Why higher costs and charges impact Armstrong’s business segments

Market Realist

ValueAct Capital's new position in Armstrong World Industries (Part 5 of 6)

(Continued from Part 4)

Higher costs and charges

Jeff Ubben’s hedge fund ValueAct Capital disclosed in a 13D filing in August that it had acquired 9,200,000 shares, or a 16.8% stake, in Armstrong World Industries Inc. (AWI). The company also saw a new passive stake acquired by Eton Park Capital. In this part, we’ll discuss Armstrong World Industries’ segment highlights.

As discussed earlier, AWI has four business segments—Building Products, Resilient Flooring, Wood Flooring, and Unallocated Corporate. Both Building Products and Wood Flooring reported increased sales during the second quarter. However, the segments saw operating income decline. The decline was driven by higher prices of raw materials and other costs.

Building Products sales increase, but operating income remains flat due to higher costs

Building Products net sales saw a 2.3% increase. It was driven by positive product mix and price. This offset the impact of lower volumes. Operating income was essentially flat in 2Q14. Improved price and mix and higher earnings from the Worthington Armstrong Venture (or WAVE) were offset by higher manufacturing—mainly depreciation charges for plant investments—and input costs. The company said it saw growth in its Architectural Specialties business. It’s a specialty ceiling system for a design-oriented aesthetic, mainly in the Europe, Middle East, and Africa (or EMEA) and Pacific Rim regions. The growth occurred during the quarter. The management noted on the earnings call that the “Americas ceilings business achieved a record EBITDA margin.”

Resilient Flooring sales impacted by lower volume in the Americas and Europe

Resilient Flooring net sales in the second quarter and first six months of 2014 declined 2%. Net sales were driven by lower volume in the Americas and Europe. Operating income also declined. It was driven by the margin impact of lower volumes, higher depreciation charges for plant investments, and higher input costs. These were only partially offset by manufacturing productivity improvements. The segment also saw reduction charges related to the closure of AWI’s Australian facility. As discussed earlier in this series, AWI is exploring strategic alternatives for its European Resilient Flooring business.

Wood Flooring sees loss mainly due to lumber price increase

The Wood Flooring segment saw net sales increase in the first and the second quarter. Net sales were driven by higher price and mix. They were partially offset by volume declines. Management noted on the earnings call that the Wood Flooring segment “EBITDA was up almost 50% versus 2013 and modestly above our expectations. Sales were up slightly versus last year’s 10% volume declines.” However, the segment saw an operating loss during 2Q14. It was driven by rising lumber prices, the negative margin impact of lower volumes and other expenses, and charges related to closure of the plant in China.

AWI’s largest individual raw material expenditures are for lumber and veneers, PVC resins, and plasticizers. In 2013, the company said  there was raw material inflation—particularly lumber—and increased production costs in the wood flooring segment. AWI said that despite improvements in U.S. unemployment and housing prices, it has seen a “restrained demand for big-ticket discretionary projects.” It forecasted the wood segment to make progress “but the challenge in the second half now looks to be an uncertain consumer demand environment.”

What lies ahead for the residential construction segment?

According to a recent report on our website, housing starts fell 9.3% month-over-month (or MoM) in June to a Seasonally-Adjusted Annual Rate (or SAAR) of 893,000 units—the lowest level since September, 2013. The report added that the summer months generally see an increase in home construction. This should benefit companies included in the iShares U.S. Home Construction ETF (ITB) and the State Street SPDR Homebuilders ETF (XHB). The holdings also include AWI, USG Corp. (USG), and Mohawk Industries Inc. (MHK). USG noted in its quarterly filing that “Industry analysts believe that the recovery in new residential construction will continue to be uneven and modest over the next few years, but over the longer term housing starts will begin to reach historical averages.”

For more on this from Market Realist, please read Why the housing starts and building permits plunged in June.

Continue to Part 6

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