MarineMax A Rising Tide Does Not Lift All Boats

MarineMax: A Rising Tide Does Not Lift All Boats|Must Read Jun. 24, 2016 7:00 AM ET1 comment

by: Lester Goh

Summary• MarineMax is priced for explosive growth. Management presents a

compelling bull case.• The bull case relies heavily on the singular assumption that boat sales could

revert back to historical peak levels.• This assumption is overly optimistic as it overlooks structural developments

in the competitive landscape. MarineMax's model is also intrinsically unattractive.

• Even if we give management credit for increasing revenues, earnings growth will not be as explosive going forward, limiting upside potential and providing asymmetry for shorts.

MarineMax: A Rising Tide Does Not Lift All Boats - MarineMax Inc. (NYSE:HZO) | S… Page 1 of 14

http://seekingalpha.com/article/3984001-marinemax-rising-tide-lift-boats 1/8/2016

• As the market begins to realize these worrying issues with the narrative, shares should re-rate substantially lower - my target price of $4.35 implies ~70% downside.

At first sight, MarineMax (NYSE:HZO) ("MarineMax", "HZO" or "the Company") appears cheap. 2015 EPS is just under $2 a share, so the Company's P/E is 7-8x.But, boating - especially high-end boating, which is HZO's target market - is clearly a highly cyclical industry, so we need to smooth the numbers over a longer time frame to get an idea of normalized earning power.Let's use a five-year period - I am not cherry-picking; I could have used 7 or 10 years, which would strengthen my argument (both would result in negative cumulative EPS). Cumulative net income over said period (2011-2015) is ~$63m or ~$2.50 per share on ~25m shares outstanding.But 2015 net income was inflated by a massive $27m tax benefit, so adjusting for that, cumulative net income drops to ~$36m, or an average of ~$7.2m per annum.Thus, normalized annual earning power is closer to ~$0.29 per share, and hence HZO's P/E on normalized figures is roughly 55x. Such a premium valuation could ultimately be justified, if, and only if, earnings are poised to explode over the next few years. And such an explosion in earnings cannot be fleeting, but must represent a "new normal", as highly cyclical businesses are most frequently valued on normalized P/E.Management Presents A Compelling Bull CaseClearly, MarineMax is priced for explosive growth. Can it achieve it? Management implies through its presentations that this is possible, and presents a bull case that is, prima facie, highly compelling.The Company prides itself as the largest boat retailer in a highly fragmented industry that is of course, ripe for consolidation. Management consistently points to signs of a broad industry recovery. With its position as market leader, the company expects to benefit disproportionately from the rebound in industry boat sales to >300k units per annum when it arrives.



HZO also emphasizes its advantages over peers, which are (1) better management information systems, (2) better people, likely due to its very own university, (3) its status as the leading partner for retail/wholesale financing, presumably derived from its large scale relative to the competition, (4) its exclusive relationship with Brunswick, which owns well-known boat brands, and (5) the absence of long-term debt on its balance sheet (the debt is related to inventory financing).If confronted with such a narrative, one can easily see that the Company is extremely well positioned for a pronounced rebound in boat sales - and that seems to be the current market perception.But, the bull case is largely predicated on the singular assumption that boat sales will recover strongly going forward.Road To Pre-Crisis Levels: Market Is Pricing In A RecoveryAs I alluded to above, MarineMax caters to a high-end market. What do rich people splurge on? Rare art, luxury cars, high-end property, among other things.It has been 7-8 years since the financial crisis, and most high-end markets have rebounded strongly by now. Rare art has probably rebounded the most, evident from the eye-popping prices art pieces sold for last year.But if you were expecting the same, strong rebound for boat sales, you would be sorely disappointed. Sure, boat sales have been increasing in recent years, but they have yet to reach their prior peaks achieved pre-crisis.



Source: Investor PresentationAs seen above, the 2015 estimate pegs average retail powerboat sales at ~177k. They dipped below 150k during the crisis, but have increased slightly in recent years.But the market clearly expects the Company's sales to rebound to pre-crisis levels (~300k unit sales annually) - indeed, it must, in order for shares to achieve a reasonable valuation multiple. As seen below, the share price has mostly recovered following the financial crisis.



Source: MorningstarIn comparison, annual sales of ~$750m have yet to even come close to pre-crisis levels of ~$1.25b, according to historical data compiled by FinBox.Note that MarineMax had ~19m outstanding shares in 2006-2007. Now, it has ~25m, or a ~30% larger share count. So the company's current value isn't that big of a difference as compared to pre-financial crisis.What bulls might be betting on (based on MarineMax's trading price) is the potential for annual industry boat sales to return close to the ~309k unit average experienced over the 1992-2006 period. That would presumably allow the Company to return to >$1b in annual sales.Structural Changes In The Competitive Landscape: What's Stopping Boat Sales From RecoveringUndoubtedly, something must be delaying the recovery. This must be the case, as in prior cycles, the recovery occurred relatively quickly. For example, when consulting the 1990-2015E data set provided by management, it seems that prior recoveries (i.e. trough to peak) occurred roughly over a three-year period - 1992-1995 and 1997-2000.



However, once the current century begun, this "three-year recovery" became non-existent. Peak sales over the 25-year period occurred during the early 2000s, and the industry has yet to recover to such a level. While MarineMax's management does not explicitly state that it expects a rebound to >300k, it does implicitly highlight it as a potential scenario - never mind that it hasn't occurred for 15 years, and counting. This can be seen in its investor presentation slides showing industry sales from 1992 to 2015E (supra) as well as the slide showing its estimate of replacement demand (infra).Seeking Alpha author Terrier Investing is skeptical of the potential rebound to >300k industry-wide boat sales driven by replacement demand, but concludes that there is "room for boat sales to continue to run". I argue that he should be even more skeptical than he already is.An astute observer would intuitively deduce that the failure to return to prior peak boat sales implies that there was a huge change in industry dynamics or the competitive landscape that occurred sometime during the early 2000s and beyond.And this change must be structural given the fact that industry sales have yet to recover to prior peaks for more than a decade.Before we profile the upstart disruptor, let's first think about the factors that would influence a purchase decision. Said another way, if you're looking to get a boat for recreational purposes, what do you look for?The first factor would be price. It's no secret that that boating isn't exactly cheap - a small jet boat sells for anywhere from $20k-80k while a large yacht will run you anywhere from $3.5m-35m a pop, according to MSRP data provided by the Company.The second would be variety in design. Different customers have different tastes, so a prospective customer is more likely to purchase from a firm that has a wide selection of different boat models.The third would be post-sale customer support. Face it - generally, if you have a boat, you aren't exactly thrilled to spend the time to maintain or clean the boat and fix up the small things that go wrong. You'd rather outsource it.



A casual browsing of MarineMax's website suggests thousands of different boat models. Its 10-K talks about how the Company provides maintenance, repair and storage services. So it's got post-sale customer support, but it's a really small part of its business at ~6.3% of 2015 sales.Clearly, the barrier to consumer adoption here is affordability.Boat Clubs As Industry Disruption - MarineMax's Addressable Market Has Contracted SignificantlyThe Freedom Boat Club was founded in 1989 to solve this affordability problem. Members pay a one-time entry fee to join the club and monthly fees from thereon out - which is likely far cheaper than purchasing a boat outright from MarineMax.But that's not the most compelling part of the club's value proposition.Instead of getting access to only one boat, which would be the case if you bought it from a boat dealer, you get access to the club's entire 1,100 boat fleet.Oh, and you don't have to bother yourself with the maintenance of the boats, those issues are all taken care of by the club.Moreover, this club is not just some small local operator. It has locations in 20+ states (and counting) and over 12,000 members. You can bet that business is booming - how else would the club be able to franchise the boat club model to aspiring business owners?Boats have extremely low utilization rates - Statista estimates that the average annual boat days, a measure of boat utilization, is anywhere between 5.5 and 11.2 days, depending on the type of boat. That makes the Boat Club model quite appealing.As a result, it's easily to postulate that the historical level of demand for MarineMax just isn't there - some of that demand is being catered to by boat clubs renting out their fleet.Replacement Demand Estimates Are Far Too Optimistic



The point on addressable market ties into my next argument - which is that management's replacement demand estimates are highly unrealistic.

Source: Investor PresentationAs seen above, management posits that average life expectancy of boats is 30-35 years, which would imply replacement demand levels similar to the prior peak boat sales achieved in the early 2000s.However, this is based on boat registrations since inception, which implicitly assumes that the addressable market hasn't shrunk - but it clearly has, as I explained above.



Thus, since management's estimates of replacement demand does not take into account structural developments in the competitive landscape - i.e. the rise of boat clubs - it seems that said estimates are likely too optimistic.The key takeaway from the above two conclusions - (1) MarineMax's addressable market has contracted, and (2) replacement demand estimates are too sanguine - is that the years of ~300k in annual average industry boat sales are long gone, and that the "new normal" is far lower, probably in the 150-180k range.Margins Have Likely Peaked, At A Level MarineMax Can't Generate FCFA quick glance at the Company's financials will tell you that revenue has been growing rather quickly - especially in the last three years. Revenue grew ~11.5% in 2013, ~7% in 2014, and ~20% in 2015.Earnings have also grown, and this is partially attributed to SG&A leverage. As a percentage of sales, SG&A peaked at ~27% in 2009, and has now fallen to ~21%. Net income hence grew from a ~$77m loss in 2009 to a ~$48m profit in 2015 - although the reader should note that 2015 net income was boosted by a ~$27m tax benefit due to a reversal of the Company's deferred tax asset valuation allowance, as I alluded to earlier.However, it would seem difficult to expect further earnings gains from SG&A cuts. Additionally, gross margins have remained at ~25% for a decade, excluding the recession years, so overall margin expansion is unlikely to be driven by higher gross margins.While management talks about focusing on higher margin businesses, this is unlikely to have meaningful implications over the next few years as the pace of the shift in mix appears extremely slow.Higher margin businesses, as defined by management, are that of the finance, insurance, and brokerage, parts & accessories, service, repairs & storage businesses. They comprised of 12.9% of sales in 2007, growing to a mere 15.2% in 2015 - 230 bps growth over eight years is hardly a needle-mover.



It is interesting to note that, at roughly double the 2015 sales figure, MarineMax earned a similar net profit margin in the pre-financial crisis years (after adjusting for the tax benefit in 2015).As a result, it is likely that the Company is nearing the limits of SG&A leverage. With little potential for gross margin expansion and SG&A leverage, it is hard to see what (other than top-line growth) would drive an increase in net profitability going forward. This attribute provides upside protection for shorts.So net margins have likely peaked, at a level where MarineMax cannot generate FCF. FCF in 2015 was negative ~$7m. Over the last half-decade, the Company has been FCF positive only twice, and even then, marginally so - 2012 FCF was ~$3m and 2014 was ~$2m.You know that you are probably not in the right business, when the only years where your FCF is solidly positive is the recession years.2009 FCF was a massive ~$207m. Clearly, this figure is an outlier, as 2010 FCF fell to ~$36m. FCF has hovered around breakeven ever since.Business Model's Risk/Reward Is Structurally Skewed To The DownsideWhile generating FCF in bad times may seem like a good thing, it is important to note that the Company was only able to throw off so much cash during the recession because it severely tightened working capital.Although it allows MarineMax to survive the recession, the negative here is that the disposal of working capital (mostly inventory at huge discounts) positions HZO poorly for a recovery.If the Company generated significant FCF in a normal economic environment and thus is able to accumulate cash, it would be able to capitalize on recessions by purchasing inventory on the cheap (MarineMax has a significant used boat business) - boats do not go out of style at the same speed as fashion, after all.However, during recessionary periods, MarineMax is likely to sell inventory at massive discounts in order to pay for its operating expenses.

MarineMax: A Rising Tide Does Not Lift All Boats - MarineMax Inc. (NYSE:HZO) |… Page 10 of 14


One thing that's holding back FCF these days is MarineMax's working capital - specifically, inventory. While sales grew from ~$524m in 2012 to ~$751m in 2015, working capital grew from ~$102m to ~$162m. 2012 inventories were ~$215m, and have grown to ~$274m in 2015. So the entire net increase in working capital was due to inventory.Suffice to say, inventory has to be purchased during the ordinary course of business, due to the fact that prospective buyers would likely want to test drive many different models before arriving at a purchase decision. So this is a structural problem that prevents the Company from generating meaningful, consistent FCF.One way to solve the problem is to increase inventory turns - and MarineMax has been trying to do that through offering discounts during the summer, among other promotional initiatives. But progress on this front has been insufficient, evident by FCF stubbornly remaining negative. Current inventory turns are nearing pre-crisis levels, suggesting limited room for improvement going forward.This required stocking of inventory and the lack of substantial, sustained improvement in inventory turns significant enough to result in solidly positive FCF highlight the intrinsic unattractiveness of the Company's model.Consider 2009, where gross margins cratered, falling ~800bps to ~15% over the span of just one year, leading the firm to post its largest non-goodwill/intangible asset related loss of ~$77m. In the prior year, HZO posted an even larger loss of ~$134m, though that loss was largely due to a massive impairment charge.In the 7-8 years that has passed since the financial crisis, the Company has yet to cumulatively earn sufficient profits to offset the losses of 2008 and 2009, a fact which serves to highlight the fragility of MarineMax's business model.In short, the HZO model has structurally skewed risk/reward. The firm posts moderate profits when times are good (but generate no meaningful FCF), punctuated by massive losses when a recession hits, forcing it to sell inventory at hugely marked-down prices, positioning it poorly for a recovery. As long as inventory turns, which are dependent on consumer behaviour, refuse to improve to the point where HZO generates robust FCF, this dynamic will be ever present.Valuation & Asymmetry



It should be clear to the reader that MarineMax doesn't deserve its ~55x normalized P/E that Mr. Market is assigning. What would you pay for a highly cyclical business with risk/reward that is structurally skewed to the downside and elusive FCF generation? I argue that a 15x normalized P/E is highly generous, suggests a ~$4.35 stock, and implies ~70% downside.What about risks to the upside?As discussed, earnings growth should track sales growth given limited gross margin and operating leverage. While sales growth has been strong in recent years, it was driven by a greater mix of used boat sales and larger boat sales - both of which are less profitable, hence leading the Company's gross margins to contract from ~26% in 2014 to 24.6% in 2015. So upside potential stemming from explosive earnings growth, ala 2010-2015, is unlikely.Boat sales also seem to be on the secular decline, largely due to boat clubs increasing the utilization of existing boat capacity as discussed, which implies that it is highly unlikely that HZO's sales, or industry sales for that matter, would explode over the next few years.These two factors alone make it hard to envision MarineMax growing into its valuation over the next few years, which should provide asymmetry for shorts as it limits upside potential.A quick thought exercise: Valuation-wise, for MarineMax to grow into a 15x normalized P/E over the next three years, it would have to earn ~$27.5m in net profits on average. If we use a five-year period, ~$137.5m cumulatively.Two years in, it is at ~$32m cumulatively, after adjusting for the $27m tax benefit in 2015. So it has ~$106m left to go, or an average of ~$35m over the next three years. For reference, revised fiscal 2016 management guidance calls for $0.68-0.75 in EPS, which at the mid-point implies ~$18m in net income on ~25m outstanding shares. Clearly, a tall order.Bulls might think it is possible because management recently raised fiscal 2016 guidance, which may signal heightened confidence regarding future prospects, but the guidance implies a YoY decline in EPS from ~$0.80, after adjusting for the tax benefit in 2015.



Management's quarterly commentary (as well as commentary from other players in the industry, such as Brunswick) suggests a favourable environment.But favourable is, for MarineMax, simply not enough, because it is priced for growth. Boat sales must explode, because the magnitude of the valuation excess requires it.And there is no indication that such an explosion is looming - even if we make the outlandish assumption that millions of Americans suddenly wanted to go boating overnight, it is likely that much of that demand would accrue to boat clubs.Recommendation: Initiate a short position in HZO with a price target of $4.35/share, suggesting ~70% downside from current levels. Catalysts include slowing sales growth and limited margin expansion, driven by competition from boat clubs. Other less firm-specific catalysts such as a general economic recession will also lead to upside for shorts. Risks to the short thesis include sustained sales growth driving bottom-line growth, which is mitigated by an end-market in secular decline. With limited risks to the upside and large downside potential, the short seems rather asymmetric, in my view.Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.Additional disclosure: Disclaimer: The author's reports contain factual statements and opinions. He derives factual statements from sources which he believes are accurate, but neither they nor the author represent that the facts presented are accurate or complete. Opinions are those of the the author and are subject to change without notice. His reports are for informational purposes only and do not offer securities or solicit the offer of securities of any company. Mr. Goh ("Lester") accepts no liability whatsoever for any direct or consequential loss or damage arising from any use of his reports or their content. Lester advises readers to conduct their own due diligence before investing in any companies covered by him. He does not know of each individual's investment objectives, risk appetite, and time



horizon. His reports do not constitute as investment advice and are meant for general public consumption. Past performance is not indicative of future performance.



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MarineMax A Rising Tide Does Not Lift All Boats