Shares of Valmont Industries (NYSE:VMI) took a tumble last week after the company released an update to its earnings outlook. EPS for the year are expected to fall short by about 8%, from $10.00-10.50 down to $9.35-9.65. The firm is experiencing worse than anticipated operating deleverage from weakness in several markets:
- The Irrigation Segment, which was already poised to post disappointing comps relative to last year's record performance, continues to show weakness as commodities prices remain low and demand for agricultural machinery has waned considerably.
- The company's Australian galvanizing operations remain hampered by a weakened Australian economy, which has seen its own outlook for GDP growth cut by 30 basis points to 2.7%. Though the company had originally forecast earnings in line with last year, it seems fair to assume some degree of deleverage in this segment moving forward.
- The Utility Support Segment (USS) continues to be difficult to predict, and though the company remains bullish on long-term earnings growth for this segment in 2015 and 2016, results are predicted to be lumpy in the near term. Operating margins are now expected to fall into the 12-14% range.
- About the only piece of good news in the estimate update related to the Engineered Infrastructure Products (EIP) segment, which is expected to show some improved profitability compared to last year.
The current diluted earnings estimate of $9.35-9.65 is based upon current shares outstanding, and does not include the effect of Valmont's recently announced share repurchasing program.
I had previously projected a fair value estimate of $168, which was updated to $177 after the company announced its share repurchase program. I have updated my discounted cash flow model to incorporate these new estimates. I use a Monte Carlo discounted cash flow model, incorporating historical trends (weighted towards more recent results), supported by an analysis of trading multiples. I now project operating margins of about 8%, 13%, 20%, and 15% for the EIP, USS, Coatings, and Irrigation segments, respectively. I project year-long earnings of about $3.74 billion, but earnings to be negatively affected by deleverage and coming in around the mid-point of estimates, about $9.50 / share. Projections and calculations are listed below.
VMI Projected Discounted Cash Flows
|(all numbers in millions)||2014||2015||2016||2017||2018||2019||2020||2021||2022||2023|
|Projected Gross Profit||939||1131||1326||1566||1830||2138||2434||2727||2944||3128|
|Projected Net Income||254||326||393||483||577||689||775||842||837||784|
|Projected Depreciation and Amortization||84||90||97||104||112||121||130||139||149||160|
|Projected Capital Expenditures||107||127||150||179||222||312||383||420||428||407|
|Free Cash Flow||169||209||246||293||357||382||424||452||467||457|
My model had already projected depreciation charges of about $80 million and capital expenditures of about $100 million, similar to management's current projection for the year. Free cash flow is anticipated to come in at about $169 million, down moderately from last year, which would imply a free cash flow yield at Friday's closing price of $151 of about 4.2%.
Looking forward, I continue to believe that the company's long-term prospects remain sound. My model had already incorporated near-term weakness in the Irrigation segment, and the Coatings segment was already anticipated to indicate weakness. In addition, though commodities prices may continue to be weak in the short term, in the long term, I think they will revert back to the mean, at which point the Irrigation segment will show significant earnings releveraging. Though the global economic recovery has been slow, it has been consistent, and I would expect economic headwinds (such as the slow Australian recovery) to abate in time. Valmont has proven adept at managing costs-- this was mentioned as a key priority for this year, given the anticipated market softness-- and I see no reason to change my long-term earnings growth expectations for the company. The planet's growing population and infrastructure needs will not suddenly disappear, and neither will Valmont.
Over the model's 10-year explicit forecast period, I continue to project a steady decline in revenue growth to about 8%, with control of revenue costs and SGA permitting an overall EPS CAGR of 11.5%. The model yields a fair value estimate (based upon TTM diluted shares outstanding) of $164, implying a PE*PB*PS*PCF product in line with historical averages (1500 vs 1450). If we take a conservative view of the share repurchase program (assuming only 1.1 million shares are repurchased), the new FVE for the company is $170, down $7 from my previous estimate. After reviewing my assumptions for the current equity risk premium, I assume a weighted average cost of capital of 10.7%.
In short, shares of VMI continue to look undervalued relative to the company's growth prospects and reliable earnings power. A reverse DCF calculation indicates that the market is only pricing in a 10-year EPS CAGR of 5.5%, which is well below what the company has proven capable of producing over the past decade. I remain long, and look to add to my position should additional price weakness take the price below $145.
Disclosure: The author is long VMI. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.