Don't know why, there's no sun up in the sky
Stormy weather, since my man and I ain't together
Keeps raining all the time -- Billie Holiday, "Stormy Weather"
I don't know for sure, but I'm guessing Billie Holiday never built a boat. Even so, those lyrics seem appropriate to the American boating industry these days. We've just come off a pair of earnings releases from the nation's two leading publicly traded boat builders, Marine Products
Marine Products saw its fourth-quarter sales slide 4% on a units-sold basis and 2% in dollar terms, culminating in a 12% drop in profits. Brunswick's situation is more difficult to parse, because the conglomerate sells not just boats, but also boat engines (to, among others, Marine Products), exercise equipment, bowling balls, and billiards. But the company does what it can to keep things simple, and its results by segment describe a 4% "organic" decline in boat sales, reduced to a 1% decline by adding in revenues from "inorganic" acquisitions. Sales of marine engines declined 2%. Operating profits fell 70% for boats and 89% for engines, with much of the decline attributable to the firm's efforts to restructure and realign its business to better fit today's troubled boating economics.
All in all, it was a miserable, rainy, stormy fourth quarter. But after reading the earnings reports and listening to the conference calls from the major players in this industry -- including retailer and 800-pound gorilla MarineMax
But first, the storm clouds
Both the makers and the retailers agree: Times are tough in the boat industry. Marine Products CEO Rick Hubbell observed that for his company, "consumer demand is lower than this time last year," as evidenced by the fact that "unit sales decreased in most product lines ... especially with respect to the smaller boats." Not that this is news to Fool readers. Way back in September of last year, we discussed the cyclical downswing in this sector, a slump that's been ongoing for even longer than that. Indeed, Hubbell puts the crest of the last cycle, and a subsequent falloff in demand, sometime in Q4 2005. Brunswick CEO Dunstan McCoy agrees: "We started to see significant weakening demand at retail in the fourth quarter of 2005."
Downstream at the retail end of the industry, the seas ride even rougher. According to MarineMax CEO Bill McGill, "the [retail boating] industry is down 10% to 15% in the December quarter in the segments in which we operate." (Ouch! When you put it that way, Marine Products' and Brunswick's results actually look pretty strong by comparison.)
Bigger is better
Where strength's to be found, it continues to be in the deep water -- or, rather, in the deep pockets of wealthier consumers. About the only things selling strongly at Marine Products last quarter, for example, were its "higher-priced SSi Sportboats." Fortunately for the company, by selling fewer boats at higher average price points, it has been able to limit the drop-off in dollar sales to just a fraction of the decline in overall units sold. Capitalizing on this phenomenon, Marine Products is moving its, er, products further up the price scale, bringing a "40-ft Chaparral sport yacht" to market for the 2008 model year. When asked on his conference call whether his company might build bigger still, Hubbell averred, "Yes, that's our strategy."
And it's a logical strategy at that. Brunswick's McCoy describes the pricing and profitability dynamics thusly: Profit margins in the "mid-20-foot range and higher tend to be greater than margins below that level -- a [bell curve] like that. And when you sell one less small boat, you would think your gross margin decline is going to be smaller than if you're not selling one larger boat." In other words, all units -- all boats -- are not created equal. Selling a 20-foot boat brings a boat maker not just more revenue, but more pennies in profit per each dollar of revenue taken in.
Less is more
That said, even if the damage has been less than the decline in units might suggest, both Marine Products and Brunswick continue to struggle with the overall decline in demand. After all, there are only so many customers who can afford to buy the big boats. So long as customers in the lower income brackets shy away from making purchases, neither boat maker can use its manufacturing base to full capacity. As a result, machinery lays idle and workers practice their thumb-twiddling. Meanwhile, depreciation charges continue to count against earnings, interest payments on financing must still be made, and employees insist on receiving their paychecks. Simply put, the fewer units get built, the larger the fixed costs of being a manufacturer loom on the income statement.
Generally speaking, dealing with a slowdown in demand requires two kinds of actions. First, the manufacturer may need to cut its prices to keep its inventories moving out of the warehouse and into consumers' (presumably large) shopping carts. Second, and tied to the first, the manufacturer must cut production, so as to avoid creating even more inventories that will subsequently need to have their prices slashed. (Investors in automakers Ford
All three companies in the boating industry seem preoccupied with this effort to manage inventories. Marine Products boasts that it was able to "react a little more quickly" than some of its competitors to the changing retail environment. It also argues that it's working actively to maintain "appropriate levels" of inventory relative to those competitors.
(Aside: While I don't mean to split hairs, I simply can't let these statements go unchallenged. Compared to year-end 2005, Marine Products' inventories are up 10% against a 4% decline in sales. For a downtrend that it claims to have been aware of since Q4 2005, that doesn't seem like a particularly "quick" reaction. I also note that Marine Products qualified its "appropriate levels" assertion, saying that its inventories were "appropriate relative to our competitors." This test isn't being graded on a curve, guys. You either have appropriate levels of inventory or you don't -- just doing a less lousy job than the other guy doesn't get you extra credit.)
Brunswick was a bit more specific on what it's doing to deal with the downturn, noting that it is "reducing production volumes to manage inventories" that McCoy termed "still too high, particularly for some select product lines that carry higher-than-average markings." The firm laid off more than 300 employees last quarter (which will yield severance costs), and McCoy confirmed that reducing production volumes will "pressure ... both gross and operating margins." (Considering that these same margins are already facing "inflationary pressures on our raw materials and labor costs," that bodes ill indeed for Brunswick's future profits.)
In the bad-for-me, good-for-you department, Brunswick noted that its discounting of products to move inventories is "up slightly" compared to last year. In this regard, McCoy highlighted discounts in outboard motors in particular, done to counter rival motor makers' own discounts. While these discounts will hurt Brunswick's margins, one suspects they will help Marine Products, which buys Brunswick's motors for use on its own boats.
Cutting inventories isn't limited to the boat makers, either. MarineMax is getting in on the slash action as well. But today's column is already getting a little lengthy, so take the weekend to digest the above, and we'll continue this story on Monday with MarineMax's actions.
Can't wait for Monday? Get more boating industry context in our September review of the industry: "Boat Makers See Shoals."