WHR, Financial) reported its fourth quarter and full-year 2021 earnings results on Jan. 26. The report highlighted some record achievements for the company. In 2021, Whirlpool’s net sales grew 13%, it saw a record net earnings margin of 8.1% (up 260 basis points) and a record Ebit margin of 10.8% (up 180 basis points), fully offsetting $1 billion in raw material inflation, and full-year earnings per diluted share were a record $28.36.
Whirlpool is a manufacturer of home and kitchen appliances. It manufactures in 10 countries and sells globally. Its brand portfolio includes seven primary brands with revenue of more than $1 billion, while the business model also encompasses white-label manufacturing for kitchen producers and other companies. The most well-known brands are Indesit, Hotpoint and Whirlpool.
Segments are reported on geographical bases, broken down into North America, EMEA, Latin America and Asia. Approximately 57% of net sales are generated in North America and 23% in EMEA. The Asian segment is shrinking. The majority of earnings comes from North America as well, with this geographical region providing 88% of total Ebit for 2021. The majority of Ebit growth reported in 2021 also came from the North America segment.
A risky investment
Why is Whirlpool a risky investment if the recent results were so great?
According to the criteria of a “wonderful” business, a rising operating margin is a good sign an investor should pay attention to because it indicates a possible “moat” build-up. The following graph illustrates the trend in the operating margin of Whirlpool for the last 20 years:
However, if we take a look at a bigger picture, we will see how margin expansion and contraction change in what is clearly a cyclical business:
It is also important to understand that moat build-up might cause operating margin expansion, but operating margin expansion does not mean there is moat build-up. We can see that operating margin expansion is part of an expansion cycle. One of the rules of guru investors which I learned from Dr. Charlie Tian’s book “Invest Like a Guru” is that it is dangerous to buy cyclical stocks at the peak of a cycle.
With cyclical stocks, a Shiller price-earnings ratio might be more useful for analysis rather than the standard price-earnings ratio. The current Shiller price-earnings ratio of Whirlpool corporation stands at 16.75, which is close to an average for the last 20 years.
Discounted cash flow model
Record earnings reported for the year reflect improved gross and operating margins. If the operating margin was “normalized” at a historical level of 7%, and earnings per share were normalized at a rather conservative $18 dollars per share, the DCF valuation still would imply a 23% margin of safety. But what margin of safety would a defensive investor prefer?
At the current price levels, the discounted cash flow model implies the company does not need to show growth even above 2% in its earnings per share to justify the current price. However, it is safer to rely on a higher margin of safety for a defensive strategy.
Expected return on investment
Returns for shareholders of Whirlpool depend mainly on the following factors:
- Dividends: The company pays quarterly dividends and has a goal of raising the payments. The current dividend yield stands at 3.4% as of the writing of this article, as the company announced a hike of 25% for the next dividend payment.
- Earnings growth: It seems reasonable and sustainable to assume 5% earnings growth based on historical information. Share repurchase is not taken into account. The company repurchases its shares and reduces the number of shares outstanding from time to time, with a three-year average share buyback ratio of 2.7%.
- Change in valuation: The company is currently valued at its average Shiller price-earnings ratio. It is reasonable to assume that no major shift in valuation will occur, since this stock is both cyclical and not very flashy.
Whirlpool does not really fit the “wonderful business” criteria. However, the company manufactures essential products for houses and might be a solid dividend play. I am putting this stock on my “next recessions list” and will consider buying it for the dividend at a Shiller price-earnings ratio at or below 15.