Sometimes if you really want to figure out how a shift in psychology can occur within a market, you have to look at the stock reaction to what's ostensibly a blown quarter and a weak forecast. If the reaction is negative, then you know there's nothing to look at, just keep moving on. That's business as usual.
But if the stock reaction is positive? Pull apart everything. Break down the zeitgeist. Figure out whether we are at some sort of inflection point where the psychology and the facts might be changing.
That's what happened Tuesday with the stock of Masco (MAS) . If you scroll through any of the myriad headlines from any of the news services about this kitchen, bath and paint company, you see endless stories about how poorly the company did and is doing.
Makes sense, right? Housing is slowing. Raw costs are escalating. The Fed is tightening. Tariffs are expanding. Numbers are coming down, with the company right up front saying that its annual earnings will now go from a range of $2.48 to $2.55 a share, to a range of $2.39 to $2.44.
Talk about a short.
But every now and then, at a point of inflection, a short becomes a long -- and that's what happened yesterday to this steady cabinet, plumbing and paint company. And how that happened can be instructive to how all the other shorts in the markets can become longs.
First, what you need to know about this very well-run company -- which has excellent financial discipline and great slots in the big box stores, especially Home Depot (HD) -- is that it was one of the worst-performing stocks coming into its quarter, down about 35%. Makes sense. Not only does it correlate with the obvious slowdown in housing caused by higher rates, but it also imports from China and has had to experience tremendous raw cost inflation. All of these have coalesced to crush the stock.
The analysts were loaded for bear -- and I don't mean Behr, their paint business -- ready to trash thing nine ways to Sunday. But what they heard was a story that they didn't expect.
First, raw costs, after crushing the company for ages, have peaked. Wood, copper, zinc, even TI02, the key paint ingredient, are coming down -- which makes sense. When demand dries up, commodity prices can go lower, for heaven's sakes. That was unexpected -- and it will flow through to the company's bottom line in 2019.
Second, while housing has slowed, no doubt, the repair and remodeling business has become stronger, as people are reluctant to leave their homes to buy new homes and lose a low-ticket mortgage. Now we know that home equity loans have gone up, too, but the consumer's balance sheet and plentiful job market has more than compensated for that.
Finally, and this is what I think no one expected, big companies like Masco have both an ability to pass on tariffs -- and to PROFIT from them. I am going to quote at length the statement on the call that turned around the stock: "We import approximately $600 million of components and finished goods that come under the tariffs... If the 301 tariffs rise to 25% as planned on January 1, this would amount to approximately $150 million of inflation -- or roughly 2.7% of our annual cost of goods sold. This is less than the amount of raw material and other inflation we effectively dealt with in 2018." So, in other words, it's not even as big a deal as the company already dealt with -- and sales held up fine.
"We believe this amount of additional cost is manageable through a combination of price increases, supplier negotiations, supply chain repositioning and other internal productivity measures." That says don't cut our numbers too deeply. Then Masco says there will be a lag between implementation and mitigation in 2019, so numbers go down and then go up later in the year.
And then here's the coup de grace: Masco acknowledges it is going to shift production from China to the rest of Southeast Asia and to its plants in Indiana, Tennessee, California, North Carolina and Texas. But the competition? "Many competitors, such as private label, source nearly 100% of their products from China, so we would have a competitive advantage against these competitors."
Put it altogether and here's what you have: A stock of a building materials play that's down 35% -- even as its raw costs are going down, its end markets are holding up because of repair and remodeling and its supply chain is strong enough and domestic enough that it can crush the private label companies that have been pressuring its margins for years.
The moral? Masco's not a sell, it's a buy. And that's how a company that slashes estimates to the theoretical bone can fly on the bad news.
