Dividend growth investing is a popular and largely successful approach to generating wealth over long periods of time. We will be spotlighting numerous dividend up-and-comers to identify the best “dividend growth stocks of tomorrow”. Griffon Corporation (GFF) is a conglomerate that offers exposure to the housing market through a variety of its subsidiaries. The company’s operational metrics are trending higher, but remain mediocre. In addition, the company’s balance sheet carries a high debt load. These factors turn us away from considering Griffon as a long-term hold, but the stock’s solid growth and attractive valuation could produce short-term returns as a value play.
Griffon Corporation is a small conglomerate that operates in a handful of businesses, including finished goods for consumers and professionals (includes tools, decor, closet systems, cabinets, garage/closet utility systems), home and building products (residential and commercial garage doors), and various defense electronics systems for both commercial and government use.
Source: Griffon Corporation
While a concentration of revenues is within the United States, Griffon’s subsidiaries sell in international markets as well. The company generates total revenues of $2.2 billion annually.
Over the past decade, the company has generated very solid growth. Revenue has grown at a CAGR of 6.35%, while EBITDA has grown at an 11.19% rate.
Griffon manages a handful of business segments that are all very different from each other. To gain a better understanding of the cumulative fundamentals of the company, we will look at some key operating metrics.
We review operating margins to make sure that Griffon is consistently profitable. We also want to invest in companies with strong cash flow streams, so we look at the conversion rate of revenue to free cash flow. Lastly, we want to see that management is effectively deploying the company’s financial resources, so we review the cash rate of return on invested capital (CROCI). We will do all of these using three benchmarks:
- Operating Margin – Consistent/expanding margins over time
- FCF Conversion – Convert at least 10% of sales into FCF
- CROCI – Generate at least 11-12% rate of return on invested capital
The company’s metrics are a bit volatile; Griffon has shuffled its business some by divesting assets (such as Clopay Plastic Products) and acquired new businesses (such as ClosetMaid). The company’s metrics consistently fall below our benchmarks, which is disappointing. However, they are trending in the right direction. Operating margin has doubled over the past decade. As the company continues to settle following its recent streak of M&A over the past few years (ClosetMaid, Kelkay Limited, CornellCookson), these metrics could improve. Still, it’s unlikely that Griffon will qualify for the label of “cash cow”. The business just isn’t as FCF efficient as we would like to see.
The other facet of our fundamental look at Griffon Corporation focuses on the balance sheet. A balance sheet is an often overlooked fundamental, but it can turn an otherwise strong business into a poor investment. When a business is over-leveraged, cash flows are restricted and investors can be exposed to risk should the business suffer an unexpected downturn.
The state of the company’s balance sheet is a red flag for us. With just $72 million in cash against $1.1 billion, Griffon’s balance sheet is quite stretched. The gross leverage ratio of 5.7X EBITDA is well beyond our cautionary benchmark of 2.5X. The leverage ratio is trending in the right direction, but this balance sheet will hang over the heads of investors and limit the company’s ability to grow its dividend and make additional investments into M&A.
Dividend & Buybacks
Griffon Corporation has paid a dividend since 2011 and has raised it each year. This means that Griffon is currently working on a nine-year growth streak. The dividend today totals an annual sum of $0.30 per share and yields 1.36% on the current stock price. Because investors can get more yield from 10-year US treasuries, Griffon Corporation is not a great option for income driven investors.
Griffon has been somewhat erratic with its dividend growth. While the dividend has grown at a five-year CAGR of 17.6%, the payout has received small raises the past two years (3.4%, 3.6%). Meanwhile, the company paid a special dividend of $1.00 in 2018 (instead of cleaning up its balance sheet). Despite this, the dividend is affordable at just over 36% of earnings (FCF has been too volatile to asses the payout from a cash basis). Management is trying to deleverage the balance sheet, so investors should expect low single-digit growth until the balance sheet is in a better spot.
Management has opportunistically bought back stock at times over the past decade. We don’t anticipate any sizable buybacks given the (much discussed at this point) state of the financials, but the share count has dropped from 60 million to 47 million (reduction of 22%). This helps grow EPS, as well as increases FCF per share.
Growth Opportunities & Risks
Griffon Corporation doesn’t participate in any sectors that would be considered to have “explosive” growth potential, but the company is entrenched well where it does compete. Management is projecting mid-single-digit revenue growth moving forward.
Source: Griffon Corporation
The potential for bolt-on acquisitions is always there, and is more likely as a long-term growth engine. The balance sheet is not currently in the state needed to support M&A.
Because of the company’s structure as a conglomerate, the business is relatively diverse. The company is, however, heavily exposed to residential construction and maintenance, so this could impact Griffon’s forward looking growth trajectory.
Low mortgage rates are fueling strong housing market activity. This plus a strong US consumer economy has created a nice tailwind for Griffon Corporation’s two largest operating segments (AMES & Clopay are 85% of revenues). The interest rate environment doesn’t seem to be poised to change in the short term, so this momentum should continue.
Risks to Griffon Corporation are centered around two major areas of concern. Despite the positive momentum of the housing market, a recessionary environment would apply negative pressures on the business. Additionally, the company’s stretched financials would increase this risk exposure. Not only would revenues see pressure, but financial maneuvering would be more difficult (higher interest rates on debts). If economic momentum begins to erode in the US, it may slow momentum for the company’s organic growth.
Griffon Corporation’s shares have had a very wide ranging year of trading. The company’s shares have fluctuated between $12 and $25, and the stock’s current price of $22 is near the high end of that range.
Analysts are currently projecting Griffon Corporation to earn approximately $1.28 per share for the 2020 fiscal year. This would place the stock’s earnings multiple at 17.20X, a whopping 45% discount to the stock’s 10-year median PE ratio of 31.50X.
This is a very large discrepancy from historical norms, so we will also look at valuation from a cash flow standpoint to gain perspective. The company’s current FCF yield of 7.04% is also near its highs of the past decade.
Both metrics indicate that the stock is undervalued against its historical norms of the past decade. The forward looking outlook of the business continues to look solid. And while the stretched balance sheet is certainly a cause for concern, we don’t feel that it’s enough of a risk that such a drastic departure on the stock’s multiple is warranted. Griffon Corporation isn’t our ideal “buy and hold forever” stock example, but the stock certainly seems undervalued enough that a shorter-term holding period (a valuation based trade) could make sense.
Griffon Corporation is a solid conglomerate that has entrenched itself well in a housing market that should continue to produce demand for the various products that it manufactures. While the balance sheet is a concern for us, the stock’s attractive valuation gives Griffon Corporation some appeal. Not a company that you invest in and hold for the long term, we like the stock more as a potential valuation based trade with a shorter time horizon.
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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.