MarineMax A Rising Tide Does Not Lift All Boats

MarineMax: A Rising Tide Does Not Lift All
Boats
|Must Read Jun. 24, 2016 7:00 AM ET1 comment
by: Lester Goh
Summary
• MarineMax is priced for explosive growth. Management presents a
compelling bull case.
• The bull case relies heavily on the singular assumption that boat sales could
revert back to historical peak levels.
• This assumption is overly optimistic as it overlooks structural developments
in the competitive landscape. MarineMax's model is also intrinsically
unattractive.
• Even if we give management credit for increasing revenues, earnings growth
will not be as explosive going forward, limiting upside potential and providing
asymmetry for shorts.
MarineMax: A Rising Tide Does Not Lift All Boats - MarineMax Inc. (NYSE:HZO) | S… Page 1 of 14
http://seekingalpha.com/article/3984001-marinemax-rising-tide-lift-boats 1/8/2016

• As the market begins to realize these worrying issues with the narrative,
shares should re-rate substantially lower - my target price of $4.35 implies
~70% downside.
At first sight, MarineMax (NYSE:HZO) ("MarineMax", "HZO" or "the Company")
appears cheap. 2015 EPS is just under $2 a share, so the Company's P/E is 7-8x.
But, boating - especially high-end boating, which is HZO's target market - is clearly a
highly cyclical industry, so we need to smooth the numbers over a longer time frame
to get an idea of normalized earning power.
Let's use a five-year period - I am not cherry-picking; I could have used 7 or 10
years, which would strengthen my argument (both would result in negative
cumulative EPS). Cumulative net income over said period (2011-2015) is ~$63m or
~$2.50 per share on ~25m shares outstanding.
But 2015 net income was inflated by a massive $27m tax benefit, so adjusting for
that, cumulative net income drops to ~$36m, or an average of ~$7.2m per annum.
Thus, normalized annual earning power is closer to ~$0.29 per share, and hence
HZO's P/E on normalized figures is roughly 55x. Such a premium valuation could
ultimately be justified, if, and only if, earnings are poised to explode over the next
few years. And such an explosion in earnings cannot be fleeting, but must represent
a "new normal", as highly cyclical businesses are most frequently valued on
normalized P/E.
Management Presents A Compelling Bull Case
Clearly, MarineMax is priced for explosive growth. Can it achieve it? Management
implies through its presentations that this is possible, and presents a bull case that
is, prima facie, highly compelling.
The Company prides itself as the largest boat retailer in a highly fragmented
industry that is of course, ripe for consolidation. Management consistently points to
signs of a broad industry recovery. With its position as market leader, the company
expects to benefit disproportionately from the rebound in industry boat sales to
>300k units per annum when it arrives.

HZO also emphasizes its advantages over peers, which are (1) better management
information systems, (2) better people, likely due to its very own university, (3) its
status as the leading partner for retail/wholesale financing, presumably derived from
its large scale relative to the competition, (4) its exclusive relationship with
Brunswick, which owns well-known boat brands, and (5) the absence of long-term
debt on its balance sheet (the debt is related to inventory financing).
If confronted with such a narrative, one can easily see that the Company is
extremely well positioned for a pronounced rebound in boat sales - and that seems
to be the current market perception.
But, the bull case is largely predicated on the singular assumption that boat
sales will recover strongly going forward.
Road To Pre-Crisis Levels: Market Is Pricing In A Recovery
As I alluded to above, MarineMax caters to a high-end market. What do rich people
splurge on? Rare art, luxury cars, high-end property, among other things.
It has been 7-8 years since the financial crisis, and most high-end markets have
rebounded strongly by now. Rare art has probably rebounded the most, evident
from the eye-popping prices art pieces sold for last year.
But if you were expecting the same, strong rebound for boat sales, you would be
sorely disappointed. Sure, boat sales have been increasing in recent years, but they
have yet to reach their prior peaks achieved pre-crisis.

Source: Investor Presentation
As seen above, the 2015 estimate pegs average retail powerboat sales at ~177k.
They dipped below 150k during the crisis, but have increased slightly in recent
years.
But the market clearly expects the Company's sales to rebound to pre-crisis levels
(~300k unit sales annually) - indeed, it must, in order for shares to achieve a
reasonable valuation multiple. As seen below, the share price has mostly recovered
following the financial crisis.

Source: Morningstar
In comparison, annual sales of ~$750m have yet to even come close to pre-crisis
levels of ~$1.25b, according to historical data compiled by FinBox.
Note that MarineMax had ~19m outstanding shares in 2006-2007. Now, it has
~25m, or a ~30% larger share count. So the company's current value isn't that big of
a difference as compared to pre-financial crisis.
What bulls might be betting on (based on MarineMax's trading price) is the
potential for annual industry boat sales to return close to the ~309k unit
average experienced over the 1992-2006 period. That would presumably allow the
Company to return to >$1b in annual sales.
Structural Changes In The Competitive Landscape: What's Stopping Boat
Sales From Recovering
Undoubtedly, something must be delaying the recovery. This must be the case, as
in prior cycles, the recovery occurred relatively quickly. For example, when
consulting the 1990-2015E data set provided by management, it seems that prior
recoveries (i.e. trough to peak) occurred roughly over a three-year period - 1992-
1995 and 1997-2000.

However, once the current century begun, this "three-year recovery" became non-
existent. Peak sales over the 25-year period occurred during the early 2000s, and
the industry has yet to recover to such a level. While MarineMax's management
does not explicitly state that it expects a rebound to >300k, it does implicitly highlight
it as a potential scenario - never mind that it hasn't occurred for 15 years, and
counting. This can be seen in its investor presentation slides showing industry sales
from 1992 to 2015E (supra) as well as the slide showing its estimate of replacement
demand (infra).
Seeking Alpha author Terrier Investing is skeptical of the potential rebound to >300k
industry-wide boat sales driven by replacement demand, but concludes that there is
"room for boat sales to continue to run". I argue that he should be even more
skeptical than he already is.
An astute observer would intuitively deduce that the failure to return to prior peak
boat sales implies that there was a huge change in industry dynamics or the
competitive landscape that occurred sometime during the early 2000s and
beyond.
And this change must be structural given the fact that industry sales have yet to
recover to prior peaks for more than a decade.
Before we profile the upstart disruptor, let's first think about the factors that would
influence a purchase decision. Said another way, if you're looking to get a boat for
recreational purposes, what do you look for?
The first factor would be price. It's no secret that that boating isn't exactly cheap - a
small jet boat sells for anywhere from $20k-80k while a large yacht will run you
anywhere from $3.5m-35m a pop, according to MSRP data provided by the
Company.
The second would be variety in design. Different customers have different tastes, so
a prospective customer is more likely to purchase from a firm that has a wide
selection of different boat models.
The third would be post-sale customer support. Face it - generally, if you have a
boat, you aren't exactly thrilled to spend the time to maintain or clean the boat and
fix up the small things that go wrong. You'd rather outsource it.

A casual browsing of MarineMax's website suggests thousands of different boat
models. Its 10-K talks about how the Company provides maintenance, repair and
storage services. So it's got post-sale customer support, but it's a really small part of
its business at ~6.3% of 2015 sales.
Clearly, the barrier to consumer adoption here is affordability.
Boat Clubs As Industry Disruption - MarineMax's Addressable Market Has
Contracted Significantly
The Freedom Boat Club was founded in 1989 to solve this affordability problem.
Members pay a one-time entry fee to join the club and monthly fees from thereon
out - which is likely far cheaper than purchasing a boat outright from MarineMax.
But that's not the most compelling part of the club's value proposition.
Instead of getting access to only one boat, which would be the case if you bought it
from a boat dealer, you get access to the club's entire 1,100 boat fleet.
Oh, and you don't have to bother yourself with the maintenance of the boats, those
issues are all taken care of by the club.
Moreover, this club is not just some small local operator. It has locations in 20+
states (and counting) and over 12,000 members. You can bet that business is
booming - how else would the club be able to franchise the boat club model to
aspiring business owners?
Boats have extremely low utilization rates - Statista estimates that the average
annual boat days, a measure of boat utilization, is anywhere between 5.5 and 11.2
days, depending on the type of boat. That makes the Boat Club model quite
appealing.
As a result, it's easily to postulate that the historical level of demand for MarineMax
just isn't there - some of that demand is being catered to by boat clubs renting out
their fleet.
Replacement Demand Estimates Are Far Too Optimistic

The point on addressable market ties into my next argument - which is that
management's replacement demand estimates are highly unrealistic.
Source: Investor Presentation
As seen above, management posits that average life expectancy of boats is 30-35
years, which would imply replacement demand levels similar to the prior peak boat
sales achieved in the early 2000s.
However, this is based on boat registrations since inception, which implicitly
assumes that the addressable market hasn't shrunk - but it clearly has, as I
explained above.

Thus, since management's estimates of replacement demand does not take into
account structural developments in the competitive landscape - i.e. the rise of boat
clubs - it seems that said estimates are likely too optimistic.
The key takeaway from the above two conclusions - (1) MarineMax's addressable
market has contracted, and (2) replacement demand estimates are too sanguine - is
that the years of ~300k in annual average industry boat sales are long gone,
and that the "new normal" is far lower, probably in the 150-180k range.
Margins Have Likely Peaked, At A Level MarineMax Can't Generate FCF
A quick glance at the Company's financials will tell you that revenue has been
growing rather quickly - especially in the last three years. Revenue grew ~11.5% in
2013, ~7% in 2014, and ~20% in 2015.
Earnings have also grown, and this is partially attributed to SG&A leverage. As a
percentage of sales, SG&A peaked at ~27% in 2009, and has now fallen to ~21%.
Net income hence grew from a ~$77m loss in 2009 to a ~$48m profit in 2015 -
although the reader should note that 2015 net income was boosted by a ~$27m tax
benefit due to a reversal of the Company's deferred tax asset valuation allowance,
as I alluded to earlier.
However, it would seem difficult to expect further earnings gains from SG&A cuts.
Additionally, gross margins have remained at ~25% for a decade, excluding the
recession years, so overall margin expansion is unlikely to be driven by higher gross
margins.
While management talks about focusing on higher margin businesses, this is
unlikely to have meaningful implications over the next few years as the pace of the
shift in mix appears extremely slow.
Higher margin businesses, as defined by management, are that of the finance,
insurance, and brokerage, parts & accessories, service, repairs & storage
businesses. They comprised of 12.9% of sales in 2007, growing to a mere 15.2% in
2015 - 230 bps growth over eight years is hardly a needle-mover.

It is interesting to note that, at roughly double the 2015 sales figure, MarineMax
earned a similar net profit margin in the pre-financial crisis years (after
adjusting for the tax benefit in 2015).
As a result, it is likely that the Company is nearing the limits of SG&A leverage. With
little potential for gross margin expansion and SG&A leverage, it is hard to see what
(other than top-line growth) would drive an increase in net profitability going forward.
This attribute provides upside protection for shorts.
So net margins have likely peaked, at a level where MarineMax cannot generate
FCF. FCF in 2015 was negative ~$7m. Over the last half-decade, the Company has
been FCF positive only twice, and even then, marginally so - 2012 FCF was ~$3m
and 2014 was ~$2m.
You know that you are probably not in the right business, when the only years
where your FCF is solidly positive is the recession years.
2009 FCF was a massive ~$207m. Clearly, this figure is an outlier, as 2010 FCF fell
to ~$36m. FCF has hovered around breakeven ever since.
Business Model's Risk/Reward Is Structurally Skewed To The Downside
While generating FCF in bad times may seem like a good thing, it is important to
note that the Company was only able to throw off so much cash during the
recession because it severely tightened working capital.
Although it allows MarineMax to survive the recession, the negative here is that the
disposal of working capital (mostly inventory at huge discounts) positions HZO
poorly for a recovery.
If the Company generated significant FCF in a normal economic environment and
thus is able to accumulate cash, it would be able to capitalize on recessions by
purchasing inventory on the cheap (MarineMax has a significant used boat
business) - boats do not go out of style at the same speed as fashion, after all.
However, during recessionary periods, MarineMax is likely to sell inventory at
massive discounts in order to pay for its operating expenses.
MarineMax: A Rising Tide Does Not Lift All Boats - MarineMax Inc. (NYSE:HZO) |… Page 10 of 14

One thing that's holding back FCF these days is MarineMax's working capital -
specifically, inventory. While sales grew from ~$524m in 2012 to ~$751m in 2015,
working capital grew from ~$102m to ~$162m. 2012 inventories were ~$215m, and
have grown to ~$274m in 2015. So the entire net increase in working capital was
due to inventory.
Suffice to say, inventory has to be purchased during the ordinary course of
business, due to the fact that prospective buyers would likely want to test drive
many different models before arriving at a purchase decision. So this is a structural
problem that prevents the Company from generating meaningful, consistent FCF.
One way to solve the problem is to increase inventory turns - and MarineMax has
been trying to do that through offering discounts during the summer, among other
promotional initiatives. But progress on this front has been insufficient, evident by
FCF stubbornly remaining negative. Current inventory turns are nearing pre-crisis
levels, suggesting limited room for improvement going forward.
This required stocking of inventory and the lack of substantial, sustained
improvement in inventory turns significant enough to result in solidly positive FCF
highlight the intrinsic unattractiveness of the Company's model.
Consider 2009, where gross margins cratered, falling ~800bps to ~15% over the
span of just one year, leading the firm to post its largest non-goodwill/intangible
asset related loss of ~$77m. In the prior year, HZO posted an even larger loss of
~$134m, though that loss was largely due to a massive impairment charge.
In the 7-8 years that has passed since the financial crisis, the Company has yet to
cumulatively earn sufficient profits to offset the losses of 2008 and 2009, a fact
which serves to highlight the fragility of MarineMax's business model.
In short, the HZO model has structurally skewed risk/reward. The firm posts
moderate profits when times are good (but generate no meaningful FCF),
punctuated by massive losses when a recession hits, forcing it to sell inventory at
hugely marked-down prices, positioning it poorly for a recovery. As long as inventory
turns, which are dependent on consumer behaviour, refuse to improve to the point
where HZO generates robust FCF, this dynamic will be ever present.
Valuation & Asymmetry

It should be clear to the reader that MarineMax doesn't deserve its ~55x normalized
P/E that Mr. Market is assigning. What would you pay for a highly cyclical business
with risk/reward that is structurally skewed to the downside and elusive FCF
generation? I argue that a 15x normalized P/E is highly generous, suggests a
~$4.35 stock, and implies ~70% downside.
What about risks to the upside?
As discussed, earnings growth should track sales growth given limited gross margin
and operating leverage. While sales growth has been strong in recent years, it was
driven by a greater mix of used boat sales and larger boat sales - both of which are
less profitable, hence leading the Company's gross margins to contract from ~26%
in 2014 to 24.6% in 2015. So upside potential stemming from explosive earnings
growth, ala 2010-2015, is unlikely.
Boat sales also seem to be on the secular decline, largely due to boat clubs
increasing the utilization of existing boat capacity as discussed, which implies that it
is highly unlikely that HZO's sales, or industry sales for that matter, would explode
over the next few years.
These two factors alone make it hard to envision MarineMax growing into its
valuation over the next few years, which should provide asymmetry for shorts as it
limits upside potential.
A quick thought exercise: Valuation-wise, for MarineMax to grow into a 15x
normalized P/E over the next three years, it would have to earn ~$27.5m in net
profits on average. If we use a five-year period, ~$137.5m cumulatively.
Two years in, it is at ~$32m cumulatively, after adjusting for the $27m tax benefit in
2015. So it has ~$106m left to go, or an average of ~$35m over the next three
years. For reference, revised fiscal 2016 management guidance calls for $0.68-0.75
in EPS, which at the mid-point implies ~$18m in net income on ~25m outstanding
shares. Clearly, a tall order.
Bulls might think it is possible because management recently raised fiscal 2016
guidance, which may signal heightened confidence regarding future prospects, but
the guidance implies a YoY decline in EPS from ~$0.80, after adjusting for the tax
benefit in 2015.

Management's quarterly commentary (as well as commentary from other players in
the industry, such as Brunswick) suggests a favourable environment.
But favourable is, for MarineMax, simply not enough, because it is priced for growth.
Boat sales must explode, because the magnitude of the valuation excess requires it.
And there is no indication that such an explosion is looming - even if we make the
outlandish assumption that millions of Americans suddenly wanted to go boating
overnight, it is likely that much of that demand would accrue to boat clubs.
Recommendation: Initiate a short position in HZO with a price target of
$4.35/share, suggesting ~70% downside from current levels. Catalysts include
slowing sales growth and limited margin expansion, driven by competition from boat
clubs. Other less firm-specific catalysts such as a general economic recession will
also lead to upside for shorts. Risks to the short thesis include sustained sales
growth driving bottom-line growth, which is mitigated by an end-market in secular
decline. With limited risks to the upside and large downside potential, the short
seems rather asymmetric, in my view.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate
any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving
compensation for it (other than from Seeking Alpha). I have no business relationship
with any company whose stock is mentioned in this article.
Additional disclosure: Disclaimer: The author's reports contain factual statements
and opinions. He derives factual statements from sources which he believes are
accurate, but neither they nor the author represent that the facts presented are
accurate or complete. Opinions are those of the the author and are subject to
change without notice. His reports are for informational purposes only and do not
offer securities or solicit the offer of securities of any company. Mr. Goh ("Lester")
accepts no liability whatsoever for any direct or consequential loss or damage
arising from any use of his reports or their content. Lester advises readers to
conduct their own due diligence before investing in any companies covered by him.
He does not know of each individual's investment objectives, risk appetite, and time

horizon. His reports do not constitute as investment advice and are meant for
general public consumption. Past performance is not indicative of future
performance.

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