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WIRE - Short Sell Recomendation

|Includes:Encore Wire Corporation (WIRE)

The company's recently filed 10K reveals a $13MM benefit to gross profit from LIFO liquidation for the year ended 12/31/09.  Looking at the previous quarterly filings shows that nearly $10MM of this benefit, occurred in the fourth quarter.  Excluding this benefit, the company's gross profit would have been nearly zero if not negative in Q4; reflecting the intensely competitive pricing environment the company faces as unit volume continues to decline significantly in the commodity wire industry which is so dependent on new construction to drive volume.  Recent Census Bureau data indicates commercial construction was down 32% Y/Y in January.  Recall that commercial construction represents approximately 70% of WIRE's end user demand.  Don't expect much pick up on the residential side either given current foreclosure inventory.  As such, intense price competition is likely to continue.   

While the company's Q4 loss of ($0.08) per share was bad enough compared to analyst expectations of a $0.06 profit, the LIFO liquidation benefit masked the full extent of the problem.  Excluding the approximate $7.6MM after-tax benefit the company realized from LIFO liquidation in the quarter would have resulted in a loss of ($0.41) per share during Q4. 

Inventory unit levels appear to be at record lows so it is likely the benefit is unsustainable going forward.  As such, I expect the true impact of the current pricing environment to be reflected in future earnings releases.  In fact, it is my opinion that the company will be unable to report a profit during the first half of next year and will come no where near the current consensus $0.58 earnings estimate.
Further, the bull case on the story has always centered on cash balances and cashflow as the company has reported massive operating and free cashflow in recent years.  However, due to the unsustainably low inventory levels the recent spike in copper prices and the company's cash cycle (60 day DSOs 40 days inventory and 10 days payable) will cause a significant drain on the company's cash going forward.  I expect the company will report significantly negative cashflow in the first quarter; somewhere on the order of ($50MM). Combined with the company's recent decision to retire their $100MM debt, I expect cash per share to decline from $5.40 per share to under $3 per share by the end of Q1 testing both the cashflow and cash balance arguments severely. 

Long story, short (pun intended)...

Disclosure: Author is currently short shares of Encore Wire

Stocks: WIRE