Is your bet on rebar manufacturer Insteel [IIIN] an even more cyclical bet?
CW: It is certainly a cyclical business. The company makes the steel-wire reinforcing products that go into concrete sold into three primary markets, housing, infrastructure and commercial construction. It’s the only pure-play public company in the space, competing with a variety of divisions of much bigger companies.
There isn’t a great deal to distinguish them from the competition, but we’ve known the company for a long time and consider them to be very good operators. We’re confident in their ability to execute to take advantage of any market turn.
We’ve owned this on and off in the past and got interested again earlier this year as the stock sold down significantly on concerns about construction and infrastructure spending. The company also was reporting particularly bad results as they worked through high-cost steel inventory on their books while demand was falling.
You obviously have to recognize if the competitive or supply/demand characteristics of an industry have changed, but if they haven’t, our basic strategy with cyclical businesses is to understand where the valuations have traded over time and buy at the low end of the range and sell at the high end of the range. With Insteel, the shares typically trade from 4-8x EBITDA. At our average price of around $7 per share, the EBITDA multiple was only 3x, which we thought was a terrific bargain.
We’re assuming you don’t expect the macro picture to get worse.
CW: We are making the assumption, as is the company, that there will be a rebound going forward from the absolute floor. We also expect an uptick in demand from stimulus-package spending on infrastructure. But we’re not saying sales go through the roof – our estimates have revenue increasing from $234 million this fiscal year (ending in September) to $260 million next year.
With inventories aligned, the profit increase should be far more dramatic. From roughly breakeven EBITDA this year, we believe they can earn $37 million next year. Our conservative fiscal 2010 EPS estimate is around $1.05.
What upside do you see in the shares, now at $11.75?
CW: The EV/EBITDA multiple on 2010 numbers is around 4.5x, still near the low end of the historical valuation range. As the cycle turns and they execute, our expectation would be to benefit from the stock gravitating to the upper end of that range, or 8x. Given that EBITDA should grow nicely beyond next year, the move in the share price could be even more impressive.