Whirlpool Feels Consumers' Pain

The appliance maker sees its biggest challenge in three decades as material costs rise and U.S. demand slows

Last year, Whirlpool (WHR) revived the memorable TV ad campaign that featured a forlorn Maytag repair man waiting for maintenance calls that never came. Unfortunately, nowadays, it's the Maytag salesman who's more likely twiddling his thumbs due to a thinning stream of buyers in stores.

On Apr. 24, The Benton Harbor, Mich.-based company reported a 24% drop in earnings for the first quarter, with strong results overseas offset by declines in its North American business.

The appliance manufacturer posted earnings from continuing operations of $94 million, or $1.22 per share, down from $124 million, or $1.55 per share in the first three months of 2007, on a 5% gain in revenue to $4.6 billion. The results fell far short of analysts' expectations of $1.57 per share. Besides rising material and oil-related costs, higher selling, general and administrative costs related to new product launches and advertising spending also reduced the company's operating profit.

"The combination of unprecedented material cost increases and seven consecutive quarters of lower U.S. demand have resulted in one of the most challenging operating environments we have seen in three decades," Jeff Fettig, the chairman and chief executive, said in a news release.

The company also cut its full-year earnings forecast to $7.00 to $7.50 per share from a prior estimate of $8.50 to $9.00, and now expects to generate free cash flow of $500 million to $550 million. The new forecast is far below the low end of analysts' estimates of $8.25 and a consensus forecast of $8.58 for 2008.

Investors promptly disapproved, pushing the shares down 10% to $73.89 on Apr. 24.

Whirlpool's earnings miss comes at a time when U.S. consumers are feeling the pinch from higher energy and food prices and worry about how long and deep a recession may be. Consumer sentiment hit a 25-year low in March.

Whirlpool lowered its forecasts for industry unit shipments in the U.S. and Europe for 2008. The company now expects U.S. unit shipments to fall by about 5% to 6% from 2007 levels, vs. a prior estimate of a 3% to 5% decline. For Europe, Whirlpool now expects 2008 unit shipments to fall 2% to 3% from last year, compared with earlier expectations for flat unit volume.

But the company still projects a 5% to 8% increase in 2008 shipments in Latin America, and a 5% to 10% rise in Asia.

Despite turbulent economic conditions in the near term, CEO Fettig said he was confident that Whirlpool's consumer brand following and new products would help the company take advantage of global growth opportunities over the long run.

In fact, first-quarter operating profit improved in all three major geographic regions outside of North America, the company said. In the quarter, sales in Europe rose 13% from the year-ago period, but were down 2% when currency effects were excluded, while better productivity drove a 17% increase in operating profit. A 24% gain in sales in Latin America – roughly 9% excluding currency effects – along with higher shipments and productivity gains caused operating profit in the region to jump 41% to $119 million. In Asia, a 19% increase in sales – 9% excluding the currency impact – resulted mostly from higher volume in India.

Whirlpool also said that its board authorized on Apr. 24 a new repurchase program for $500 million worth of stock. The company bought back $97 million of common stock during the first three months of 2008, completing its prior repurchase program.

Even with the lower profit outlook, JPMorgan Securities said earnings could be hurt even more, as steel order prices through June have risen 24% since the end of March, when they were already up 35% year-to-date.

"[Steel] producers have announced surcharges [that go into effect on] May 5, which we believe may not be fully reflected by guidance," JPMorgan analyst Michael Rehaut wrote in an Apr. 24 research note. "Whirlpool continues to expect to achieve cost-based price increases, which we believe will be difficult to achieve." Rehaut reaffirmed his underweight rating on the stock. (JPMorgan Securities has provided investment banking services to Whirlpool in the past 12 months and it or its affiliates expect to receive compensation for such services within the next three months.)

Price hikes will be hard to implement "given our view for a more promotional environment amid increased competition from import brands (LG and Samsung)," Rehaut said in his note.

Not so, says Laura Champine, an analyst at Morgan Keegan in New York, who thinks not only Whirlpool, but all appliance makers, will have to raise prices to offset higher raw materials costs – for everything from base metals like copper to oil and oil-derived products such as plastics, paints and resins. She notes that the company is targeting savings of 1.8% of sales from productivity improvements by the end of year. "But their cost increases will be bigger than that, so they're going to need more than that, which they hope to get from price increases," she says.

In the past, retailers were able to push back on manufacturers, demanding productivity improvements before they agreed to boost prices for appliances, but that argument won't fly anymore, says David MacGregor, an analyst at Longbow Research in Cleveland, Ohio. "Productivity [gains] won't be enough to offset increases seen in steel, stainless steel and diesel prices," says MacGregor, who has a buy rating on Whirlpool.

Given that Whirlpool is the tenth largest shipper in the U.S., "$4.50 [per gallon] diesel is pretty painful, so they need to get the price increases," MacGregor says. "It's unrealistic for the consumer to expect to be able to buy an appliance today at yesterday's raw material prices."

Champine recognizes that a substantial portion of consumers may opt to wait to buy a new refrigerator or washing machine if they feel prices are too steep. She estimates that discretionary purchases by customers whose current appliances aren't broken account for 30% of the total U.S. market. "That's why you're seeing the number of industry units shipped down 9% in the first quarter on top of [being] down 9% in the first quarter of 2007," she says.

Despite the plunge in profits and the lower 2008 outlook, Champine is maintaining her outperform rating on the stock. "Even in this quarter, which was terrible, the company still took share [from rivals] in every single region in the world," she says. "The cost increases are hurting them, but they're hurting the smaller guys even more. When the cycle turns, Whirlpool is very well positioned."

MacGregor agrees, although he thinks Whirlpool will probably suffer another bad quarter before the price increases start to work their way through the supply chain and affect profitability.

One positive point he thinks others aren't considering is how Whirlpool's margins would improve if the Federal Reserve decides to fight inflation and pushes interest rates back up. That would strengthen the U.S. dollar and open the floodgates for steel imports into the U.S. market. By that time, which could be sometime in 2009, the price increases will have stuck and steel prices will start to come down, he predicts. For investors with a longer time horizon, there's a reasonable prospect of Whirlpool delivering a positive earnings surprise in 2009, he adds.

And even with the lower free cash flow estimate for 2008, the yield on free cash flow is in excess of 10%, MacGregor says. And with the stock $8 cheaper than it was on Apr. 23, he says Whirlpool is still a very cheap stock.

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