Valuation: Undervalued

Investment Thesis:

Increased home improvement spending, increased spending on outdoor living spaces, and an increased demand for domestically manufactured products create the perfect storm for certain stocks in the market.
- This has been observed by the tremendous growth seen in Home Depot ($HD) and Lowes ($LOW) recently.
However, there are other companies who can take advantage of these conditions and have more room to grow than these other large cap stocks. One stock that fits perfectly into these macro trends is Griffon Corp. ($GFF)
- Offer a wide variety of home improvement products and tools to consumers through their many subsidiaries.
Griffon Corp. can take advantage of these trends and has massive growth potential, which is good enough in itself, however they are also vastly undervalued, which makes such an investment even more favourable.
- According to several valuation techniques undergone in my valuation, $GFF is undervalued and has the potential to grow by 81.98%, which would result in a share price of $47.35.
  - As always with such a large upside potential, there are some underlying risks which will be displayed under the “risks” section of this report.

Company Overview:

Griffon Corporations is a diversified management and holding company, who conducts their business through their subsidiaries. Griffon Corp. was founded in 1959, is headquartered in New York, NY, and is listed on the NYSE under the ticker $GFF.

Griffon owns, operates, and acquires businesses in multiple industries and geographic locations. Griffon provides innovative, branded products that are of superior quality, which helps them to differentiate from the rest of their competition.

Griffon operates a diverse portfolio of businesses, (which will be explained in depth later in this report) to reduce variability, seasonality, and cyclicality.

Griffon Corp. has split their business operations into 3 main segments:

The AMES Company:
- The AMES company is the North American leader of branded consumer/professional tools, and products for home storage, organization, landscaping, and outdoor lifestyle.
Clopay Corp.
- Clopay is North America’s largest manufacturer and marketer of garage doors, rolling steel doors, and grille products for residential, commercial, institutional, industrial, and retail use.
Telephonics
- Telephonics is a globally recognized provider of sophisticated intelligence, surveillance, and communication solutions for defense, aerospace, and commercial customers.

These segments will be explored in more depth under the “company information section”

Investment Information:

Macroeconomic Outlook:

Home Improvement Spending:

If I asked you to think of one product that was the most popular product bought by consumers in 2020, what would you say? I know I would say face masks and/or hand sanitizer, and this is probably what most other people would also say. But what if I told you that kitchen faucets, kitchen cabinets, and toilets were the most popular products during the pandemic. Some of you might think I am lying; however, I am in fact telling you the truth (hook me up to a polygraph tester, and it will confirm this).

According to data from the NPD group, the home improvement sector skyrocketed 22% during the pandemic. This is no surprise, as even before the pandemic, this sector was still gaining traction as the homeownership rate was quickly increasing.

Furthermore, 77.2% of people took on at least one home improvement project (ranging from gardening to full remodels). This was made possible by the extra disposable incomes that many Americans enjoyed during the pandemic, extra income that would be best spent where we were all forced to spend the majority of our time in, this being our homes. This surge in home improvements sent stocks like Home Depot ($HD) and Lowe’s ($LOW) skyrocketing in 2020, and even in 2021.

This extra spending on home improvement also helped companies that manufacture home improvement goods such as toilets, faucets, cabinets etc. Some companies that also benefitted from this additional spending include Ethan Allen ($ETH), Masco ($MAS), and many more. This is also true for some of the AMES Company’s subsidiaries, such as Closetmaid, suite symphony, express shelf, master suite, space creations, and style+ who manufacture closet systems, shelving, stackable storage, cabinet pull-outs and racks, and garage/utility systems. It also would have benefitted the subsidiaries of Clopay, which include Holmes Garage Door, and Ideal Door as they both provide residential garage doors. All of these companies listed above are subsidiaries of Griffon Corp. and all would have benefitted from increased home improvement spending.

Lastly, it is commonly known that since the pandemic started, low interest rates have fueled the housing market, and with this string housing market came increased home improvement spending. However, it is important to think as an investor “what will happen if this doesn’t continue, what if the housing market slows down or has a correction”. It obviously depends on how severe this correction would be, if it was 5-10%, or if it was 90% and we were all sent back to Armageddon. A good example of the effects on homme improvement spending during a smaller correction comes from 2019. In 2019, the housing market dropped 7% to start the year, and the general outlook was either negative or stagnant. However, during this correction, Harvard studied a wide variety of cities and no city that they studied exhibited a decrease in remodelling spending amounts. Despite the overall slowdown of the market, many cities exhibited increased spending, this trend is favourable for companies like Griffon, as we might see some sort of correction to the housing market in the near future.

Sources:
Lowe's (LOW) earnings Q1 2021 beat estimates (cnbc.com)

The rise of the home improvement sector — and where it could go next | Retail Dive

Why Americans are holding off on remodeling their homes (for now) - MarketWatch

Outdoor Living:

Outdoor living spaces have always been viewed as a luxury or nice-to-have addition to people’s homes, however the COVID-19 pandemic changed this view from a nice-to-have addition to a necessity. This is largely due to the amount of time people are looking to escape their homes and the indoors from being “couped up at home” as a result of the pandemic. This is causing people to spend their extra, saved, disposable income on their “outdoor retreats” and enjoy their time outside.

57% of homeowners plan on continuing their use of outdoor spaces after the pandemic is over. Many of these people are also willing to make investments into their outdoor spaces to make it more livable and add value to their homes. Since there is this level of commitment to improving their outdoor spaces even after the pandemic, it is likely that we see this trend continue for the foreseeable future.

As a result of this willingness to invest in their own backyards, several pool companies have gone public and are growing quickly. Goldman Sachs is forecasting a 12% CAGR in the pool industry this year and has upgraded their estimates on several pool stocks accordingly. However, this additional outdoor spending is not just limited to pools. Scotts Miracle-Grow ($SMG) has grown by over 160% since pandemic lows, Brightview (landscaping company) ($BV) has grown by over 100% since pandemic lows, and many other outdoor living/improvements stocks have also benefitted.

This benefit was felt within Griffin Corp. as they have many subsidiaries that provide long-handle, yard, striking, and hand tools as well as other yard improvement tools (ie. Wheelbarrows, and cleaning tools). Furthermore, some of Griffin Corp’s subsidiaries offer pots/planters, decorative aggregates, water features, water hoses, outdoor decor ad outdoor lifestyle products. These subsidiaries of Griffin Corp. that offer these products have benefitted from the increased amount of spending to improve personal outdoor living spaces.

Sources:

Pool Corporation (NASDAQ:POOL), (SWIM) - Pool Stocks Make A Splash: Two Ideas From Goldman Sachs Analyst | Benzinga

COVID-19 led to homeowners prioritizing outdoor living | Warwick Beacon (warwickonline.com)

Domestic Manufacturing:

Studies have shown that today US consumers prefer US products that claim lower environmental impacts. However, this was not always the case as people used to think US manufactured goods were cheap and/or inferior. Furthermore, consumers are now more worried about where their products are sourced from and if the manufacturing processes are ethical and/or sustainable. This recent surge in demand for US made products has helped many local manufacturers gains business.

Joe Bidens newly released infrastructure plan noticed the change in consumer preferences over domestic products and assigned a budget for manufacturing job creation in the USA. This plan helps to convert US manufacturing from a dying industry to a National asset. However, many of these jobs will be focused on creating jobs in the green energy sector.

This shift in consumer preference in conjunction with additional funding for US manufacturing creates the perfect environment for companies like Griffon Corp. and their subsidies who create affordable, quality products that are manufactured ethically in the USA. There is no data available on the effects that this will have on Griffin Corp. as a company however, it will be interesting (to say the least) to see the effects that these factors will have on their business.

Sources:

Biden’s infrastructure plan would benefit from a healthy domestic battery supply chain | Greenbiz

Aligning Interests of Domestic Manufacturers and Consumers | 2020-04-16 | ASSEMBLY (assemblymag.com)

Financial Information:

Share Offering: Griffon completed a $178M share offering for 8,700,000 common shares in August 2020. This is not ideal for investors, as previous shareholders shares have been diluted by 18.32%, which is reflected in the share price (fell 18.93% between August 2020 – September 2020). However, between October 2010 and October 2018, Griffon’s shares outstanding fell from 62.12M to 45.67M, which signals share buyback which inflated existing shares by 26.48% over 8 years.
Acquisitions: Griffon Corp. has had their own personal history with acquiring companies (12 acquisitions in the past 7 years), however some of their subsidiaries have been acquiring companies as well. An example of this was in June 2018, Clopay (one of Griffon’s subsidiaries) acquired CornellCookson for $170,000. Although this is a relatively small purchase, it still sends a message that Griffon and their subsidiaries are looking to grow their businesses. Furthermore, CornellCookson generated over $200,000 for Clopay in their first year of operations, meaning that Clopay got a fantastic deal on the acquisition. Some other recent acquisitions include La Hacienda (2017), Kelkay (2018), and Apta (2020).
Seasonality: Griffon’s revenue and income are generally the lowest in the first and fourth quarters due to the seasonality of the AMES and Clopay segments. This is because Clopay’s business is driven by renovations and home improvements, which generally take place during warm weather and over 95% of Clopay is US and Canadian operations (so even though in our winters, it is summer in Australia, their portion of sales does not offset the low revenues in North America during our winters).
Employee Compensation Plans: Griffon currently has 1,167,172 common shares available for employee equity plans. Although this is good for the company because shares/ownership makes employees work harder, if all of these shares reach the market, it is likely to see dilution of 2.06% which would be reflected in a 2% share price decrease.
Financial Improvements: Griffon Corp. has increased their revenues by 12% YoY, decreased their interest expense by 2% YoY, and they decreased their effective tax rate by 6.12%. All of these factors contribute to a higher Free Cash Flow, which will increase their valuation through a DCF model.
Indebtedness: As of 2020, Griffon Corp. has $1.06B of debt, and although this may seem like it is a lot, Griffon actually plans to incur more debt to keep their Debt to EBITDA multiple close to 3.5x. Furthermore, the paid off over $50 in debt in 2020, decreasing their debt by 4.4% YoY. Also, a lot of this debt was achieved through financing acquisitions, which is a good use of debt, which will generate future returns.
Leverage Reduction: Griffon has reduced their debt to EBITDA multiple (leverage) by 2.7x in just 2 years, this is great news and recently Griffon has exceeded their own leverage expectation of 3.5x (currently 3.1x).
Future Margin Improvements: Griffon plans to increase the margins of both AMES and Telephonics. As you may have noticed, Clopay has been excluded from this group because they have already exceeded margin expectations. However, Griffin plans to increase AMES margins from 10.2% to 12% or higher, and they also are planning to increase Telephonics margins from 7.5% to 12%. If they are successful in achieving this, investors will become increasingly excited about the future prospect of Griffon Corp.

Company Information:

Intellectual Property: The AMES Company, and Clopay Corp. have a combined 1,378 trademarks, and 263 pending trademarks. Furthermore, they have 650 issued patents and are in the application process for 149 more patents. Griffon Corp’s intellectual property is valuable and lasts for between 14-20 years for patents, and no time limit for trademarks.
Competitive Advantages: Griffon Corp. has a large portfolio of recognizable brands and have longstanding relationships with many bleu chip customers (ex. Home Dept, Lowes, Walmart have all been customers for 30+ years). Furthermore, Griffon has been a market leader in numerous categories (tools, home, garden, closets etc.) for a long time. Lastly, Griffon has top-tier manufacturing and distribution channels and processes, and are constantly innovating their products.
The Ames Company: The AMES company is Griffon’s largest segment, representing $1.2B in annual revenues (49% of total revenues). The AMES Company operates in the USA (65%), Europe (8%), Canada (7%), Australia (19%), and other countries (1%). The AMES company offers multiple different categories of tools, pots/planters, landscaping, outdoor lifestyle, and storage/organization products. The AMES company is able to offer these products through their 29 subsidiaries, which will be linked below this analysis as an image.
Clopay Corporation: Clopay is Griffon’s second largest segment, bringing in $969M in annual revenues (38% of total revenues). Clopay operates largely in USA (95%), but also operates in Canada/other (5%). Clopay focuses primarily on residential repair/remodel (51%), but also Commercial Construction (38%) and Residential Construction (11%). Clopay offers residential garage doors, sectional doors, service doors, and shutters/grilles, all under their 3 subsidiaries (Holmes, Ideal Door, and CornellCookson). Clopay has 52 distribution centres in North America, and a network of 2,500 professional dealers.
Telephonics: Telephonics is Griffon Corp’s smallest segment of their business, representing 13% of total revenues ($321M annually). Telephonics provides their Communications/Surveillance (50%), Radar (39%), and other (11%) systems to their customers which consist of the US Government (65%), International (30%), and commercial (5%) clients. Telephonics operates under their 2 subsidiaries and has garnered an excellent reputation with their customers.
Total businesses: Griffon Corp. operates their own company, as well as their 37 subsidiaries (3 of which are AMES, Clopay, and Telephonics, which each have their own subsidiaries). A list of all of Griffon Corp’s subsidiaries can be found as an image at the end of the report.

Valuation Information:

WACC:

I found Griffon Corp’s WACC on a website called Gurufocus, in which they explained their calculations and arrive at a final figure of 9.48%. This figure is consistent with other websites and estimates which are all around the 9% range. This WACC is used in both of my DCF models.

CAGR:

I found the CAGR through looking at $GFF’s financials, in which I found the annual EBIT growth rate over the past 4 years. By doing this I arrived at a CAGR of 23.18%.

Interest Expense Increase Rate:

To find the interest expense increase rate I took the average growth in the interest expense over the past 3 years. By doing this I arrived at an interest expense increase rate of 1.46%

Tax Rate:

I was able to find Griffon Corp’s annual effective tax rate for the fiscal year 2020 in their 10-K filing with the SEC. Griffon Corp. stated that their annual tax rate for 2020 is 32.2%.

Free Cash Flow (FCF) CAGR:

This growth rate is only found in my second DCF model, in which I used Griffon Corp’s expected FCF for 2021 and found the CAGR of their historic FCF’s (through their investor presentation) to estimate future FCF growth.

Competitor Information:

There are a couple of similar companies in terms of operations, market cap, and geography. These companies were all included within the comparable analysis. These companies consist of Stanley Black & Decker ($SWK), Snap-On Inc. ($SNA), The TORO Company ($TTC), and The Eastern Company ($EML).

The closest competitor/company that would be comparable to the operations of Griffon Corp. would be TORO. This is because the TORO Company, like Griffon has many subsidiaries that manufacture different products, and the go through many acquisitions. However, when we look at TORO through the comparable analysis, they are one of the most, if not the most overvalued company on the list. This fact might hint at the fact that the comparable analysis might be understating Griffon Corp’s fair value and is something to keep in mind.

Investment Valuation and Plan:

Valuation:

In order to value Griffon Corp. I decided to undergo 2 DCF models of my own, as well as comparing my results to the DCF model achieved through tracktak (a DCF calculation cite). Additionally, I decided to undergo 3 comparable analyses, which will be explained further under the “comparable analyses” section.

DCF #1:

In this DCF model I used the WACC, CAGR, Interest expense increase rate, and tax rate as described in the “valuation information” section. By utilizing these figures, I arrived at a fair value of $36.37/share, which implies an upside of 39.78%. This upside is very reasonable, but I decided to also undergo a second DCF to validate these results.

DCF #2:

In this DCF I used figures from Griffon Corp’s investor presentation to undergo the DCF. In this presentation they showed their FCF figures over the past 5 years and estimated their 2021 FCF. I started this DCF with their estimated 2021 FCF’s and then applied a growth rate to it. This growth rate was found by looking at the FCF growth over the past 3 years (which can be found in the “valuation information section”. Once I arrived at the FCF’s between 2021-2030, I applied the same WACC (as found in the 1^st DCF) to discount the FCF’s to their present values, in order to value Griffon Corp. This DCF arrived at a fair value of $60.04/share, which implies an upside of 130.75%. This is much larger than the previous DCF valuation, but consirms that Griffon Corp is undervalued.

Average DCF:

I took the average of the 2 DCF models that I conducted in order to get one price target via DCF models. By doing this I arrived at an average valuation of $GFF of $47.35, which implies an upside of 89.98%.

TrackTak DCF:

In order to arrive at this DCF I had to input the CAGR, Griffon’s target operating margin, and the year of convergence. By inputting these figures, TrackTak automatically populated a DCF model (which can be found below as an image). This DCF arrived at a fair value of $64.00/share, which implies an upside of 145.96%. This is similar to my 2^nd DCF model and further confirms that $GFF is undervalued.

Comparable Analyses:

EV/EBITDA:

I used this multiple to value Griffon Corp. because it is a commonly used multiple when valuing companies. When comparing Griffon Corp’s EV/EBITDA multiple to that of their competitors (listed in the “competitor information” section), the comparable implied that Griffon Corp has a fair value of $40.90/share, which implies an upside of 57.19%.

EV/Revenue:

This multiple is most commonly used when companies undergo acquisitions. This is very much the case when looking at/valuing Griffon Corp, as we know they have completed 12 acquisitions in the past 7 years. By comparing this multiple to that of their competitors, Griffon Corp’s fair value is $64.65/share, which implies an upside of 148.46%.

P/E:

Like the EV/EBITDA multiple, P/E is used very commonly when valuing companies. By comparing Griffon Corp.’s P/E to that of their competitors, we find that $GFF has a fair value of $40.42/share, which implies an upside of 55.34%. All of the comparable have different fair values, however, there is one thing that they all have in common. This one factor is that they all indicate that $GFF is undervalued.

Average Comparable Analyses:

In order to find one price estimate for the comparable analyses, I averaged the fair values of all 3 estimates. By doing this, I arrived at a fair value of $48.66/share, which implies an upside of 87.01%. This is very close to the figure achieved through the average DCF valuation.

Plan:

Any entrance into a position of $GFF, under the $30.26 level, would be a very good buy that will help to mitigate risk.

I would consider selling my position of $GFF as soon as the price hits $47.35, as stated in the average DCF valuation.

By following this plan (assuming you bought at the current price of $26.02) would yield a 81.98% return, which is a very favourable return for investors.

Catalysts:

Future Acquisitions: Stock prices have been known to jump on the news off acquisitions, especially when the company gets a good deal on the acquisition. This was the case when Clopay acquired CornellCookson, and they brought in more revenue ($200,000) in the first year of operations, than the acquisition price ($170,000). If Griffon Corp. can keep finding these high value acquisitions, it will help to explode their growth.
Financial Improvement: If Griffon Corp. meets their future margin, revenue and EBITDA targets, this will help make their financial report beat estimates and get eyes on this stock. This will be a bullish signal as it will get investors excited for the future of Griffon Corp.
Leverage/Debt Reduction: If Griffon Corp. can pay off a large portion of their debt and further improve their leverage ratio (which already is exceeding estimates) it will help Griffon Corp notify their investors that they are financially healthy. If Griffon pays off this debt, it will reduce the inherent risk of such an investment which will draw in additional investors.
Intellectual Property: If Griffon Corp can continue to apply for and be grated patents/copyrights, they will be making it harder for new companies to enter their market and enjoy a larger market share. This could help Griffon’s stock price and increase their market cap.
Earnings Report: Griffon Corp. is set to release their earnings either in late July or early August this year. Knowing that there are multiple economic trends that are boosting their sales/business, we can be fairly confident that Griffon Corp. will beat earnings, helping to propel an upward movement in their share price.
Macroeconomic Factors and Overall Sentiment: Many macroeconomic factors/trends that are currently being observed can be beneficial to Griffon Corp. helping to drive their revenues to new high’s.

Risks:

Ongoing Effects of COVID-19: Since Griffon Corp. has international operations, the lockdown measures for their different geographies vary, causing inconsistencies in their revenue/performance by geography.
Future Share Offerings/Employee Packages: Griffon Corp. has had a history of providing employee stock packages and undergoing share offering in order to finance their business operations. This is a risk because both of these factors put extra shares into the market thereby diluting the existing shares. This was the case in 2019, as Griffon offered shares and diluted the existing shares by 18% (and this was reflected by 19% decrease in the share price).
Indebtedness: Although Griffon Corp. is taking on debt for all of the right reasons (to acquire companies and expand), their level of long-term debt (over $1B) might scare potential investors away. Furthermore, as they continue to acquire companies, they will accrue more debt, which will further scare off potential investors.
Loss of Large Customers: Home Depot, Lowes, and the US Government are all large customers for Griffon Corp. and future earnings results rely heavily on revenue generated from selling products to these large customers. Losing one of these customers would have a noticeable effect on an earnings report and drive customers away from the stock.
Raw Material Price Increases: If you have read some of my previous posts on certain stocks, you would know that there is supply chain issues currently occurring, which are causing the prices of wood and steel to increase. This increase in price of both wood and steek could affect the profitability and margin targets on earnings reports. This may make their earnings seem less than expected and cause a decrease in share price.
International Trade Policies: If the countries that Griffon and their subsidiaries operate within declare unfavourable trade policies with each other (ie. Increased tariffs on products) this will have a negative impact on Griffon’s profitability.

Portfolio Reasoning:

This stock fits in perfectly with the portfolio philosophy
- Undervalued
- Small-Cap
- Favorable Macroeconomic factors
Helps to diversify the portfolio
- I do not have a stock in the portfolio quite like this one
  - The company itself is diversified in many segments through their subsidiaries.
- Favorable analyst coverage
  - The average analyst price target is $33.50
- Poised for growth
  - Griffon Corp. has future growth prospects and is acquiring the necessary companies in order to meet these projections.