Fortune Brands Innovations Inc

NYSE:FBIN

Earnings Call Transcript 2017-Q4

[Operator]

Good afternoon. My name is Cheryl, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fortune Brands Fourth Quarter 2017 Results Conference Call. [Operator Instructions] Thank you.

I would now like to turn the call over to Mr. Brian Lantz, Senior Vice President of Communications and Corporate Administration. You may begin your conference call.

[Brian Lantz, executive]

Good afternoon, everyone, and welcome to the Fortune Brands Home & Security Quarterly Investor Conference Call and Webcast. We are pleased to be here today to provide an update on our progress during the fourth quarter of 2017 and provide our 2018 guidance. Hopefully, everyone has had a chance to review the news release issued earlier. The news release and the audio replay of the webcast of this call can be found in the Investors section of our fbhs.com website.

I want to remind everyone that the forward-looking statements we make on the call today, either in our prepared remarks or in the associated question-and-answer session, are based on current expectations and market outlook and are subject to certain risks and uncertainties that may cause actual results to differ materially from those currently anticipated. These risks are detailed in our various filings with the SEC such as our Annual Report on 10-K. The company does not undertake to update or revise any forward-looking statements, which speak only to the time at which they are made.

Any references to operating income, earnings per share or cash flow on today's call will focus on our results on a before charges and gains basis for continuing operations, with the exception of cash flow, unless otherwise specified.

With me on the call today are Chris Klein, our Chief Executive Officer; and Pat Hallinan, our Chief Financial Officer. Following our prepared remarks, we've allowed some time to address questions that you may have.

I will now turn the call over to Chris.

[Christopher Klein, executive]

Thank you, Brian, and thanks to everyone for joining us today.

In the fourth quarter, sales growth accelerated across our businesses and was led by plumbing. Demand for our home and security products continues to be solid, and our teams again drove strong operating margins across all segments.

For the full year, we continued to execute on our strategy of disciplined profitable growth as we increased earnings per share double digits. Sales grew 6%, and our operating margin increased to 13.7%. Our teams again grew sales and margin simultaneously. The margin improvement delivered during 2017 keeps us squarely on track to achieve 15% operating margin when the housing market returns to steady-state levels over the next few years.

In addition, we delivered incremental growth during the year as we spent $140 million on the 2 plumbing acquisitions of Shaws of England and Victoria + Albert; repurchased $215 million of our shares; and again increased our quarterly dividend. All in all, our teams have continued to execute at a high level against our strategy, and we are performing well in a market that continues to recover gradually. Our product and brand positioning remains strong, and the momentum we have built sets us up for continued success in 2018.

Let me first take you through our fourth quarter results and my thoughts on our full year performance in 2017. Then I will discuss our view of the U.S. home products market, our 2018 outlook for sales and EPS growth and our thoughts on capital allocation. And finally, I'll share a view on the impact of the recently passed tax reform legislation in our company.

Beginning with the quarter. Overall sales increased 6%, with some storm-related weakness in October transitioning to strength as we moved into November and December. Operating margin performance was solid, increasing to 13.5%, with margin expanding across our home segments.

Turning first to Plumbing segment. Plumbing sales were 10% in the quarter, and with organic growth of 9%, we continue to outpace the market. This was an especially strong performance against our 19% growth rate in the fourth quarter of last year. The growth was driven by broad-based strength in our core markets as consumers responded to our new marketing and accelerated pace of product innovation; strength in new adjacent categories, including disposals in all of our markets and sanitary ware in China; and the successful integration and performance of the 4 acquisitions that were completed over the last 18 months.

As a reminder, the Global Plumbing Group was formed in December of 2016, and the strategy began to prove itself throughout 2017. The power of this platform to create value through accelerating organic growth and expanding incremental growth is already starting to show. The fuller product and brand portfolio we now offer in plumbing, combined with our well-established distribution strength and leverage across North America and China, is taking hold. We're driving growth in new and existing sales channels, including showrooms, hospitality and online, and the new team structure has accelerated growth in our core Moen business as well.

On the back end, we're leveraging share procurement engineering, product development and overhead to drive efficiency and cost savings. In short, the GPG has delivered on our high expectations in the first 18 months. Going forward, we'll continue to enhance our capabilities, products and talent while remaining active and looking for incremental acquisition and partnership opportunities. Importantly, we continue to believe we are on track to reach $2.5 billion in plumbing sales by 2020.

Turning next to Doors. Sales were up 6% for the quarter. The Doors team delivered another quarter of strong performance and overcame the headwinds associated with severe weather early in the quarter. Wholesale growth was driven by share gains in new construction, where the Therma-Tru brand continues to resonate with large homebuilders and industry-leading door distributors. Retail door sales also continued to be a terrific story in the quarter. Our new product and display investments have resulted in sustained share gains and additional store placements. As a result, retail sales have come in above expectation throughout 2017 despite significant inventory placements associated with new product launches in the prior year. We have strong momentum in Doors going into 2018 and plan to invest more in this business, which Pat will discuss in a little more detail later.

In the Security segment, sales increased 4% for the quarter. High single-digit increases in Master Lock U.S. retail and double-digit increases in safety and international drove the growth and offset the exit of a commercial product line we announced last quarter. Safe sales were also up double digits in the quarter, as we're less constrained by our own capacity following the successful integration of our SentrySafe manufacturing facility. Security business continues to post strong operating margin overall, driven by the manufacturing consolidation and an improving mix. As we move forward, we see enhanced opportunity in 2018 to increase sales across commercial, retail and international markets with continued margin improvement.

For our Cabinet segment, sales were up 4% in the quarter, slightly above the cabinet market, which we believe is currently growing at about 3% overall. Similar to recent quarters, sales of in-stock cabinets and vanities were stronger than the overall market, growing low double digits as we continue to gain share with our product innovation and our sophisticated supply chain and logistics models that support the unique needs of the largest home centers. This part of the market also benefits from low project complexity and strong value for price product lines.

Sales in our largest channel dealer were up low single digits in the quarter. Our new construction lines performed well, and the premium end of the market was positive again, reversing negative trends we saw earlier in the year. The middle of the market remains sluggish, and our dealers continue to face constraints in their access to enough installers in many markets around the country.

The balance of our Cabinet business, which includes builder direct, home center special order and Canada, grew mid-single digits. Strong new construction demand in builder direct drove solid growth in the quarter, and builder sales increased high single digits. The builder direct business continues to generate strong sales and margin growth. As we continue to be precise in terms of where we focus, we're evaluating expanding our footprint into areas where we can achieve profitable growth. Canada was down low single digits, but up low single digits when adjusting for some exited business.

Looking past the quarter at our overall Cabinets business, it's clear we have some parts of the business that are performing very well. These include simpler project offerings at lower price points across our in-stock cabinet and vanity lines as well as higher price point custom lines in dealer, where we continue to invest in innovation, customer service and technology. And larger contractor remodelers are having more success securing trade labor.

The new construction builder market also remains robust across both builder direct and through our dealers. However, some parts of the cabinet market remain softer. Notably, the middle-of-market semi-custom Cabinet business continues to be constrained in many places across channels. As we've done in the past, we're addressing these market opportunities and constraints head on. We're making targeted capital investments in the parts of the cabinet market that are growing to increase capacity, innovation and service to support the growth. In the middle-of-market semi-custom, we're tightening things up and allocating our capacity against our best dealer in home center opportunities as we go deeper with important customers in markets that are growing and have labor available.

On the margin, we're also backing away from targeted pieces of less attractive business, which will help us continue to improve our mix from a margin and growth perspective. We have also initiated some pricing actions to offset tariffs and commodity and labor inflation. We'll see the benefit of these actions as the year unfolds.

So overall for Cabinets, sales growth in the quarter was solid and slightly above market and at good margins. As we look forward, we see growth in 2018 for our Cabinets business in the mid-single digits, inclusive of the market dynamics we see, share gains we're experiencing and select exits of some U.S. and Canadian business that is less attractive to us going forward. Margins will also continue to expand as pricing actions begin to cover inflation, and we actively allocate our capacity and product innovation towards our most attractive opportunities.

Turning to the full year. In 2017, we executed well against our strategy of profitable growth. We delivered solid sales, earnings and margin results that continue to reflect healthy consumer demand for our home and security products and our continued commitment to disciplined profitable growth. It's also a strong performance in the face of continued labor constraints, a return to an inflationary environment, severe hurricanes and uncertainty on trade and tax policy throughout much of the year.

In the full year 2017, we grew sales by 6%, earnings by double digits and increased total company operating margin to 13.7%. Importantly, inside of each business, we made significant progress on our strategies to enhance our sustainable competitive advantages and achieve profitable growth.

In Plumbing, we proved out our GPG strategy and added to the power of the platform to drive accelerated organic and incremental growth while maintaining the strong operating margins for this segment. In Doors, our share gain performance gave us a broader platform to build upon, and our 2018 plan now includes significant investments to accelerate growth further. Our Doors business produced solid operating margin improvement during 2017, rising by over 150 basis points, and we expect continued solid margin improvement in 2018. In Security, our core business grew solid mid-single digits, and full year operating margin improved to nearly 15%. We have additional growth opportunities with new product introductions across our markets.

And in Cabinets, we stayed disciplined and focused on profitable growth while navigating a heavier promotional environment, continued trade labor constraints, a new plywood tariff and elevated demand for low price points and simpler projects. With our focused, strategic approach, we continued to grow sales and profit despite the challenging market backdrop and some changes in mix, and we remain committed to leveraging our industry leadership.

Now let me turn to our full year outlook for 2018, starting with our view of the U.S. home products market. Our 2018 annual outlook is built on an assumption that the U.S. home products market, which impacts roughly 75% of our sales, grows at a 5% to 7% rate, similar to last year's market growth, with favorable housing market demand drivers and demographics. Within that overall assumption, we anticipate that the pace of repair and remodel demand in 2018 grows at a rate of 5%, similar to 2017.

New home construction is assumed to grow at high single digits in 2018. Single-family is expected to continue to grow faster than multi-family, and single-family entry-level activity is expected to remain strong. Our total global market, which includes assumptions for the U.S. market as well as other international and security markets, is expected to grow at a combined 5% to 6% for 2018. Based on that total global market assumption, continued share gains, plus our recent plumbing acquisitions, we expect solid top line growth for 2018, with our full year sales increasing 6% to 7% over 2017.

With this market sales growth, our teams are focused on delivering full year EPS before charges and gains in the range of $3.54 to $3.66, which includes the favorable impact of tax reform. So overall, our 2018 outlook is based on reasonable market growth assumptions based on the basket of indicators we monitor. We will continue to execute on our growth strategy, and I feel good about the winning momentum that our teams are carrying into the year.

On top of improving sales and earnings organically across our portfolio, we also deployed capital in value-creating ways in 2017 as we completed 2 plumbing acquisitions, repurchased shares and again increased our quarterly dividend. We continue to focus on creating meaningful incremental shareholder value by using our strong free cash flow and balance sheet to make strategic acquisitions and return capital to shareholders.

Our acquisition pipeline continues to be robust, and I remain encouraged by the number of things we're working on. While there was a brief pause in the fourth quarter as many parties awaited the potential implications of tax reform, the decks are not clear and many situations are becoming more active. Some opportunities we are evaluating are tuck-ins, and some are of a more significant size. We are looking for long-term opportunities that make sense strategically. As a reminder, since our 2011 spin-off, we've deployed $1.5 billion on 8 acquisitions over the past 5 years. Over the next 3 years, we continue to believe we have the potential to deploy more than $3 billion to drive this incremental growth and shareholder value.

Before I turn the call over to Pat, I want to talk about the recently passed tax legislation and its impact on our business. We're excited about the new tax legislation. At a high level, it reinforces the advantages of being a big U.S. manufacturer with a large percentage of domestic sales. We're a clear winner as a result of the changes and are better positioned now than we were only 6 weeks ago. Large homebuilders are also now better off, and U.S. consumer will see more disposable income, providing an increasingly healthy backdrop to the U.S. housing market. And so I do not see the new tax rules that specifically relate to housing and real estate as being a headwind. Instead, I see an opportunity for incremental top line growth due to the strength of underlying demand in an environment which just became more favorable.

Regarding our tax rate, the recently passed tax legislation was positive and, going forward, the benefit should be significantly favorable. Our estimated 2018 effective tax rate will be between 24% and 26% all-in. As a result, a good portion of lower U.S. federal tax rate will flow directly to our bottom line. We now have more money to work with and tax incentives to continue to invest in our already sizable U.S. manufacturing and employee base.

Since the housing recovery began, our company has created over 4,000 jobs in the U.S.A., over 80% of them in manufacturing plants and distribution centers across the country. We will continue to invest in capital and people to drive growth, including property plant equipment, technology and an accelerated pace of new product innovation, which should help us drive long-term growth in the business while generating even more free cash flow. To sum up, tax reform is a significant positive that will enable us to continue creating growth opportunities and deploy additional capital to drive long-term shareholder value. We look forward to leveraging our improved position to sell even more products in the most exciting housing market in the world.

With that, I will now turn the call over to Pat, who will review our financial performance and provide more details on our guidance.

[Patrick Hallinan, executive]

Thanks, Chris, and good afternoon. As Brian mentioned, to best reflect ongoing business performance, the majority of my comments will focus on income before charges and gains from continuing operations.

Let me start with our fourth quarter results. Sales were $1.4 billion, up 6% from a year ago despite labor constraints, which continue to impact the rate of U.S. home products growth and a soft October due to hurricanes. Organic sales grew 6%. Consolidated operating income for the quarter was $187 million, up $14 million or 8% compared to the same quarter last year. Consolidated operating margin improved 20 basis points to 13.5%. EPS were $0.80 for the quarter versus $0.71 the same quarter last year, increasing 13% and were at the upper end of our guidance range. For the full year 2017, EPS were $3.08 versus $2.75 last year, increasing $0.33 or 12% and came in well above our initial guidance at the start of the year, which called for $3 in full year EPS at the midpoint.

Now let me provide more color on segment results. Our plumbing sales for the fourth quarter were $469 million, up $43 million or 10%, driven by strength across most of our businesses and geographies, including a strong finish from the companies acquired during 2016. Organic sales increased 9%. Operating income increased $10 million to $97 million, up 11%. Operating margin for the segment was 20.8%. For the full year, plumbing sales of over $1.7 billion increased $186 million or 12%. Operating income of $371 million was up $39 million or 12% over the prior year. Operating margin was 21.6%. Our new Global Plumbing Group is delivering on our strategy of growing sales above market while maintaining an operating margin around 21%. In 2018, we expect plumbing sales to grow high single digits, and the Plumbing group continues to target operating margins around 21%.

Turning to Doors. Sales were $129 million, up $7 million or 6% from the prior year quarter. Sales were up at all channels, and operating income increased $3 million to $19 million, up 15%. Operating margin was 14.5% for the quarter, up 120 basis points. For the full year, door sales increased 6% to $503 million. Operating income grew 20% to $75 million, and operating margin increased 160 basis points to 14.8%.

For 2018, we expect doors sales growth to be in the high single-digit to low double-digit range as we invest in additional retail expansion and in new products to drive growth. Operating margin in our Doors business next year is expected to be well above 15%. 2018 leverage will be below that over the last few years as we invest further in retail expansion and new product development.

For Security, sales were $159 million in the fourth quarter, up $6 million or 4% versus the prior year. Segment operating income of $24 million was flat, and operating margin was 15%. The flat operating income reflects the impact of material inflation. We expect pricing actions to offset material inflation during 2018.

For the full year, Security sales increased 2% to $593 million. Operating income increased 8% from the prior year to $88 million, and operating margin was up roughly 80 basis points to 14.9%. Strength in our core business drove the strong operating results as core sales grew 5%, offsetting a commercial product line exit. We expect the performance of our quarter to remain strong throughout 2018.

In 2018, we expect Security sales growth to be in the mid-single digits range as we capture additional top line opportunities in safes and leverage sales momentum in commercial and international. Operating margin in the Security business next year is expected to be over 16%. We expect price to offset commodity inflation and mix and operating improvement to drive margin expansion.

Turning to Cabinets. Sales were $626 million, up $25 million or 4% versus the prior year quarter. Sales were up in all channels, excluding Canada, which declined slightly, driven by the strategic exits and business refocusing we discussed on prior earnings calls. Dealer sales of $303 million were up 1% from the prior year. Sales of stock cabinets used in new construction were up mid-single digits, and sales of premium cabinets maintained stable low single-digit growth. Both showed promising strength at year-end. Softness in semi-custom cabinets limited dealer growth in the quarter. Sales of in-stock cabinets and vanities of $143 million increased low double digits, driven by strong home center POS and share gains.

R&R projects requiring relatively low labor intensity such as those involving in-stock cabinetry continued to experience strong demand. Strong demand for low labor intensity high-affordability products is a trend we see across our businesses and expect to continue. Sales in home center semi-custom, builder direct and Canada of $180 million were up 4%. Builder direct sales increased high single digits despite the team holding some orders in the quarter and builders fell behind due to labor.

Home center semi-custom grew low single digits, and Canada declined low single digits. Despite the decline, our refocused business in Canada continues to show progress as sales grew low single digits after adjusting for exited business. Operating income for the Cabinet segment increased $3 million to $67 million or 5% over the prior year quarter, with operating margin increasing 10 basis points to 10.7%. Slower-than-anticipated dealer growth in semi-custom and inflation relative to price constrained fourth quarter and second half margin expansion.

During 2018, pricing actions and capacity rebalancing will reaccelerate margin expansion. Pricing actions have already been implemented in most segments of our Cabinet business. Also, our disciplined approach to promotion will be tightened further during 2018 to be consistent with the demand trend and the inflationary environment.

For the full year, cabinet sales of $2.5 billion increased $69 million or 3% over the prior year, and operating income grew 5% to $272 million. Operating margin increased 20 basis points to 11%. While our 2017 margin expansion was less than anticipated, the team did a good job navigating a challenging market environment and continues to lead the cabinet industry in terms of ability to grow sales and deliver strong operating margin performance. In Cabinets, we anticipate improved sales growth and operating margin expansion during 2018, driven by strong pricing and promotion discipline, capacity management and continued improvement to dealer sales. We expect cabinet sales to grow mid-single digits in 2018, with operating margin improvement of more than 50 basis points.

To sum up consolidated fourth quarter performance, sales increased 6%, and EPS were at the upper end of our range at $0.80. Our total company operating margin was 13.5%. For the full year 2017, sales increased 6%, and EPS grew 12% to $3.08. Total company operating margin was 13.7%, a 50 basis point improvement. And our full year operating leverage, excluding acquisitions, was 27%. We are well on track to reach our long-term goal of approaching 15% operating margin when the housing market returns to steady-state levels.

Turning now to capital deployment. During 2017, we repurchased $215 million in shares, including $39 million during the fourth quarter. We spent approximately $140 million on plumbing acquisitions and approximately $110 million on dividends, and increase the 2018 dividend rate. 2017 free cash flow was $464 million, reflecting a conversion rate of almost 100%.

Even after a meaningful capital deployment in 2017, our December 31 balance sheet remains solid. Cash was $323 million, debt was $1.5 billion and our net debt-to-EBITDA leverage was 1.4x. Additionally, we have significant capacity under our revolving credit facility to continue to deploy capital to drive incremental growth.

Turning last to the details of our outlook for 2018. Based on our projected 5% to 7% U.S. home products market growth and our total global market growth of 5% to 6% as well as continued share gains in our areas of strategic focus, we expect full year 2018 sales to increase 6% to 7% compared to 2017. Our resulting outlook for 2018 EPS are in the range of $3.54 to $3.66. The midpoint of our EPS outlook reflects an increase of 17%. The impact of tax reform on 2017 was nominal, and the go-forward benefit of tax reform to our business is significant due to the sizable reduction in our effective tax rate. The annual 2018 EPS outlook includes the following assumptions: interest expense of around $55 million, a tax rate between 24% and 26% and average fully diluted shares of approximately 155 million.

In summary, fourth quarter and full year EPS had strong growth. The solid performance of our business for the year, the momentum we have created with the Global Plumbing Group and the expected continuing market recovery give us confidence in continued solid growth in the coming years. Importantly, the 50 basis points operating margin increase in 2017 and another 50 basis points margin improvement expected in 2018 place us on track to achieve our long-term operating margin targets. Also, as demonstrated by the continuing plumbing acquisitions, share repurchases and the dividend rate increase, we remain focused on using our balance sheet and cash flow to drive incremental shareholder value. And our credit facility agreement provides significant flexibility to continue to drive incremental shareholder value.

I will now pass the call back to Brian.

[Brian Lantz, executive]

Thanks, Pat. That concludes our prepared remarks on the fourth quarter of 2017 and our full year 2018 outlook. We will now begin taking a limited number of questions. [Operator Instructions]

I will now turn the call back over to the operator to begin the question-and-answer session. Operator?

[Operator]

[Operator Instructions] Our first question comes from the line of Michael Rehaut of JPMorgan.

[Michael Rehaut, analyst]

First question I had was just on the broader macro outlook. And as always, it's very helpful to get your views on, as you've stated previously, how you expect the different end markets to grow in 2018. But I was hoping to get a little bit more detail in terms of what you're seeing in the U.S. and what drives some of the confidence around some of the -- specifically, U.S. housing market, how things have been. You mentioned the cadence in 4Q and how it's improved during the quarter perhaps off of some of the hurricane challenges. But in general, as you look at 2018, where do you see relative areas of strength across your different businesses? And potentially, where could you see some areas of upside?

[Christopher Klein, executive]

Thanks, Michael. Yes, we track a lot of variables in the market, and the things that we're tracking and looking almost uniformly point positive. We did start the quarter in October still softer, especially down south and in Texas off the storms. We did -- we felt that the cadence of the business in October wasn't quite where it would have normally been. It picked up November and December. December especially finished strong. You never know, December historically is kind of a quiet month. But there was backed up demand flowing through December. If I look across all the things we're tracking, GDP, unemployment, consumer sentiment, housing [ information ] data, homeownership rates, rolling 90 days of orders, permits and starts. Housing inventory, both new construction and existing housing stock inventory, they all point good. Affordability remains good. Interest rates are ticking up. But in the spectrum of overall affordability, where you've got disposable income rising as wages are going up, tax cuts will benefit disposable income. The affordability metrics we look at are good. R&R dynamics are positive. I think -- expected availability of remodeling crews to do as much work as there is demand for it. I'll talk about that in a minute. But there's strong demand out there. Our kitchen and bath dealers report a lot of traffic, except when the snow is falling and the ice storms are going on in the East Coast. Their showrooms were busy. Kitchen and bath show was busy as well. And there's a little bit of tailwind coming in off of the storms, kind of like Hurricane Sandy. We couldn't put our finger on it, but it was a little bit stronger off the East Coast throughout the year. And I think we started to see that at the back half of the year. I think we'll see it in the first half of this year. So all that points toward a lot of demand. The real constraint in the market is labor and the labor out in the market. We're okay in labor in terms of our plants, our ability to manufacture the products we sell. But labor in the end markets, skilled trades, especially carpenters, installers, it's just there's a tight pull-in. So jobs are getting sequenced. The construction is like a little bit backed up. But the projects are there, the demand is there. It's just how it will flow. To the extent we have pretty good weather first part of the year, we'll see a lot of that continue to flow through. And then the other thing we're tracking obviously is inflation, both input cost inflation, wage inflation. But then also it gives you some pricing power up in the market, and so that's what we're watching in general. But that's the by-product of the strength that we're seeing overall even with tax cuts on top, and for us, it's a really good thing. It's kind of like it finally pays off to be this big U.S. manufacturer with over 75% of our sales in the U.S. Maybe we got a little tailwind finally after spending the last 9 years in this recovery kind of fighting it off. Now we've got a little bit of breeze in our back, which feels good. So I think we're positive coming into the year. And then across our businesses, I think we're going to see it unfolding in the end markets. Our 2 biggest business, Plumbing and Cabinets, is really seeing strong demand coming in. Doors had some great share gains there. And in Security, [ emerging ] opportunities.

[Michael Rehaut, analyst]

Chris, I mean, it's a great answer. And certainly, I agree with some tailwinds supporting continued solid repair model growth with, perhaps, the tax reform adding a little bit to that. And I know that's, for some people, a little bit in contrast of concerns of repair and remodel demand slowing as the cycle progresses. So I appreciate that. I guess, second question, shifting towards from the top line part of the equation to the margin part of the equation. You mentioned in your guidance incorporating about a 50 bp margin expansion in '18 similar to the 50 bps you experienced in '17. When you kind of look at it from an incremental margin -- consolidated incremental margin standpoint, you're now a couple of years in a row, if you blend, again, on a consolidated basis, looking in more closer to like the low 20s of incremental margin versus kind of a banner year in 2016 when you almost hit 30%. And of course, that was coming off of some investments that you were making in the prior couple of years. So my question is, how should we think about incremental margins over the next couple of years? I think, is it fair to say that in '18, you have a little bit of a catch-up with some of the pricing actions and some of the -- offsetting some inflation that you started to experience in the back half of '17? Should we still think about a mid-20s type of incremental margin as the norm? Maybe you could help us kind of think through the pluses and minuses of the -- of what's helping or hurting the margins in '18.

[Patrick Hallinan, executive]

Sure. Mike, yes, you should expect 25-plus percent incremental margin. And I think if you adjust for acquisitions, you'll see that. But I'd step us back to we feel like we're solidly on track for 15% when the housing market is at 1.5 million starts, which we would see as kind of the 2020-ish or thereabouts time frame, and we're marching towards that at 50-plus bps a year. If you look at '17 and you adjust for acquisitions, you get about a 27% incremental margin. Yes, '16 was considerably higher since '16 benefited from deflation that '17 did not benefit from. And '18, the first half of '18 we'll be taking price. Prices will be flowing into various channels over the first half. And so the margins in the second half will be stronger than the back half. But again, if you look at '18, and again, you get to the end of the year and you adjust for inflation, you should be seeing leverage of 25-plus percent. So we feel like we are on track for that 15% at steady state. We are still tracking incremental margins at 25-plus percent. There will be timing lags price to commodity or absorbing the early stages of acquisitions where you'll -- you could be off that cadence by a little bit. But we still feel like we're broadly on track with where we've been heading.

[Operator]

Your next question comes from the line of Scott Rednor of Zelman & Associates.

[Scott Rednor, analyst]

Chris, I wanted to maybe have you talk a little bit more about the Cabinet strategy. To the prior question on kind of incrementals, it seems to be focused on that segment where you're -- we're expecting more margin expansion in 4Q. And you got a lot of different things going on as you look to '18. I think this is a business that you set the stage could get back to 14%, 15% margins in 2 to 3 years. Just want to hear kind of what's the strategy to get there now that it seems like there might be a different path.

[Christopher Klein, executive]

Yes, I'd just say second half of the year, we saw a couple of things going on. Obviously, input costs rose and so we started pricing actions in the fourth quarter carrying through the first half of this year. They take a little while to work through the system. It's both pricing and reduction on promotion. We're the least aggressive of those promoting, but we're going to pull back even a bit tighter. And then there's mix. The parts of the market are a little challenged in mid-market, semi-custom. They're flattish. It's not kind of a significant negative like we saw in the premium end of the market 18 months ago, probably 2 months ago. But that mix part in the middle was a little weaker than what we had anticipated. So as we move into '18, pricing action will be a part of it. The other piece of it is allocating our capacity into those more attractive parts of the market and focusing on those customers and those segments that are giving a stronger margin. Just pause for center on the home -- pause for second on the home centers. The 2 largest home centers are actually doing quite well, kind of looking aggregate across their in-stock cabinets, vanities and the special order business. The third largest home center has been struggling and actually had a pretty weak '17 in cabinets. And so we're backing away from them, and we're really redirecting and going harder at the 2 largest home centers as well as going deeper in dealer. We're expanding our dealer base. We had a number of terrific account wins in 2017, took share away from some of our competitors. And we're going deeper into that business. And so that pivot moves you toward a richer mix of business in the market. Thought like if you think back a few years, we exited Builderwest because the dynamic of that business was not improving. And we allocated capacity to the parts of the builder market that were giving us good return and good growth. And that's the same thing now as we look at that little part of the market. Where are we getting good growth? We're getting good growth, good margin profile at the top 2 home centers. We're getting good growth in profiler and dealer, and we're going to run hard in those segments. If we're big enough, we're sitting here across 1/4 of the market in every channel, every price point that we can direct the business, we can direct the flow of what we want and still bring in pretty good growth but improve that margin profile. So I mean, this is what we've been doing over the last 6, 7 years. We've gone from breakeven up to 11% margin by doing exactly what I'm describing. And so the next step of the journey is to continue to focus, look at where competitively there's good margin, direct the business into that harder and back away from parts of the market where it doesn't look as attractive anymore. And our ability to execute that is really unparalleled, given our size and scope of our business. So it's more of the same, but in transition, you kind of see different effects flowing through the P&L. Is that clear? Or is it -- there's a lot going on in that statement. Just [indiscernible].

[Scott Rednor, analyst]

No -- yes, I think that's great detail. I guess, just from the market perspective, why do you think the markets -- I think you mentioned 3% for cash, that will be below both your macro indicators on the R&R and new construction side. Is there anything else competitively going on? I was just curious to get maybe your thoughts there.

[Christopher Klein, executive]

Yes, the 3% number is market overall. Some would even say it's only 2%. For perspective, our fourth quarter in the U.S. only was about -- we did about 5%. So if I take Canada out of our numbers, our cabinet number in the U.S. was about 5% growth. Across the market that -- we're saying about 3%. Some would say it's a little bit less than that. It's labor. The demand out there for projects is high. They're backed up. And if you go around to our dealer network and talk to them about kind of where is the growth going to come, it's going to come to those places where they have access to labor, where bigger dealers are locking up some labor. It's installation and carpenter labor in the market. So the demand is there. There's a lot of projects in the queue, a lot of designer activity. It's just getting it through and into the market. So I'm optimistic about the market overall, and I think we're solving this incrementally over time. I think builders are doing better than smaller builders in the market at accessing labor in general. The bigger contractors are having more success than the smaller local guys. So it's getting there, but it's working its way through. Home centers is up, and bigger home centers are having more success in access of labor than, as I've discussed, the smaller parts of that market as well. So we'll go where the strength is. We'll go to where the market is actually able to handle the projects and that's going to give us good growth and good margins. So it's -- the dynamic, it's kind of one of those by-products of tight labor market. When you're at the unemployment levels we're at right now, you don't have a lot of immigration. Immigration typically would have brought in more skilled trades. Would have brought in more carpenters, more electricians, masons, plumbers. So we got the pool we've got. We're trying to bring some more talent into the industry and we're making progress on it, but it's taking the time it's taking. Outside of that, I'd just say, competitively, we're in a very strong place in cabinets. We're winning share, we're winning business. It's the extent we can get the flow into the market. The accounts are there. The penetration of accounts is strong, so I feel good about the positioning of the business overall.

[Operator]

Your next question comes from the line of Susan Maklari of Crédit Suisse.

[Susan Maklari, analyst]

First, I wanted to delve in a little bit more into the weather. I know that you mentioned that you certainly saw maybe some kind of a slowdown that came earlier in January as a result of that. Do you think that that'll sort of cause any kind of a shift in terms of the timing that we see things coming together this quarter?

[Christopher Klein, executive]

It's too soon to say. It's interesting because I think we had some storms roll through a good chunk of the country. But unlike where we had really bad weather year like 2014, where we kind of had half the country frozen for 6 weeks, most of the storms moved through, it thawed out a bit, traffic resumed. Our plants may have been off a day here or a day there, but got back up again and are recovering. So I'm not sure it will persist. There'll probably be a catch-up into February from some January volume. But it's nowhere near where we had really bad weather year like '14, where it kind of shifted demand into the latter part of the whole year. So I'm not as concerned about it as we sit here today. But it's February 1, so I guess, I shouldn't declare a victory yet. But I think we're okay. I think it was just -- there were a few disruptive weekends where people stayed home and didn't go to the local home center or kitchen and bath dealer to talk about remodeling their kitchen. They just kind of started the fire and sat back only until the snow melt.

[Susan Maklari, analyst]

All right. Got you. That makes sense. And then my second question is, and this is kind of bigger picture and thinking further out. But as you look across your business and you think about maybe some of the political rhetoric that's coming down, the changes in the taxes, all these things, do you think, over time, we could perhaps see more of your offshore competition moving to U.S.-based manufacturing? Did that kind of change their cost structures, the competitive dynamics that you face? How do you think about that coming together over time?

[Christopher Klein, executive]

So a couple parts to that. I think as a big U.S. manufacturer, clearly, the tax code was really written to benefit companies like ours. And so as we sit here today, our cost structure is advantaged. And I think that's a good thing for us. Were international competitors to come into the U.S. and set-up plants, I think there's a curve on all of that to come up and attract the labor and to get the process flows. And this is a tough industry in many places, and so the experience we have in manufacturing in some of these sectors is tougher to replicate. So over time, you could see it. I guess, the pressure would come on wages if they're bidding up for wage labor in our marketplace. But for today, I actually feel really good. I think, as I sat here a year ago, I was a bit more concerned about overall trade relations. And I have to say that there's been any huge breakthroughs. But the total overall feels a little bit more constructive. So things like NAFTA, China, were not in a period of complete unknown, which is what I felt like this time last year. I think that parameters of where things can wind up are tighter, and so we feel pretty comfortable about all of that. So I'd just say, for today, we feel really good. It's kind of like finally our time has come as a big U.S. manufacturer. We hung in there. We've got over 16,000 people in the U.S. across 87 manufacturing facilities. So when they write a tax code that benefits big U.S. manufacturers, we're sitting here in kind of a sweet spot.

[Operator]

Your next question comes from the line of Michael Eisen of RBC Capital Markets.

[Michael Eisen, analyst]

I just wanted to start quickly on GPG and kind of thinking back to when you guys originally set your targets. I think the commentary was mid-single-digit organic growth plus upside from M&A. Now you guys are posting 9%. It sounds like you're expecting the organic part to continue being strong. Can you help us think about how the original acquisitions you've made are playing into the organic channel and whether this strategy has changed going forward to be more organic-driven than acquisitions?

[Christopher Klein, executive]

Yes. I'm delighted to talk about Plumbing and GPG. It's going really well. So when -- we did a lot of work, obviously, before announcing the changes we made in the summer of '16. And we talked about reorienting and really allowing for more product to go through our existing channel, leveraging our back-end, doing some acquisitions, really bringing more product through the channels that we've got. We did a couple acquisitions early on and we followed on with some in '17, and it's going well. They're executing really well. The acquisitions were of a very high quality, and so those products and those brands are very well accepted in the channels that we've got. So we're moving more product through our historically very strong channel positions across North America and across China -- moving more product through China. So that gives us greater confidence than I was even sitting here 18 months ago. And as we're looking at other acquisitions and we're looking at partnership opportunities to get other brands and other products to move through the system, we feel really good. We also invested in some talent, upgraded our marketing organization, our operations organization. The pace and cadence of innovation picked up, and so we're pushing more product through at a faster cadence. And so that's working well. There's just a lot that's executing really well, and so I feel good about -- we laid out a target of $2.5 billion by 2020. Frankly, that's a lower-risk target now as I sit here than it was 18 months ago. And we've done some acquisitions and have improved out the organic side of it. And it gives us more confidence as we're looking at other things that we might acquire partnerships who might have -- we have a set of metrics here to understand what's reasonable that we can bring through that system, and those guys are executing really, really well. So it gives us a lot of confidence. And the plumbing part of the market, we got really good margins there. And our commitment is to kind of hold that margin at 21% to 22% on that range. Targeting 21% came in a little bit ahead of that, particularly all above the market. And that's where we're able to in '17. And that's where our plans are for '18, all quite reasonable and we're pretty excited. I mean, when you embark upon something, it looks great on a PowerPoint and it looks great when you're talking about it, you got to execute. And we now have 18 months execution and a team that's firing on all cylinders. So we feel really good about the plumbing group right now.

[Michael Eisen, analyst]

Very helpful and very encouraging as well. Just thinking of following up on some comments. As you look at your balance sheet, and you talked about kind of a long second half of the year in M&A activity, specifically in that segment, Chris, I think you mentioned that your -- you now have deals that seem active now, significantly higher and that you're looking at things of a more significant size than you had recently. Can you talk maybe if that's more across the portfolio if you're considering things that are outside of your current product set? And kind of bigger picture, would it be unrealistic to expect more M&A activity outside of the plumbing group as you move forward the next couple of years?

[Christopher Klein, executive]

Thanks. I think we're looking at things within the portfolio across the businesses. We're probably more focused on plumbing than other sectors, but we're looking in other sectors inside of our existing portfolio. And we're looking at some things that are outside of those 4 core but have very similar characteristics of being consumer-oriented home products, not commodity-building products. So strong brands, strong channel positions, strong pricing power, all those things that are allowing us to take price now are the characteristics of things we look at in terms of acquisitions. Don't want to say too much because I'm going to give away stuff we're looking at, but there's a lot of things we're still looking at now. And I think there's receptivity as we're looking at things. Frankly, I think clarity on the tax law helps family situations where people are wondering how that was going to unfold in terms of the state taxes. In general, I think, just looking at our inbound tax treatment on things we're acquiring is clear, both international assets as well as domestic assets. And then partners that are selling understanding kind of how things are going to get treated as they're realizing returns from their investments. So I think there's clarity. We're deliberate. We've got a lot of things we're working on, a lot of people we're talking to and we'll remain disciplined and deliberate. But I think given the scope of the things we're looking at, I'd expect we're going to do some things in '18 into '19. And we certainly have the balance sheet capacity to take those things on. And so we put pressure on ourselves to look at and we've got a lot of things we don't put pressure on ourselves to close. I think you can get in trouble when you do that. You cut corners. So we're disciplined in that. I wouldn't call us overly conservative. We're smart about businesses and the sectors that we're looking at. We've been in this a long time. I've been in this a long time. And so we'll work on it hard, spend a lot of time on it. But we'll remain disciplined. And then to the extent we have excess capacity, we'll certainly be active by the next years. We currently have about $550 million, I think, authorization still outstanding. So you'll see us doing that as well. So we'll be active in deploying our capital this year. It's back to the commitment I made 6.5 years ago when we became public that we have great operators. We don't need to save cash for a rainy day. We'll restructure and do things if there's a rainy day. So we're going to be aggressive in deployment of capital and we're going to take that spirit into '18. Markets that I just talked about is -- we think is pretty good end market. One reason to be positive.

[Operator]

Our last question comes from the line of Phil Ng of Jefferies.

[Philip Ng, analyst]

Good to hear you're pivoting some of your capacity in Cabinets and Door to capture some of the growth down the road. But just curious, how quickly can you ramp that up? And will some of these investments make you serve these first-time homebuyers and low labor intensity markets a little more effectively?

[Christopher Klein, executive]

So it's -- as often is the case, we're already in the middle of it. I have to stay out of describing things that are kind of new and interesting as we've already been doing that and as opposed to we're going to go do this. So we've already been doing this. So yes, we're targeting parts of the market where we see a good margin profile and good growth. Some of that is addressing first-time homebuyer market. Our direct-to-builder business continues to be strong. And our builder business through dealer is strong and national, and we're coming at that with our strong portfolio, which is coming into first-time homebuyer universe. So we're just getting tighter. So things I talked about are we're going to go harder in the direction that we've been moving and putting capacity and business up against the places that we see the best opportunity and not being afraid to back away from parts of the market that have underperformed. And we're kind of like we're just not going to stick with stuff that is lackluster. And that right now is some of that mid-market. I talked about some of the dynamic with the third largest home center, which is not an attractive place to be right now. So we're going to double down on the places that are growing. We're going to double down on the partners that are growing with us. And together, we're looking at one of the best opportunities on the market. We're already having success in that. We're just going to increase the focus in that part of the market. We have a great operating team. We have the best operating team in the industry in our cabinet group. And so when we put our minds in stuff, we execute all day long. In periods of markets moving, we're pretty deliberate about watching and don't overreact. But when we commit to something, these guys execute like crazy and they're in the middle of it and it's going well. So you'll see it unfold throughout the year, and you'll see that margin moving. We'll be expanding margin in Cabinets 50 to 70 basis points, and we'll come in close to 12% for the year and we'll keep marching forward. So feel good about that. We've evolved in this business over the last 8, 9 years through the recovery and it's the same core group just executing the hell out of that business.

[Philip Ng, analyst]

That's really helpful. And then the growth out of your Plumbing business has been really impressive. Based on what you're seeing, do you think you're outpacing the market just from some of the investments you're making? And China seems to be really strong. But at least there's some concerns that, that market -- the real estate market is cooling a little bit. Just want to get your thoughts on China as you think about 2018 as well.

[Christopher Klein, executive]

Sure. So overall, in Plumbing, we are outpacing the market. I bring it back to the basics that we're putting more products through the strength of the channels, so where we had the business historically only focused on a narrow set of products with a single brand. We've now got multiple brands going through these channels, and we're really leveraging the power and the strength of our presence and that's driving a lot of growth. Innovation is driving growth. Investments we're making in brand-building and marketing is driving growth. E-commerce, we have an outstanding team there, and they continued picking it up in the market. So in that core North America, yes, we're gaining shares and there's real strength there. China is probably a little bit better than I thought it would be. A good year, and '18, frankly, is just looking good. I think the dynamic in China is, overall, the market is tightening up. But there's a concentration in China with the bigger builders. And the bigger builders are buying smaller builders, and we've got good relationships with the bigger builders. And so proportionately, we're winning there because of investments we've made over the last decade with the right relationships and executing well there. And then the R&R part of that market, which comes through both the showrooms and e-commerce is also strength for us. We've got 1,000 showrooms, Moen showrooms across the country and we focus on Tier 1, Tier 2. And so we're in the markets where the R&R market is pretty consistent and growing. So I'd say that market unfolded better than I thought it would in '17. I'm looking at '18 and I'm probably feeling better overall about that market than again I might have a year ago. There's volatility in that market. There has been for a long time, we've been there 24 years now. And so we've lived through a lot of cycles in China. But we've got a really good team on the ground. Been there a long time. We've built that business from scratch and then evolved with the market and leveraged again the relationships and the channel strength where we see the end markets performing. We follow where that strength is and we can execute well. So the markets are doing well of course. We also expanded the product portfolio in China. We're moving more to kind of full-room solutions. And so we look back 5 to 6 years, we expanded into vanities. We more recently expanded into sanitary ware solutions and showering systems and other things. So it's -- when you've got kind of these Moen standup stores, you can really be pushing full-room solutions, and that's going really well. So that dynamic in the market at that local footprint is strong for us and a strong competitive advantage.

[Operator]

This concludes today's conference call. You may now disconnect.