Why Boat-Building's a Tougher Business Than It Looks

Marine Products (NYSE: MPX  ) 's flagship brand Chaparral is the third-largest manufacturer of sterndrive powerboats in the U.S., based on 2012 unit sales. But its leading market share can't help it avoid the difficulties of operating in an industry with bad economics.

Unattractive business economics

According to Marine Products' most recent 10-K, there are approximately 70 sterndrive manufacturers in the industry, with the top 10 manufacturers accounting for about 78% of total market share in the 18-to-35-foot sterndrive category, based on 2012 data. This intense competitive rivalry is reflected in the fact that Marine Products has made little headway in increasing its market share over the past decade, with the market share for its Chaparral brand staying range-bound at 7.7%-8.4% from 2002 to 2011.

To make things worse, Marine Products is not solely competing with other boat manufacturers for customers' dollars. If you have both money and time to spend, you have practically unlimited leisure options. You could splurge your cash on sports cars, or spend a full day enjoying yourself at ski resorts. In addition, consumer demand for boats is highly discretionary, suggesting that people will hold off their purchases if the economy is bad.

Margin downtrend

Marine Products' fiscal 2012 gross margin of 18.3% is a far cry from the gross margins of 25.9% and 21.5% registered in 2003 and 2007, respectively. This downtrend reflects the key challenges that Marine Products faces.

First, boat manufacturing is a capital-intensive business, demanding a minimum level of sales volume to break even on economies of scale. While Marine Products sold 3,404 boats in fiscal 2012, on par with sales volume in 2008, this 2012 figure is only about half that of the 6,245 boats sold in 2006.

Secondly, the increase in the number of boats it sold -- from 2,100 in 2011 to 3,404 in 2012 -- is potentially misleading as a sign of market recovery. The company introduced lower-margin entry-level models, which make up a bigger chunk of its sales. In fact, Marine Product's average unit selling price fell from about $48,000 in 2011 to $41,000 in 2012, partially offsetting any gains in sales volume.

Last but not least, labor and commodity costs are creeping up. Regulations like the Affordable Care Act are adding to the labor cost burden. Also, higher oil prices adversely impact the cost of Marine Products' petroleum-based raw materials.

Future outlook

Chaparral's market share of the 18-to-35-foot sterndrive market grew strongly to 13.9% in the first quarter of 2013, which compares favorably with 11.6% for the same period in 2012, and 8.4% for full year 2011. Notwithstanding this, I believe that the market share gain, partially boosted by the introduction of the new, smaller, entry-level Chaparral models in the fourth quarter of 2011, might not be sustainable.

It is not difficult for other premium boat manufacturers to introduce similar cheaper entry-level models. On the other hand, boat manufacturers focused on the entry-level value segment will seek to compete on cheaper prices and better features.

Also, the gain in market share seems to come at the expense of profitability, with Marine Products' most recent quarterly gross margin falling by 170 basis points year over year to 17.3%. 

Going forward, Marine Products announced in April this year that it's decided to enter the recreational jet boat market, with its first jet boat models to be introduced within the next 12 months. I see this as an extension of its strategy of targeting new boating customers with more affordable boating options, since jet boats tend to be less expensive than their sterndrive-powered counterparts.

Peer comparison

Marine Products' peers include Brunswick  (NYSE: BC  ) and MarineMax (NYSE: HZO  ) .

Brunswick is a leading manufacturer of recreational products, and its Sea Ray and Bayline are the top two brands in the 18-to-35-foot sterndrive market, with the largest market share based on 2012 unit sales. Brunswick delivered a decent set of results for the second quarter of fiscal 2013, with quarterly revenue and gross margin up by 4% and 60 basis points, respectively. Looking ahead, it has guided for a 4% growth in full year revenue, notwithstanding an uncertain outlook for the U.S. powerboat market.

Unlike Marine Products, Brunswick has diversified beyond its core marine business. Fitness equipment and bowling & billiards accounted for 17% and 9% of its fiscal 2012 revenues, respectively. The bright spot for Brunswick continues to be its fitness business, which is riding on the wave of positive health and wellness trends. It has seen significant growth in the sale of fitness machines to its health club and hospitality customers in the most recent quarter.

MarineMax is the largest recreational boat retailer in the U.S. Compared with Marine Products, it exhibited greater margin stability. Excluding the results for fiscal 2009, which were affected by the Global Financial Crisis, MarineMax's gross margins have remained stable within a narrow range of 24%-25%. Nevertheless, it still suffered losses in three of out of the past ten years, reflecting the difficulty of operating in a cyclical and capital intensive marine industry.

It grew quarterly revenues and core net income before taxes by 16% and 20% for the third quarter of fiscal 2013. MarineMax's efforts in enhancing promotional activities to meet the challenges of poor weather paid off, with a 16% increase in same store sales. Its balance sheet also remained strong, with the absence of long term debt on its books. With inventory range being a key differentiator in attracting customers, MarineMax's balance sheet strength will allow it to stock up on the broadest product range available. 

Conclusion

Boat-building is a business with low profitability, given the fragmented nature of the industry and the availability of customer alternatives to recreation boats as a form of leisure. The long-term gross margin downtrend for Marine Products further strengthens my bear case on this stock.

 

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