Encore Wire: Amazing Operating Cash Flow Growth
Summary
- WIRE's operating cash flow exploded from $57.5 M in 2020 to $233.9 M in 2021.
- Management is using the cash to grow market reach and reduce operating costs, which bodes well for the future.
- The balance sheet remains very strong with $294.9 M cash and zero debt.
- I believe WIRE still has room to run, and expects 30-50% upside from its current level.
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Investment Thesis
Encore Wire (NASDAQ:WIRE) is a low-cost manufacturer of electrical wire and cable for commercial buildings, houses, and apartments. The main customers for WIRE are wholesale electrical distributors who sell the electrical wires and other products to electrical contractors. Riding the construction boom across the U.S., WIRE's business is growing at a rapid pace. Given the overall U.S. housing market growth trajectory, strong balance sheet, and their expansion plan, I expect WIRE to continue their success into the foreseeable future. I believe WIRE presents a great investment opportunity for a long-term investor because:
1. The demand for WIRE products will remain strong for the foreseeable future, and WIRE is in a great position to take advantage of the growth in demand.
2. Their financial strength is top notch with $294.9 M cash, zero debt, and a 6.09x current ratio.
3. Their expansion plan and cost reduction plan will serve their growth trajectory very well and ultimately reward shareholders.
Rapidly growing business and continuing strong demand
WIRE's revenue has been growing at a solid pace for the past several years (5 year average of 10.76%), and it started to accelerate earlier this year (most recent quarter's YoY revenue growth at 90.73%). This explosive growth is caused by two factors.
The first is growth in product volume. During the last earnings call, management mentioned that copper unit volumes increased 7.9% and 13.3% for the three-month and nine-month periods ending in September 2021, compared to the previous year. Given the ongoing construction boom around the U.S., I expect this robust growth in product volume to remain stable into the foreseeable future.
The second is the increase in the price spread between raw material and finished product. The copper spread increased by 181.1% compared to last year (wire price increased by 91% vs. copper price increased by 55%), and this has significantly contributed to revenue growth and profitability for WIRE. Given their vertically integrated business model, WIRE is well positioned to take advantage of this volatile market movement (both raw material and finished product) to increase market share. Their EPS and tangible book value per share trend and the vertically integrated business model are shown below.
Source: Slide from investor presentation
Top notch financial strength
WIRE's financial strength is truly top notch, and their balance sheet is pristine. They have $294.9 M in cash, while having zero debt. Also, as their growth has been through organic methods (R&D and plant expansion), they have zero goodwill on their balance sheet. Since I expect their healthy operating cash flow to continue (positive for decades and now $233.9 M in 2021) and their vertically integrated business model to protect them from market volatility, I believe their balance sheet will only strengthen for the foreseeable future. The summary of their financial strength and the trend in operating cash flow are shown below.
Source: Slide from investor presentation
Expansion and cost reduction plan
Like any other great business, WIRE continues to invest money on capacity expansion and cost reduction. During the last earnings call, management mentioned that their two-phase expansion plan (shown below) remains on schedule. In mid May, they opened a new service center, which is fully operational at this point. Also, they are repurposing the distribution center to expand manufacturing capacity, and this is on schedule to open early 2022. This expansion will further enable growth and cut costs.
One aspect of WIRE's expansion that separates them from other companies is the fact that they always focus on organic growth. While growth via acquisition does provide faster growth, companies tend to overpay for the new business (resulting in large goodwill on their balance sheet). Also, there is always a possibility of failed integration of the new business, which ends up costing a lot of money and creating a headache for the company. WIRE's commitment to grow their business organically through manufacturing expansion provides steady growth while ensuring that the balance sheet stays healthy. WIRE's CAPEX plan and the two phase expansion plan are shown below.
Source: Slide from investor presentation
Intrinsic Value Estimation
I utilized DCF model to estimate the intrinsic value of WIRE. For the estimation, I utilized the TTM operating cash flow ($233.9 M) and current WACC of 7.8% as the discount rate. For the base case, I assumed operating cash flow growth of 10% (5 year average growth rate for revenue) for the next 5 years and zero growth afterwards (zero terminal growth). For the bullish and very bullish case, I assumed operating cash flow growth of 15% and 20%, respectively, for the next 5 years and zero growth afterwards.
The estimation showed that the current stock price represents 30-50% upside from the current level. Based on the continuing construction boom, and WIRE's expansion plan and financial strength, I believe that WIRE is more than capable of achieving a 15-20% increase in operating cash flow over the next several years. I expect WIRE's business to continue a high growth trajectory for the foreseeable future.
Price Target | Upside | |
Base Case | $166.10 | 29% |
Bullish Case | $200.26 | 56% |
Very Bullish Case | $241.28 | 88% |
The assumptions and data used for the price target estimation are summarized below:
- WACC: 7.8%
- Cash Flow Growth Rate: 10% (Base Case), 15% (Bullish Case), 20% (Very Bullish Case)
- Current Operating Cash Flow: $233.9 M
- Current Stock Price: $128.68 (12/13/2021)
- Tax rate: 30%
Risk
Both demand for the electrical wire product and the costs of raw materials are highly cyclical. Construction activity fluctuates quite a bit, and copper prices can undergo wide swings at a time. Therefore, an economic or construction slump may negatively impact WIRE's growth trajectory, while increases in copper price many negatively impact their margin. However, WIRE has a very strong balance sheet with no debt, and their vertically integrated business model offers protection from severe margin compression caused by fluctuation in commodity prices. Therefore, I believe WIRE's long-term growth trajectory will remain intact, regardless of short-term market adversity.
Conclusions
I believe WIRE presents a great investment opportunity for a long-term investor. Their superior business model, strong balance sheet, and robust expansion plan will ensure the steady and rock solid growth trajectory that they have been enjoying over the past decade. Their two phase expansion plan is on schedule to increase manufacturing capacity and capture additional market share. While fluctuations in commodity price or declines in product demand may present temporary challenges to WIRE, their long-term trajectory should remain intact due to their strong cash position and vertically integrated business model. I expect 30-50% upside from the current level.
This article was written by
Disclosure: I/we have a beneficial long position in the shares of WIRE either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.