December 11, 2014 Armstrong World Industries, Inc. (AWI-NYSE) Current Recommendation Prior Recommendation Neutral Date of Last Change 08/24/2014 Current Price (12/10/14) $47.71 Target Price $43.00 SUMMARY DATA UNDERPERFORM 52-Week High $61.37 52-Week Low $45.31 One-Year Return (%) -10.99 Beta 1.14 Average Daily Volume (sh) 503,677 Shares Outstanding (mil) 55 Market Capitalization ($mil) $2,619 Short Interest Ratio (days) 4.73 Institutional Ownership (%) NA Insider Ownership (%) NA Annual Cash Dividend $0.00 Dividend Yield (%) 0.00 5-Yr. Historical Growth Rates Sales (%) -0.9 Earnings Per Share (%) 16.1 Dividend (%) N/A using TTM EPS 22.0 using 2014 Estimate 22.9 using 2015 Estimate 20.7 Zacks Rank *: Short Term 1 3 months outlook 5 - Strong Sell * Definition / Disclosure on last page SUMMARY In third-quarter 2014, Armstrong World reported adjusted earnings of $0.83 per share, a 2% decline year over year, impacted by lower volumes, higher SG&A expenses and input costs. Also, its net sales fell 0.2% year over year to $728 million and came below management s guidance range. The company slashed its adjusted earnings per share outlook to the range of $2.00 $2.15. Soft demand environment, fundamental challenges across its Resilient and Wood Flooring businesses, pricing pressure and raw material inflation continue to weigh on the company s performance. Thus, we are reiterating our Underperform recommendation on Armstrong World with a target price of $43. Risk Level * Below Avg., Type of Stock Mid-Blend Industry Bldg&Const-Misc Zacks Industry Rank * 97 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2012 636 A 675 A 695 A 613 A 2,619 A 2013 622 A 707 A 730 A 661 A 2,720 A 2014 634 A 710 A 728 A 638 E 2,710 E 2015 651 E 728 E 758 E 665 E 2,802 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Mar) (Jun) (Sep) (Dec) (Dec) 2012 $0.49 A $0.73 A $0.98 A $0.34 A $2.53 A 2013 $0.21 A $0.60 A $0.85 A $0.32 A $2.04 A 2014 $0.42 A $0.60 A $0.83 A $0.23 E $2.08 E 2015 $0.50 E $0.68 E $0.97 E $0.15 E $2.30 E Note: 2012 Quarterly Figures will not add up due to rounding off and 2013 Quarterly Figures will not add up due to onetime adjustments. Projected EPS Growth - Next 5 Years % 17 2014 Zacks Investment Research, All Rights reserved. www.zacks.com 10 S. Riverside Plaza, Chicago IL 60606
OVERVIEW Incorporated in 1891 and based in Pennsylvania, Armstrong World Industries, Inc. (AWI) is a leading global producer of flooring products and ceiling systems used primarily in the construction and renovation of residential, commercial and institutional buildings. The company designs, manufactures and sells flooring products (mainly resilient and wood) and ceiling systems (mostly mineral fiber, fiberglass and metal) across the globe. As of Sep 30, 2014, the company operated 34 manufacturing plants in 8 countries, including 20 plants located throughout the U.S. In addition, through its joint venture with Worthington Industries, Inc. Worthington Armstrong Venture (WAVE) the company has an interest in eight additional plants located in six countries. These plants are engaged in the production of suspension system (grid) products for Armstrong s ceiling systems. The major markets the company caters to are - North American Residential The company s ceiling and wood flooring products are used in new home construction and home renovation. North American Commercial Ceilings and Resilient Flooring are used in commercial and institutional buildings both for new construction as well as renovation. Outside of North America Most of the revenues generated outside North America come from new constructions and renovations in the commercial sector in Europe. The company reports the performance of its business under the following operating segments Building Products (Approximately 48% of revenues in the third quarter of fiscal 2014) produces suspended mineral fiber, soft fiber and metal ceiling systems for use in commercial, institutional and residential settings and its products are sold worldwide. The segment also sources complementary ceiling products. Resilient Flooring (Approximately 33%) produces and sources a wide range of floor coverings mainly for homes, and commercial and institutional buildings. The products are sold globally and the portfolio includes vinyl sheet, vinyl tile and linoleum flooring. In addition, the segment sources and sells laminate flooring products, vinyl tile products, vinyl sheet products, adhesives, and installation and maintenance materials and accessories.. Wood Flooring (Approximately 19%) produces and sources wood flooring products for use in new residential construction and renovation. It also finds usage in some commercial applications in stores, restaurants and high-end offices. The product offering includes pre-finished solid and engineered wood floors in various wood species and related accessories. The company derives almost the entire Wood Flooring revenues from North America. Unallocated Corporate includes assets, liabilities, income and expenses that have not been allocated to the business units. Balance sheet items classified as Unallocated Corporate are mainly income tax related accounts, cash and cash equivalents, the Armstrong brand name, the U.S. prepaid pension cost and long-term debt. Expenses for the corporate departments and certain benefit plans are allocated to the reportable segments based on known metrics, such as specific activity, headcount or net sales. The remaining items, which cannot be attributed to the reportable segments without a high degree of generalization, are reported in this segment. Equity Research AWI Page 2
REASONS TO SELL Armstrong World reported net sales of $728 in the third quarter, below management s guidance range of $740 $780 million due to lower volumes in Resilient in Europe and Wood flooring in the Americas. Prior to the third quarter earnings release, the company had trimmed its full year and third-quarter outlook. This was driven by escalating price pressure and competition in the wood business, challenges related to capacity utilization in the European flooring business and as consumers started shifting toward LVT and away from traditional residential resilient products in North America. Following the third quarter release, the company further slashed its previous adjusted earnings per share outlook of $2.15 $2.40 and now expects it to lie in the range of $2.00 $2.15. The company s sales guidance for the full year stands in the $2.68 to $2.72 billion range, which includes the impact of foreign exchange. The lowered guidance was due to the overall softer demand environment. The resilient business in Europe continues to underperform due to a weak macro environment. Moreover, industry overcapacity and the challenges of rationalizing cost in Europe led to an acceleration of competitive activity in the quarter resulting in lower-than-expected volumes and increased manufacturing absorption efficiencies. The company is essentially exploring methods of divesting this money losing business. The resilient business in the Americas is affected by softer-than-expected repair/remodel environment. Moreover, there has been an accelerated consumer shift from traditional vinyl products to luxury vinyl tile (LVT), where the company s presence is negligible. Additionally, a shift to glassbacked products from felt-backed products, where the company has larger share, is also impacting the business. In Wood flooring, housing starts and residential repair/remodel lagged expectations in the third quarter. Armstrong World s price increase in June did not gain traction in the market. Competitive pricing and share pressure intensified in the quarter. An increasing trend during the quarter was that of homebuilders shifting from solid wood to engineered wood as prices of solid products have gone up significantly compared to engineered products over the last two years. This will have a substantial impact on Armstrong World, considering it has higher share in solid wood, which also carries higher margins. Equity Research AWI Page 3
Armstrong World s main raw material expenditures are for lumber and veneers, PVC resins and plasticizers as well as natural gas. In the third quarter and first nine months of 2014 costs for raw materials, sourced products and energy negatively impacted operating income by $8 million and $30 million, respectively. The Wood flooring segment s profitability has particularly been affected by raw material inflation (hardwood lumber). The company also had to deal with inefficiencies from additional hiring to meet demand. With the recent increase in lumber prices, the company expects annual inflation in the range of $30 million to $40 million for 2014. The major part of the increase will affect the Wood segment s results. RISKS Armstrong World periodically modifies prices in each of its business segments in response to changes in costs for raw materials and energy, and to market conditions and the competitive environment. Armstrong World implemented a price increase in its Building Products business in the Americas in the third quarter of 2014. The company also recently announced price increases in its Building Products business in India and Russia to offset foreign currency devaluations. The increase will take effect in the fourth quarter of 2014. A price increase on select resilient products in the Americas will be effective in the first quarter of 2015. The company may implement additional pricing actions if raw material prices remain elevated. Armstrong World expects its LVT plant that is scheduled to begin selling products in the third quarter of 2015, to contribute positively to its results and help gain market share. The company is currently in the process of on-shoring its engineered wood capabilities which will allow for shorter lead times, reduced costs and lower inventory levels for customers. Phase I of this production ramp at its Somerset, KY facility has already taken place, while some new products have started shipping. Phase II is currently underway and is expected to be completed by early 2015, which should allow for additional capacity and new products. Armstrong World expects savings from its cost reduction efforts to partially benefit the fourth quarter and expects to fully gain in 2015. RECENT NEWS Armstrong Beats Q3 Earnings, Falls on Y/Y Slump & Weak View Oct 27, 2014 Shares of Armstrong World Industries, Inc. lost about 5.5% and closed at $46.12 after the company reported its third-quarter 2014 results on Oct 27. Adjusted earnings fell 2% year over year to $0.83 per share impacted by lower volumes, higher SG&A expenses and input costs. Earnings, however, came ahead of the Zacks Consensus Estimate of $0.78. Including one-time items, earnings plunged 39.4% to $0.57 per share from the prior-year quarter figure of $0.94. Operational Update Net sales declined marginally by 0.2% on a year-over-year basis to $728 million but surpassed the Zacks Consensus Estimate of $726 million. Revenues came below management s guidance range of $740 $780 million. Lower volumes in Resilient in Europe and Wood flooring in the Americas led to the decline, partly offset by favorable price and mix. Equity Research AWI Page 4
Cost of sales went up 2.6% year over year to $564 million. Gross profit declined to $164 million from $180 million in the year-ago quarter. Consequently, gross margin contracted 210 basis points (bps) year over year to 22.5%. Selling, general and administrative (SG&A) expenses increased 10.7% year over year to $114 million, due to higher spending on promotional activity. Adjusted operating income dropped 8% year over year to $87 million. Operating margin also declined 90 bps year over year to 12%. Segment Performance Building Products: Net sales at the Building Products segment increased 4.8% to $351.7 million, aided by positive mix, price and volume. Adjusted operating profit for the segment was $86 million compared with $85 million in the year-ago quarter. Improved price and mix, and higher earnings from WAVE were offset by higher manufacturing and SG&A expense. Resilient Flooring: The Resilient Flooring segment reported a decline in sales to $239.6 million, compared with $246.2 in the year-ago quarter due to lower volumes in the Americas and Europe, partially offset by improved mix. The segment s adjusted operating profit plunged 43.5% year over year to $13 million due to lower volumes, higher SG&A expense and unfavorable mix and price. Wood Flooring: Net sales in the reported quarter tumbled 7.4% year over year to $137 million due to decline in volume. The segment posted adjusted operating profit of $6 million, which improved three-fold from $2 million in the prior-year quarter. Financials Cash and cash equivalents were at $148.4 million as of Sep 30, 2014 compared with $137.7 million as of Sep 30, 2013. Cash flow from operations was $111 million in the first nine-month period ended Sep 30, 2014 compared with $161.7 million in the prior-year period. Guidance Armstrong World Industries expects its full-year 2014 adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) to be in the band of $355 $475 million. The company slashed its previous adjusted earnings per share outlook of $2.15 $2.40 and now expects it to lie in the range of $2.00 $2.15. The company s sales guidance for the full year stands in the $2.68 to $2.72 billion range, which includes the impact of foreign exchange. For 2014 free cash flow is expected to be in the range of $0 $40 million. For the fourth quarter of 2014, the company expects sales to be between $610 and $650 million and adjusted EBITDA in the range of $55 $75 million. Equity Research AWI Page 5
VALUATION Currently, shares of Armstrong World are trading at 22.9x our 2014 EPS estimate of $2.08. The stock is trading at a 34% discount to the peer group, based on 2014 earnings estimates. The company s current trailing 12-month earnings multiple is 22.0x, compared with the 29.7x average for the peer group and 18.9x for the S&P 500. Over the last five years, Armstrong World shares have traded in a range of 15.8x to 40.1x trailing 12-month earnings. We are maintaining our Underperform recommendation on Armstrong World, which indicates that the stock will perform below the market. Our target price is $43 or 20.7x our 2014 EPS estimate. Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low Armstrong World Industries, Inc. (AWI) 22.9 20.7 17.0 11.5 22.0 40.1 15.8 Industry Average 34.6 18.8 15.5 13.9 29.7 126.2 19.5 S&P 500 17.6 16.4 10.7 15.9 18.9 19.6 12.0 USG Corporation (USG) 22.1 14.3 14.0 13.7 25.8 54.4 24.2 Owens Corning (OC) 20.7 15.2 16.0 7.5 20.1 38.9 11.2 Graña y Montero SAA (GRAM) 13.2 11.6 NA 7.7 12.7 19.0 13.5 James Hardie Industries plc (JHX) NA NA NA 17.9 22.7 36.7 15.3 TTM is trailing 12 months; F1 is 2014 and F2 is 2015, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA Armstrong World Industries, Inc. (AWI) 3.5 5.6 0.9 16.4 1.3 0.0 10.1 Industry Average 5.9 5.9 5.9 32.4 0.6 0.7 15.2 S&P 500 7.2 9.8 3.2 23.3 NA 1.9 NA Equity Research AWI Page 6
Earnings Surprise and Estimate Revision History Equity Research AWI Page 7
DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of AWI. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1138 companies covered: Outperform - 16.3%, Neutral - 77.3%, Underperform 6.1%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Equity Research AWI Page 8