The housing market has enjoyed a strong recovery so far in 2019.
Low mortgage rates and increasing affordability have spurred demand this year. We've seen new home sales, housing starts, and building permits all rise to their highest levels since the financial crisis.
And the rebound should be set to continue.
With the Federal Reserve pledging to keep interest rates low, mortgage rates will continue to stay low for the foreseeable future. You see, the Fed controls short-term interest rates via the federal-funds rate.
Long-term rates, on the other hand, are primarily driven by inflation expectations. And inflation has continued to fall below the Fed's 2% target.
Low long-term rates are good for the housing market...
Mortgage rates are higher than long-term Treasury rates, but the two rates are correlated. The benchmark 30-year fixed mortgage rate typically runs 0.5% to 1.5% above Treasury rates.
Low mortgage rates increase demand by making homes more affordable for buyers. They also allow folks to spend more money on their homes, which helps drive up prices as well.
This has led to a strong housing market throughout this year. But it's not just homebuilding stocks that are benefiting...
A healthy housing market and robust home-improvement spending go hand in hand. After all, homeowners are more willing to put money into their homes if they believe they'll get a good return on their investment. And as home equity increases, homeowners have more incentive to repair and remodel their homes.
Today's company has established itself as one of the leaders in home improvement.
Masco (NYSE: MAS) manufactures and sells building materials and home-improvement products. The company's early claim to fame was its faucets. The company's founder, Alex Manoogian, pioneered the single-handle faucet.
It had a ball valve that combined volume control with the mixing of hot and cold water. After improving the design, Manoogian patented it and brought the first washerless ball-valve faucet to market. It was called the Delta faucet.
In the 1960s, Delta expanded to bath faucets. And in the 1980s, Delta introduced the first domestically produced faucet with a pull-out spray head.
Plumbing products still make up Masco's largest segment today, accounting for nearly 50% of the company's net revenues. And it has thick profit margins, too: With an operating margin of about 18%, the unit had the widest margins of any segment at the company.
But that's not all Masco does. It also produces paints, primers, stains, and waterproofing coatings.
The company owns the popular Behr paint brand, which it purchased in 1999. Behr anchors Masco's decorative architectural-products segment, which accounted for about 32% of Masco's sales last year.
In the late 1970s, Behr became one of the first suppliers to home-improvement giant Home Depot (HD). Since then, the national retailer has named Behr its "partner of the year" 10 times. To this day, Behr is available exclusively at Home Depot.
Masco has two remaining low-margin businesses: cabinets and windows. Combined, these segments accounted for about 20% of Masco's sales. But because of their low margins, they accounted for less than 10% of the company's operating profits.
But Masco is exploring ways to offload these low-margin businesses. In fact, earlier this month, the company announced it came to an agreement to sell its Milgard Windows & Doors unit to MI Windows and Doors for $725 million.
Currently, around 85% of Masco's sales come from the repair and remodel (R&R) channel (as opposed to sales from new construction). Should it offload its cabinet and window businesses, Masco's R&R sales would likely rise to more than 88%. That would make the company less dependent upon homebuilding, which is inherently cyclical. So the divestiture will help Masco's overall business become less sensitive to downturns.
By the numbers, Masco is a strong company.
At 15%, Masco's operating margin is the widest of any of the housing-related companies we track. This means that Masco is well-run and that its management has an eye on costs.
Free cash flow ("FCF") is the cash left over after all operating expenses and business investments. A company's "FCF margin" measures its FCF relative to revenues. Masco's three-year average FCF margin is 8.6%.
Masco's FCF margins are solid, but not stellar. Keep in mind that Masco's operating margins and FCF margins will widen should it shed its cabinet and window businesses.
Management uses this FCF to reward its shareholders.
Over the past 12 months, Masco returned more than $800 million to shareholders through dividends and share repurchases. And this was not a one-off, either.
In the last three years, Masco returned nearly $400 million in dividends. And it reduced its shares outstanding by nearly 10%.
Masco's business is strong, and so is its price action.
Shares have risen more than 50% this year, and recently hit a new 20-month high.
Given that mortgage rates are set to stay low for the foreseeable future and the housing market remains strong, Masco should continue to have strong tailwinds. And as it's in the process of divesting its low-margin businesses, MAS shares are poised to outperform.
Sometimes investing is simple.