This article is part of our Rising Star Portfolio series.
Appliance makers, like the leading washing machine maker Whirlpool (NYSE: WHR), have begun to emerge from the tumble cycle that was the late decade housing market. On the face of things, Whirlpool looks cheap: It trades at only 11 times earnings and expects to grow those earnings by 10%-15% over the next few years. I'd like to own shares of the dominant global appliance king for the Un Portfolio, but only if shares pull back a bit.
It's good to be king
Whirlpool is the largest major appliance company in the world and has leading market share positions in North America and Latin America, and has top three ranks in India and Europe. It competes with other powerhouses such as Electrolux (OTC BB: ELUXY.PK), General Electric (NYSE: GE), and Kenmore, which is owned by Sears Holdings (Nasdaq: SHLD) but contracts work to GE and Whirlpool, among others. Even though those competitors sound formidable, Whirlpool is easily larger than any close rival. From its powerful perch, the company can spread its fixed costs over its massive $18 billion sales base, negotiate better prices for its key inputs, and support its six billion-dollar brands, and many growing, smaller brands with adequate marketing.
Being large also affords Whirlpool the ability to reinvest heavily in research and development. Since 2005, it has received nearly 500 patents. Currently, the company is focusing its research efforts on designing smarter, more energy efficient appliances and making them more geographically and culturally relevant. For example, Whirlpool designed a refrigerator for sale in India that features a smaller freezer and expanded veggie drawer to account for the typical Indian diet.
Whirlpool is also in an enviable position to extend its brands, like KitchenAid and Brastemp, into emerging markets. The company benefits from the fact that emerging markets are generally growing faster than established markets, as well as the fact that appliances sales should outpace general economic growth because they are becoming more and more common in the homes of the newly minted middle class. The company's sales growth and margins should benefit as major appliances penetrate more homes across the globe. I expect Whirlpool to increase its 15% share of the global appliance market as it wins new customers in these markets.
But not all that glitters is gold
Although much of the picture looks great, Whirlpool does have some stains. Whirlpool carries $2.5 billion in debt, with almost 80% of that coming due at the end of 2015. That debt load nearly doubles when you include the $2.1 billion worth of pension and postretirement health care benefits. Paying off its debt and funding its benefits obligations will certainly ding future free cash flow.
In 2009, the company changed its method of depreciating for all long-lived production machinery and equipment. This boosted earnings by $48 million. It doesn't seem to me that Whirlpool is engaging in financial shenanigans; rather, it's simply trying to better match its expenses and revenues. And the company is well within generally accepted accounting rules -- it just looks a little fishy on the surface.
Finally, although Whirlpool looks extremely cheap, its 2010 earnings and cash flow are overstated because of temporary tax benefits. The company won't receive the benefits in future years and will be on the hook to pay more cash taxes. If we ignore the transitory benefits of these taxes, the company looks much less undervalued.
The bottom line
At its heart, Whirlpool is a manufacturing company with well-recognized brands, but little pricing power. And while it's well-run and has attractive growth potential, it's not the type of business I'd pay up for. At $75-$80 per share, I think shares would represent an attractive reward for the inherent risk, so I'm adding Whirlpool to the Un Portfolio's watchlist.
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