Atkore: Intrinsic Value Still Shows Upside

Summary

• Atkore had a truly impressive year with 65% YoY revenue growth and 293% YoY EPS growth.
• Their profit margins are far superior to industry peers, and these superior margins demonstrate their economic moat.
• Even with declining revenue expected due to price normalization, their intrinsic value is higher than the current price.
• I expect an upside of 10-20% from the current level.

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Investment Thesis

Atkore (NYSE:ATKR) manufactures and sells electrical, safety, and infrastructure products. They have a market leading position in PVC electrical conduit. Trends towards new construction, digitalization, charging infrastructure for electric vehicles, and electrification of buildings for net zero energy will drive demand in the foreseeable future. I believe Atkore presents a great investment opportunity for a long term investor because:

1. The demand for their products will continue for foreseeable future. Because of the price normalization, they will experience some revenue decline for the next couple of years, but the revenue will continue its growth trajectory afterwards.
2. Thanks to their strong economic moat, they have outstanding profitability and cash generating ability.
3. Their balance sheet has gotten stronger over the past couple of years, and they are cash rich. This will allow them to acquire key business to further strengthening their product offerings and growth prospects.

Impressive Revenue in 2021

Atkore had a spectacular 2021. They posted record net annual sales, with net income increasing by $1.16 B, from $1.77 in 2020 to $2.93 B in 2021. Most of the jump in sales resulted from a favorable price spread due to underlying market conditions. Although raw material costs increased, Atkore was able to pass the costs to the consumer and increase the price of the finished product by a larger amount. The favorable pricing conditions resulted in an increase in gross margin from 27.8% to 38.4%. Overall, management attributed the increase in net sales to higher sales prices (84.1%), greater sales volume (7.6%), and new sales from recently acquired Queen City Plastics and FRE Composites Group (6.8%).

Despite the outstanding year, management expects revenue to decrease during 2022. This drop in sales reflects the expectation that pricing (particularly for PVC products) will return to more normal historical levels. The timing for prices to return to normal is uncertain. Therefore, Atkore should continue to see some benefit from elevated pricing during fiscal 2022, but only over the near term. Management has provided guidance of $650-700 M for Adjusted EBITDA, which represents a 20-23% drop from its record $897.5 M in fiscal 2021. Analysts are somewhat more optimistic, projecting about a 5% increase in revenue in 2022 followed by a small drop in 2023.

The Adjusted EBITDA plot below shows Atkore’s historical performance (blue) as well as management’s 2022 forecast (red). EBITDA increased 179% during the bumper 2021 year. Considering the 5 year period from 2015 to 2020, Adjusted EBITDA increased by around 29% on an annualized basis. EBITDA is projected to decrease for the next 2 years, as the pricing advantage fades over time. Even though the 2022 levels represent a decrease from 2021, they still indicate a 53-69% annualized gain relative to 2022. Overall, residual pricing strength, enhanced sales volume, and new business from the recent acquisitions combine to produce a very positive outlook for the company going forward. I expect the company will experience ongoing growth in sales volume and open new market positions through acquisitions, even as prices stabilize over time. The 2022 outlook is given below.

Source: Author

Source: Slide from investor presentation

Impressive profitability and cash generation ability

Atkore has achieved impressive profitability over a long period of time. Their profit metrics (the elevated current ones and 5 year average ones) are far superior compared to the sector medians (shown below). This superior profitability represents their economic moat and superior business model. Thanks to this economic moat, they were able to generate a lot of cash from operations, and this operating cash flow has been increasing as they have grown. Their operating cash flow was $58 M in 2012, and it grew to $572 M in 2021. Even with the declining revenue expected over the next couple of years, I have little doubt the long term trajectory will be upward, given the demand increase for their products in the long term. Reflecting this impressive profitability and cash generating ability, management announced in December a $400 M stock repurchase plan over the next 2 years. I expect this stock repurchase to have a positive impact on their stock price.

Source: Seeking Alpha

Strengthening Balance Sheet

The balance sheet is significantly stronger than it has been previously. The past two years have been a boon for the Cash and Short Term Investment Account, which increased from $123.4 M to $576.3 M. A loan refinancing earlier in the year and a voluntary prepayment of $26 M of the principal decreased the net debt leverage ratio from 1.6 in 2020 to 0.2 in 2021. The quick and current ratios now stand at 2.2 and 2.7, respectively. Cash from operations has steadily increased since 2013, at an annualized basis of 15% using the 5 year time span from 2015 to 2020. Reflecting the favorable pricing climate, cash from operations was $572.9 M in 2021 compared to $248.8 M in 2020. The strong outlook for 2022 should serve to further strengthen the balance sheet, and allow management to shop for potential acquisitions.

Intrinsic Value Estimation

I used a DCF model to estimate the intrinsic value. Given the unusually high sales revenue of 2021, I based the calculation on the 2020 EBITDA with a multiple of 1.08 to focus on organic growth, rather than temporary price elevation. Disregarding the pricing increases, volume growth was around 8% while recent acquisitions captured additional sales of around 7%. Thus a growth rate of 8-15% appears reasonable, and a conservative multiple of 1.08 was selected for the calculation.

For the estimation, I utilized EBITDA ($341.0 M) as a cash flow proxy and current cost of equity of 7.5% as the discount rate. For the base case, I assumed EBITDA growth of 8% for the next 5 years and zero growth afterwards (zero terminal growth). For the bullish and very bullish case, I assumed EBITDA growth of 12% and 15%, respectively, for the next 5 years and zero growth afterwards. The 8% growth reflects the growth due to increased volume, while the 15% bullish case represents growth consistent with 5 year averages from 2015 to 2020 (15% growth in cash from operations, 29% growth in EBITDA).

The estimation revealed that the current stock price represents 10-20% upside. Given the expected synergy from the recent acquisition of Four Star industries and increasing demand growth for their product, I believe they will achieve this upside and growth further in the long term.

	Price Target	Upside
Base Case	$113.18	1%
Bullish Case	$132.20	18%
Very Bullish Case	$148.26	32%

Click to enlarge

The assumptions and data used for the price target estimation are summarized below:

• Discount Rate: 7.5%
• EBITDA Growth Rate: 8% (Base Case), 12% (Bullish Case), 15% (Very Bullish Case)
• Adjusted EBITDA: $315.7M in 2020 * 1.08 = $341.0 M
• Current Stock Price: $109.60 (12/30/2021)
• Tax rate: 22%

Risks

If I have to guess one thing that the market hates the most, it would be uncertainty. Unfortunately, the magnitude of revenue decline for next couple of years are very uncertain for Atkore, and this will limit Atkore's upside until the market has a better sense of where the product prices will stabilize. Given the uncertainty created by the Omicron variant and supply chain disruption, it may take quite a while before that happens. Ongoing supply chain disruptions and labor shortage also add the uncertainty to the prediction. However, given their cash rich position and excellent future prospects, I believe Atkore's long term growth prospects are favorable.

Conclusion

I believe Atkore presents a good investment opportunity for a long-term investor. Their products are essential to our lives and to the U.S. economy. Both new construction and the retrofitting of existing infrastructure will require electrical components, which will drive demand for their products. Also, they have high profitability and have demonstrated that they can generate lots of cash. There exists a level of uncertainty surrounding raw material and finished product prices over the next couple of years. However, Atkore is seeing growth in sales volume and have recently added several acquisitions, which provides a favorable long-term outlook. I expect 15-30% upside from the current level.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.