Fortune Brands Innovations is a narrow-moat-rated manufacturer of building products, featuring a portfolio of well-established brands such as Moen (plumbing fixtures), Master Lock (security), Therma-Tru (doors), and Fiberon (composite decking). Although Fortune Brands operates globally, around 90% of its revenue is generated from the US and Canada, with two-thirds of North American housing-related revenue linked to the repair and remodel (R&R) market, which is less cyclical compared to new construction.
Over the past two years, the stock has significantly underperformed the Morningstar US Market Index due to concerns regarding near-term US housing fundamentals amid rising mortgage rates, as well as the company's exposure to tariffs. With tariff exposure projected to account for approximately 11% of 2024 revenue, there is potential for profit margins to be impacted if not addressed. However, management is confident in their ability to fully offset these incremental tariff costs through price increases, cost-reduction initiatives, and supply chain adjustments, and we find their mitigation plan credible.
We maintain a positive long-term outlook for the US housing market, anticipating a robust rebound in US residential construction by 2027, along with a mid-single-digit long-term growth trajectory for R&R spending. The R&R market is expected to benefit from secular trends such as an aging housing stock and the growing adoption of smart home and energy-efficient products. We believe Fortune Brands will outpace the growth of the US R&R and new-construction markets, particularly due to its expanding range of connected products, including smart plumbing fixtures, leak detection devices, and home security solutions.
Currently, we view the stock as significantly undervalued. The existing valuation suggests that operating margins may not exceed 17% again; however, we believe Fortune Brands can achieve operating margins closer to 18% with improved demand. During its 2022 investor day, management outlined a strategy aimed at reaching a long-term operating margin of 20%-22%. Our valuation approach is more conservative, but there remains considerable upside potential if management successfully realizes its long-term profitability goals.
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