Mastercraft (MCFT)

A market-leader in a duopoly that checks a lot of boxes.

Mastercraft Boat Holdings designs, manufactures, and markets recreational powerboats for a wide range of buyers through its three product lines; Mastercraft, the main segment for ski/wake boats, which is the market leader; Crest, which produces recreational pontoons; and Aviara, their in-house luxury boat segment introduced in 2019. All of Mastercraft’s product lines are marketed as superior products, which customers are willing to pay for, evidenced by their 21% market share in the motorboat industry, and their industry leading share in ski/wake boats (their main segment). 

While there are many smaller players, Mastercraft forms a duopoly in the industry with their peer Malibu Boats (MBUU), however despite being slightly more expensive on an earnings basis, Mastercraft is cheaper on an Enterprise Value basis (whether it be compared to EBITDA, EBIT, pre-tax earnings, or FCF) while generating higher returns on invested capital, higher returns on equity, and higher free cash flow per share than their main competitor. Compared to non-Malibu peers (according to their proxy statement) they trade at a P/E higher than only two others, making in continue to look compelling on a relative basis. 

The company’s earnings look relatively strong, as NI was badly hurt in 2022 by impairment costs due to their selling off a failing segment (NauticStar) – a bad investment that they quickly divested from, a sign that can be seen as both good (quick to divest a problem segment) or bad (poor capital allocation). Apart from a freak 2020 year, the company continually grows revenues, operating income, net income, and free cash flow year over year, while being able to relay some increased costs from inflation to their consumers – 1Q23 and 2Q23 saw all three segments grow sales/unit, and only the main segment saw lower unit sales, which was more than offset by the increase in price. 

Their pricing power as a market leader and strong brand name helped them navigate past earnings and balance sheet difficulties from Covid and they are now posed to grow even further. And while their earnings continue to be hurt from their past investment in NauticStar, this should be finished hurting their net earnings numbers in the quarters to come and has had no effect on their recent growth in FCF and OCF. In the six months ended January 2, 2022, OCF was at 12.2 million; the same period in 23 saw OCF at 78 million, and much of that cash went directly into short term investments as the management team looks for more growth opportunities. 

Additionally, Mastercraft has very little debt, leading to their net cash position of 40.3 million, which is more than comfortable for the foreseeable future and avoids any risks of needing to issue more equity or any potential bankruptcy or insolvency concerns, as well as any liquidity crunches. 

The last piece to this investment puzzle is the company’s management team, which looks to be a strong point for the company, even when factoring in the recent poor investment (and following divestment) in the NauticStar segment. For starters, Mastercraft’s management equity policies are similar to Costco’s, a company renowned for their incredible incentivization plan, and the job it does in aligning upper management with shareholders. While insider ownership only makes up ~2.6% of shareholders, the short-term and long-term incentive plans force management to think like a shareholder. Currently, the CEO and chairman (Fred Brightbill) holds 4.2x his salary in stock, while the CFO holds 6.8x his salary in stock. Additionally, the clawback policy prevents management from over-emphasizing short-term results and manipulation for quick bonuses. 

While Mastercraft doesn’t have a ton of insider buying, the management incentive plans have me quite comfortable with the situation, and unlike Malibu, there is very little insider selling. Much of the management has also been with the company for a long period of time, and they are all very familiar with the industry, and have no major red flags in their individual histories. In fact, Mastercraft management has put such an emphasis on safety in the workplace (as they know this is what is important and sets them apart) that they recently celebrated 2 million man-hours worked without lost time due to injury – this screams attention to detail, focusing on the right things, efficiency, and quality – all things you love to see as a shareholder. 

Finally, a major risk to the company is shrinking margins, and buildup of inventory, as in the motorboat industry, inventory quickly can become obsolete, or sold at much lower prices with new models constantly coming. Management quells both concerns. In the recent difficult environment, management has managed to significantly reduce SGA expenses, and have shown their willingness to move quickly when a problem (NauticStar) arises.

A few other risks that are pertinent to the business are supply chain risks, which are not unique to Mastercraft, and the fact that their product is quite expensive. This could pose a headwind going into a recession, as luxury boats are plausibly something that consumers would limit spending on when needing to save money. However, I believe that while this is true, most customers likely have significant wealth as they are already in the market spending thousands on luxury speedboats. Their customers have relatively inelastic spending habits, so they won’t bear the brunt that others might. 

Getting into some back of the envelope (shoutout Supremex!) math, Mastercraft has a 5-year revenue CAGR of >25%, 5-year average ROIC of >20%, and 5-year average ROE of >40% despite a terrible drawdown during Covid, and currently trades ~10x earnings and ~5x LTM FCF. Margins in the space and for Mastercraft have been relatively stable over the past 10 years (gross margins around 25%, EBIT margins a little more than half that), and even in an environment where revenue stagnates, they are posed to deliver >10% FCF yield over the next 5 years – before even discussing the possibility of buying back stock, which they are currently doing (another 24.5 million is authorized).

If we can assume revenue at least stays where it is around $700M, and EBIT margins at 14%, we get $100M in recurring operating profit, and recurring NOPAT at $77M after adjusting for taxes. In years of little-to-no growth the company required roughly $4M in CapEx, while depreciation and amortization currently run around $13M. To be safe, we’ll say that there’s only $6M in savings a tech has likely progressed to lower future depreciation expenses, giving a rough estimated EPV of $83M. At an EV of $465M, the implied discount rate is almost 18%, which seems high to me.

I feel like there is more research needed on my end in this case, and the company is a bit bigger in size than I would normally look at, but it is certainly interesting and despite a market cap of over $500M, there is not a ton of coverage. Either way, I think this is a very interesting spot for Mastercraft, and definitely something I will be diving into deeper.