This year, the S&P 500 has produced an impressive 21% return. The Magnificent Seven mega-cap tech stocks, driven by hopes for an awe-inspiring, just-around-the-corner artificial intelligence boom era, have produced most of the gains. However, these stocks might not provide much of a lift next year as elevated expectations meet a more humble reality.
Where can investors find stocks that can drive stronger returns even if the market goes nowhere? One source is to find out-of-favor companies that have attracted the attention of activist shareholders. Activists focus on turning underperforming stocks into winners. These highly specialized investors take ownership positions in laggards, then engage with the company leadership to make meaningful positive changes to the company’s strategy, management and profitability.
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Companies have two basic resources: revenues and assets. Revenues are produced by selling something of value and are a source of cash for the company. Assuming that the value proposition is worthwhile and is producing reasonably stable revenues (activist shareholders tend to avoid companies with weakening revenues), activists can drive changes to how the company uses the incoming cash. Is the cash being efficiently allocated to drive more revenues and value to new and potential customers? Are manufacturing or services being produced efficiently enough? Is the company keeping its overhead costs under control? How productive are the dollars being re-invested in keeping offerings relevant and sufficiently profitable?
Activist investors also focus on assets. The most important asset for most companies is their talent base. Is the leadership providing sufficiently focused strategic and tactical direction and oversight? Are the right people in place to execute the company’s strategy? Activist shareholders look at other assets, like real estate, brands and business lines to evaluate whether their value is being fully realized or if they might be worth more if owned by someone else.
An Interesting Campaign by Activist Shareholders
MasterCraft Boat Holdings (MCFT) – This company makes the MasterCraft brand of powerboats, as well as Crest pontoon boats and the innovative Aviara luxury day boats. Following the initial public offering in July 2015 at 15, MasterCraft’s shares more than doubled on strong results in the booming economy. The pandemic, with its massive stimulus checks and consumers’ desire to get outdoors, revitalized what was looking like a cyclical slowdown. As we exit the pandemic era, MasterCraft’s outlook has dimmed once again. In the most recent quarter, sales fell 39% and EBITDA tumbled 66%. The shares have slid 40% to 21, not much higher than the IPO price from over eight years ago. Many investors would instinctively avoid these types of stocks.
However, MasterCraft has a few attractive traits that provide confidence to prospective investors that it will make it through the downcycle and rebound sharply in the next upturn. These traits make the stock worth a closer look.
First, the company appears to be well-managed. CEO Fred Brightbill, who has led the company since 2019, offloaded NauticStar following a failed turnaround attempt by his predecessor. Brightbill has also expanded MasterCrafts’ more successful core segments. His shareholder value orientation, spelled out in the company’s capital allocation framework, is helping support the company’s free cash flow while also allowing selective share repurchases at the currently depressed price.
MasterCraft has a robust balance sheet, which will support it during the downturn. Debt is modest at $53 million and is more than offset by $90 million in cash. Impressively, the management has reversed the 2019 position in which the $114 million in debt swamped the $6 million cash balance.
Another valuable trait is the presence of activist shareholder Coliseum Capital. Coliseum has been a long-term shareholder and recently raised its stake to nearly 12%. Managements can be tempted to squander a robust balance sheet – so an activist can provide a valuable reminder that a company is owned by its shareholders. With Coliseum holding a sizeable stake, MasterCraft is much less likely to waste its assets. We also note the presence of high-quality value investor Capital Research, which recently raised its stake to 5.7%. Their ownership suggests confidence in the company’s prospects, management and share value.
MasterCraft shares trade at a highly discounted valuation of 5.2x depressed 2024 estimated EBITDA and 8.6x similarly depressed estimated 2024 earnings per share. For perspective, the shares trade at 2.4x last year’s EBITDA, suggesting that the stock would be remarkably inexpensive if earnings return to their prior peak in the next upcycle.
While a deep downcycle would likely exert severe pressure on MasterCraft’s earnings and could drive its shares back to the IPO price, the traits outlined above indicate that the stock may be worth a starter position now. If the shares tumble, long-term investors would want to consider adding to their position on the weakness. If the economy remains reasonably healthy, owners of these discounted shares could have a nice ride.
As specialists in value investing, we focus on companies that trade at sizeable discounts to their underlying value. We do all the extensive analysis and valuation work to help you benefit from truly undervalued stocks. Our capabilities save you time while boosting your chances of profitable investing.
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