On June 7, I wrote an analysis of the IPO of Houston Wire & Cable (NASDAQ:HWCC), which closed at $16.54 on July 3. The text of my original write up follows:
Houston Wire & Cable (HWCC) plans on offering 8.5 million shares (4.25 million from insiders) at a range of $12- $14. William Blair and Robert Baird are lead managing the offering. Post-offering HWCC will have 21 million shares outstanding for a market cap at $13 of $273 million. IPO proceeds will go towards paying down debt.
This is the 2nd go round at an IPO for HWCC. They debuted in 1987 and were purchased by ALLTEL in 1989. HWCC was then sold to current majority owner Code Hennessy & Simmons LLC in 1997. In 2000, HWCC acquired their largest competitor. Post-offering Code Hennessy & Simmons LLC will own 38% of HWCC post-offering. Note that CH&S is divesting 30% of their stake on IPO.
From the prospectus:
“We are one of the largest distributors of specialty wire and cable and related services to the U.S. electrical distribution market.”
In 2005 HWCC served 2,600 customers including virtually all of the top 200 electrical distributors in the U.S. Essentially a 'middle-man' in the US electrical wire & cable market. The electrical distribution market is quite fragmented with many small suppliers and buyers. HWCC as the largest wire and cable distributor feels their size allows them to give distributors access to the most comprehensive range of products in a single source and manufactures access to the greatest number of distributors.
HWCC lists their products, essentially though any sort of electrical wire and cable one can think of, they distribute. While they sell products from 150+ suppliers, 55% of their revenues are from three supplier manufacturers. Concentrating purchases from free suppliers allows HWCC to manage inventories a bit better, but also allows them to derive greater volume rebates annually from the three.
HWCC ships product same day from 11 different locations nationwide and has 450,000 square feet of warehouse space. Other complementary services include custom cutting to meet specs, 24/7/365 service and support from company employees and inventory management allowing 'just in time' as needed delivery. Also HWCC has established their own line of low-smoke, zero-halogen cable products that are sold under the LifeGuard name. HWCC is first mover in this niche of low-smoke zero-halogen cable.
HWCC's end customers fall into three groups, 1) Utility market- includes utilities, rural cooperatives and municipal power authorities. Growth area here is fueled by the need for additional power generation in the US; 2) Industrial market - catch all involving manufacturers and producers; 3) Infrastructure.
The electrical distribution market has grown an average of 5% annually the past 20 years and is expected to grow 8% in 2006. While not a cyclical boom/bust sector, the sector has tended to grow more rapidly during economic expansion and slower during economic stagnation. Specialty wire & cable annual sales account for $7 billion in the US annually.
Strategies going forward to promote earnings growth are to manage inventory effectively, pursue acquisitions and broaden sales/product base of their in-house lines.
No real cash on hand post-offering, $8 million in debt remaining. Note that pre-IPO HWCC had $57 million in debt, this offering has enabled them to clean the balance sheet.
Coming off the '01/ '02 economic slowdown growth has been strong. Note though that revenues dipped sequentially in each of 2002 and 2003, although HWCC was able to post a profit in each. If another economic slowdown hits, expect similar. Whether growth past 3 years has been fueled by a generally friendly economic landscape or the ability of the largest player HWCC grabbing market share is hard to say. My guess is a little of both, although attention must be paid to the fact HWCC is growing at a more rapid pace then the sector as a whole.
HWCC grew revenues 15% in 2004 and a strong 24% in 2005 to $214 million. Gross margins have improved each of the past 3 years and hit 26% in 2006. Solid gross margins for a middle-man type operations often these type of businesses will see gross margins in the teens. After all in theory manufacturers could sell directly to end users, in addition competition could sprout up to under price HWCC's business. Both would pressure margins and each is quite common in a 'middle-man' type operation. The fact that HWCC is able to post solid gross margins in this type of business is a good sign.
Operating expenses have declined each of the past 3 years showing nice economies of scale for HWCC. They're spending less for every new dollar of revenue, again a good sign.
After tax net margins have also increased strongly each of the past years hitting an adjusted 7% in 2005. As always I fold out anything that will not recur when a company goes public. In this case, HWCC by paying off debt on offering has virtually wiped out their annual debt servicing expenses. After tax net for 2005 was $0.71 cents. At a $13 pricing HWCC would be trading 18 X's trailing earnings.
What will HWCC earn in 2006? Well they had a simply blowout first quarter thanks to capital spending in the Gulf Coast post-hurricanes. They bested the 3/05 quarter by nearly 50%, just enormous growth for this sort of company. I don't think that sort of growth will continue, but the blowout Q1 almost assures HWCC of posting a nice revenue increase in 2006. I do think conservatively HWCC can boost 2006 revenues 25%-30% in 2006. Again this is conservative, if hurricanes again ravage the Southeast in fall of 2006 and/or the economy does not slow then revenues could come in higher. I'm going to go with 26% revenue increase in 2006 to $270 million. I think margins will expand, continuing the trend the past 3 years. Again though I just don't think they'll expand at the pace of the first quarter of 2006. I think 8% net margins in 2006 is quite reasonable, an increase of 1% off of 2005.
Estimated net for 2006 is $1- $1.10. Again this number assumes rather flat quarterly numbers throughout the final 3 quarters of 2006. At a $13 pricing then, HWCC would be trading 12 X's 2006 earnings.
Risks- As alluded to above the largest risk here is an economic downturn. While HWCC has proven they can manage a downturn and still turn a profit, a slowdown would bring sequential decreases in revenues/ earnings. Due to a strong balance sheet and management that has effectively managed through downturns previously HWCC is in no danger of financial issues during anything but a massive slowdown. In fact their financial strength could very well lead to a market share growth during the next slowdown. Still though, such a slowdown would bring down estimates and stock price.
I like this offering. HWCC had simply a blowout first quarter 2006. Their #1/#2 suppliers Belden (NYSE:BDC) General Cable (NYSE:BGC) have both seen their stock prices rise substantially in the past year, both are currently trading at a more expensive 2006 multiple then HWCC in range. In addition analysts have taken BDC and BGC's 2006/ 2007 earnings estimates up substantially the past 90 days. HWCC had a blowout quarter and their 2 largest supplier have had their annual earnings estimates going forward taken up substantially. I like that, very similar situation to the HEES IPO a few months prior.
Yes HWCC has economic slowdown risks. However the trends have been solid and the multiple in range should allow for reasonable aftermarket appreciation. Solid deal -- I'm recommending this one in range and even a bit above.
HWCC 1-month chart: