatility.
Another potential risk to our thesis is the threat of increasing penetration from Korean appliance importers LG and Samsung into the domestic market. Both of these companies have carved out reasonable market share, though we believe much of their gains were the result of increased retail distribution which culminated in 2013 with Lowe’s adding LG and Samsung entering Home Depot stores. From this point forward, long-term market share gains must come from product quality and innovation, and we believe Whirlpool has the ability to compete well against its peers in both areas.
In summary, the poor timing of the Maytag acquisition is apparent, but the integration and rationalization of the cost base were successful and have positioned the company to enhance margins over the long-term. The benefits of cumulative knowledge are also paying off for shareholders, as Whirlpool has used its experience with Maytag to opportunistically double its European business and guide its strategy to maximize cost and distribution synergies in Europe. Whirlpool has positioned itself well for volume recoveries and increased penetration across the globe, and we believe shareholders will benefit as more of each dollar falls to the bottom line.
1 According to data from the Association of Home Appliance Manufacturers.
Originally published on October 20, 2015
The views expressed are those of the research analyst as of October 2015, are subject to change, and may differ from the views of other research analysts, portfolio managers or the firm as a whole. These opinions are not intended to be a forecast of future events, a guarantee of future results, or investment advice.