This Company Does Not Fear Cyclicality

Some investors will avoid manufacturers of fun but nonessential products like pleasure boats or automobiles, because they're worried that customers will delay or even cut such purchases in bad times. Brunswick , the largest manufacturer of pleasure boats globally, faces the same kind of problems as its consumer discretionary peers. However, it has tackled these issues head-on with its focus on new product innovation and cost control.

Innovation and awards are important
The durability of modern boats makes boat-building a tough business. Fiberglass boats, one of the categories Brunswick manufactures, could last for more than 75 years, based on an article posted on the American Composites Manufacturers Association's online magazine.

Brunswick would be a sitting duck if it chose to wait for customers to upgrade their boats when they become obsolete. Thankfully, it has not rested on its laurels. It's consistently spent 2.6%-2.8% of its revenues on R&D for the past three years.

Earlier in the year, Brunswick's Sea Ray 370 Venture boat received a 2013 Innovation Award at the Miami Boat Show.  The new model offers more onboard space and minimal engine noise with its concealed outboard propulsion system, for which won it the aforementioned award. It looks like the company's R&D efforts may have started to pay off.

A highly honored rival
Brunswick is not the only company to realize the importance of awards in illustrating the quality of one's products. 

Winnebago Industries , a leading manufacturer of motor homes, travel trailers, and fifth wheel products. Similar to Brunswick, Winnebago sells nonessential leisure vehicles and equipment, but has focused on quality and product innovation to differentiate itself from its peers.

First, Winnebago received the Quality Circle Award from the Recreation Vehicle Dealers' Association for 18th consecutive year in October 2013, showing that the dealers who vote for the award have been very satisfied with the quality of Winnebago's products.  Second, it also the only motor-home manufacturer to be awarded Ford's "fully meets" classification every year since 1997. To receive this distinction, companies have to show that they have manufactured their vehicles under high quality standards that maintain the integrity of the Ford chassis system. 

It's no mean feat for Winnebago to win this kind of recognition from satisfied upstream and downstream partners. Going forward, it should have no problems leveraging on its brand equity to increase its leading 20.5% market share of the U.S. motor-home market.

Cost control: The only antidote for high-fixed-cost business
While Brunswick, like Winnebago, drove revenue growth through product innovation and awards wins, it will not have survived the ups and downs of a cyclical industry without a strong focus on cost management.  

Southwest Airlines' early success had very much to do with the fact that it used only one aircraft type - the Boeing 737. Since mechanics only had to learn how to maintain and repair one type of jet, and the company only had to buy components for that model, Southwest's strategy helped keep its maintenance costs low.

Brunswick took a page out of Southwest Airlines' book by reducing its number of brands and consolidating manufacturing operations to boost cost efficiency, following the boating industry downturn that started in 2007.

Even as of 2013, Brunswick is still moving ahead with its cost rationalization efforts. In August, it completed the sale of its sport fishing convertible yacht brands, Hatteras and Cabo, to focus on its core brands. Brunswick also announced plans to consolidate its yacht and motor yacht production at its Palm Coast manufacturing plant in March 2013. The results speak for themselves, with Brunswick having improved its operating margin from 1.9% in fiscal 2007 to 7.1% in 2012.

Focus on profitability, not growth alone
In the second quarter of fiscal 2013, Brunswick grew its revenues by 4%, while expanding its gross margin by 60 basis points to 27.5%. This is the strongest evidence of Brunswick's success in cost control.

Going forward, Brunswick's earnings growth should be driven by operating margin increases from cost reduction and international expansion. Brunswick still derives about 62% of its sales from the U.S., which represents significant room for growth outside its domestic market. In particular, Brazil, a leading marine market, appears promising. But Brunswick is not blindly rushing into Brazil, having already laid down a solid foundation. It already has a Brazilian manufacturing plant and office established in August 2011 and May 2012, respectively.

Running a business in a cyclical industry is as tough as it gets, and companies also have to get the sales mix right to be profitable. Brunswick has executed its growth plans well thus far, by focusing on its most profitable brands and expanding overseas in a phased manner. The financial numbers of Marine Products  seem to tell another story of growth, but one that possibly happened at the expense of profitability. 

Marine Products' flagship brand Chaparral competes with Brunswick's Sea Ray and Bayline in the 18-to-35-foot sterndrive market. Sea Ray and Bayline are the top two brands in the market with the largest market share based on 2012 unit sales, while Chaparral is in third place. Chaparral grew its market share in the segment to 13.9% in the second quarter of 2013, which represents a huge jump from 11.6% for the same period in 2012.

Marine Products' market share gain could be largely attributed to a change in sales mix with the introduction of the new, smaller, entry-level Chaparral models, which sport lower margins. While Brunswick has exhibited margin expansion over the past few years, Marine Products has gone the other way. Its fiscal 2012 gross margin of 18.3% is a sharp drop from 2007's 21.5% and 2003's 25.9%.

In a cyclical industry like boating, Brunswick has stood firm with its commitment to product innovation and cost control. This has been reflected in its financial performance, but not in its valuations. Brunswick remains the cheapest of its peers at 16 times forward P/E, making it a safe and attractive play on the boating industry.

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