AZZ's Got the Power

It helps to have friends in power, and AZZ Inc. (Nasdaq: AZZ) is making a gridful of them. By selling the essentials for power generation, transmission and distribution, AZZ is taking part in the flush times of its customers, building profits as it powers up the industry.

The dynamics of AZZ’s business is au courant. It is benefitting from the need for replacement equipment for the aging distribution substation and transmission grid market, expansionary spending in the petro-chemical market and the recovery of the power generation market. It balances sales across the power and industrial markets.

In addition to electrical equipment and components for global markets, Fort Worth, Texas-based AZZ provides hot dip galvanizing to steel products in the United States, a process that forestalls erosion. In fiscal 2007, the company’s electrical and industrial products segment accounted for 58% of sales, and galvanizing 42%.

Speaking on the fiscal 2008 third quarter conference call Jan. 4, CEO David Dingus said that not only is the power generation market encouraging, but “the maintenance of announced build schedules of new power generation plants, the emphasis on renewables such as wind energy, and the addition of scrubbers to existing facilities should continue to positively impact our market and orders in future quarters.”

The CEO’s remarks came as the company raised net income guidance for fiscal 2008 through February to $2.12 to $2.22 per diluted share, the highest in the 51-year history of the company and up from $1.95 to $2.05 previously. Revenues were projected in the range of $315 million to $325 million, unchanged from previous expectations.

Revenues for the third quarter ending Nov. 30 were up 32% to $86.6 million, compared to $65.4 million for the same period the previous year. Net income increased 54% to $8.1 million, or $0.66 per diluted share. For the first nine-months of the year, AZZ’s revenues were up 39% to $243 million. Net income also was up 39% to $20.4 million, or $1.67 per diluted share.

AZZ’s electrical products transmit medium and high-voltage electricity and protect the distribution of power from generation to end-user. The company's industrial products include industrial lighting and tubular products used for petro-chemical and industrial applications. It provides lighting products to the petroleum, food processing and power generation industries. When these industries are surging, as they are now, AZZ’s fortunes thrive.

“There is absolutely no doubt that eventually we are impacted by change in industrial demand,” said Dingus when asked on the conference call what the impact would be of a slowdown in electrical and industrial demand. But projects are mainly driven by improvements in infrastructure in the petro-chemical and power markets, and in the distribution network, meaning there would be a lag time of about six months between a slowdown and impact on AZZ’s business.

Dingus did say there has been “some plateauing” in the general industrial market, but that “there is no doubt that what is going on in petro-chem, as well as what’s going on in power generation, is significantly helping our galvanizing business.”

Third-quarter revenues for the electrical and industrial products segment increased 44% as a result of an increase in market demand and improved pricing, primarily from the markets of high voltage transmission, power generation and utility distribution. In the galvanizing services sector, revenues rose 19% in the quarter from the previous year.

International business, which the company began to focus on in 1999, started to pay off in fiscal 2007 with sales in China and the Middle East. International sales are expected to be 25% to 30% of electrical industrial product sales in the current 2008 fiscal year, and will provide order flow in the first quarter of fiscal 2009 beginning in March. Although the company relies on business in China and the Middle East, it also sells into South America. Dingus said sales are being driven by power generation, power distribution and power transmission.

“AZZ represents a compelling play on increased spending on power transmission and distribution spending,” wrote Ned Borland, analyst at Next Generation Equity Research, LLC, on January 7. “We expect to see backlog grow further in FY2009 from current levels as international power generation opportunities come to fruition and strength continues domestically.”

Backlog was essentially flat with the previous quarter at $147.1 million as of Nov. 30. AZZ had a book-to-ship ratio in the quarter of 98% and expects approximately 30% of the backlog will be shipped by the end of fiscal 2008, Borland wrote in his research note. Backlog could trend higher in early fiscal 2009 with the expectation that international orders should outstrip bookings. About 23% of the company’s backlog will be exported.

Borland, one of two analysts covering AZZ, raised his fiscal 2008 earnings per share estimate to $2.24 from $2.14, and maintained his 2009 estimate at $2.50. He has a “buy” rating on shares and a target price of $43, representing 17 times his 2009 earnings estimate.

Shares of AZZ closed Wednesday at $32.85. For the year, AZZ, with market capitalization of $398 million, is up having rallied strongly on the third-quarter results. Its 52-week range is $17.51 to $41.58.

AZZ’s business, though, is susceptible to a slowdown in the industrial sector, and it is also subject to rising raw material costs, such as steel, aluminum and copper in the industrial product segment, and zinc and natural gas in the galvanizing segment. The company so far has been able to pass along these increases to customers, with particular success in the industrial product segment.

The company’s acquisition strategy is paying off, as are its efforts to increase sales to its existing customer base, expand into new markets and efficiently run operations. If market conditions remain favorable, AZZ will more than get by with a little help from its friends.

Disclosure: none