Encore Wire: A Long-Term Deep Value Play

May 14, 2022 3:05 AM ETEncore Wire Corporation (WIRE)9 Comments5 Likes
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Summary

  • Encore is a wire and cable manufacturing company that rallied behind the copper price hike in 2021 and garnered a 51% price return in the previous 52 weeks.
  • The company is investing in its manufacturing and operational capabilities to achieve a higher volume growth and market share to avoid overly relying on high prices.
  • It has a fortified balance sheet, great financial metrics, and is trading at a discounted price despite a share price surge.
  • I rate the stock a buy because of its great potential for capital appreciation in the next 3 to 5 years.

Copper wire cu raw industry production and heavy metallurgical

FactoryTh/iStock via Getty Images

Investment Thesis

Encore Wire Corp. (NASDAQ:WIRE) is a low-cost electrical building wire and cable manufacturer, primarily supplying to wholesale electrical distributors. Its products are used for interior electrical wiring in commercial and industrial buildings, homes, apartments, manufactured housing, and data centers.

The company's share price is down 12% YTD compared to 18% of the S&P 500 but up over 51% in the previous 52 weeks because of the surge from the start of Q3 2021 till the year-end. The surge was triggered by a steep revenue growth on the back of rising prices and strong volume growth.

Wire stock performance Chart

YCharts

The positive industry outlook and Encore's investments in its manufacturing facilities bolster the prospects for sustainable volume growth in the foreseeable future. Further, despite a surge in the share price, the company is currently trading at attractive valuation metrics; in fact, considering its solid fundamentals, the stock is still trading at a discount.

I am bullish on the stock because of its solid fundamentals, positive market outlook, and an undervalued share price filled with attractive upside potential.

Bullish Industry Outlook

According to Allied Market Research and Fortune Business Insights, the global copper wire and cable market is expected to grow at a CAGR of about 6% and range between $267 billion to $300 billion by 2030. This growth will be facilitated by increasing investments in the transmission and distribution of electric power, high cash flow in smart grid projects, and growth in demand for data centers and the telecom industry.

Global Wire & Cable Market

Allied Market Research

According to Global Market Insights, the North American wire & cable market, Encore's primary market, exceeded $27 billion in 2020 and is also expected to grow at a CAGR of 6% along with the global market, reaching $44.5 billion by 2027. This growth will also be fueled by the growing communication industry and upgrades of the grid infrastructures.

North America Wire And Cable Market

Global Market Insights

One particular product that will bolster this growth is the low voltage segment comprising wires and cables ranging from 50 volts to 1,000 volts, accounting for over 56% of the global market share in 2021.

Global Wires and Cables Market Share by Voltage 2021

Fortune Business Insights

In North America, this segment is expected to exceed $26 billion by 2027 because of its extensive use for secondary power transmission & distribution across residential, commercial, and industrial applications.

Encore's product catalog is highly diversified to leverage the growing demand in all segments, including the low voltage segment, with its growing capacity and copper spread, occupying an approximately 9.9% market share based on Q1 2022 TTM revenue.

Topline Growth and Profitability

Since the pandemic, the company has had a significant uproar with significant quantifiable growth in 2021 and Q1 2022. Its copper unit volumes increased 8.6%, and the copper spreads increased 86.1% QoQ in the MRQ, outpacing the industry growth CAGR. With the company's over 400,000 square feet distribution center being repurposed into a manufacturing plant in the current year, Encore will have an additional capacity to boost its growth and market share.

The company has great profit margins because of its low-cost manufacturing and cost savings achieved by all its manufacturing and distribution operations handled from a single 449 acres site. Encore's margins exceed the industry median and its 5-year average with a wide margin, sporting a 3-year revenue CAGR of 29.84%, 3-year net income CAGR of over 102%, and a 3-year diluted EPS CAGR of over 103%.

WIRE Profitability Summary

Seeking Alpha

Given that these numbers have been highly inflated because of the 2021 price surge, even the company's 9-year CAGR tells a sweet story with net income growth of almost 27%, EBITDA growth of 23.1%, and Book Value growth of 11.3% per annum. As a further vote of confidence in the company, its 5-year average of management effectiveness ratios also beats the industry medians.

WIRE Management Effectiveness Ratios

Seeking Alpha

Risk of Faltering Copper Prices

Since 2021 is an outlier and might put into question the reliability of the company's growth prospects, it is pertinent to look closely into the future sustainability of the growth metrics. Higher sales in 2021 were primarily driven by an almost 85% increase in the selling price of copper wires. This trend was carried into Q1 2022 with a 43.3% increase in copper wires' average selling price, leading to net sales of $723.1 million.

The cost of materials also increased as the average cost per pound of raw copper purchased increased by 19.3% in Q1 2022. Still, the company has a strong enough footing to pass on the costs to its customers, mitigating the risk of shrunk margins.

So a major risk that the company faces is a crash in copper prices which may force the company to reduce the selling prices of its copper wires, straining its topline growth. Since March 31st, these prices have declined by 13%, and the forecasts offer a mixed sentiment, with the World Bank forecasting a bearish trend while the IMF is taking a bullish perspective for 2022 and vice versa for the long-term.

IMF Copper Price Forecast

Knoema

World Bank Copper Price Forecast

Knoema

The company is bolstering its position via strong volume growth by reinvesting into its manufacturing facilities and operational capabilities to sidestep a heavy reliance on the inflated sales price. It has a CAPEX to sales ratio of 4.31%, higher than the industry median, and a YoY Capex growth of a little over 23%, almost equivalent to the industry median.

The company expects to spend between $150 to $170 million in 2022 and 2023 and between $80 to $100 million in 2024d to expand the vertical integration in its manufacturing processes to reduce costs and modernize its wire manufacturing facilities to increase capacity and efficiency.

This is a good sign by the management to leverage the cash generated through the heightened prices and inject it into the business to solidify its future revenue and cash generation abilities.

Valuation

Encore's valuation metrics are a strong point in favor of the company. It is trading at a discount to its 5-year averages and the industry median in almost every relative valuation metric. An amalgamation of all these metrics applied to WIRE's financial figures turns up a target price of around $195, an upside of over 50%.

WIRE Valuation Summary

Seeking Alpha

After the recent price surge, an upside of 50% seems unrealistic, but the company has a debt-free balance sheet, holds almost 20% of its market cap in cash, has an Altman Z score of over 11, solid financial growth prospects, and a strong and growing market share. The copper prices might make the stock subject to short-term volatility, but the long-term prospects of this growth stock appear completely intact.

Conclusion

Encore is a strong player in the wires and cables market with a fortified balance sheet and pristine operational cycle. Its progressive approach to expanding its manufacturing operations is a positive mark that the management is actively looking to create shareholder wealth and value.

I haven't dived deeper into the company's product line in this article, but the overall market outlook and the usability of its products are undeniably promising. Last year the Biden administration announced a $2 trillion infrastructure plan, which will all amalgamate to create unique opportunities for the company.

Despite being vulnerable to short-term copper price risks, with a long-term horizon, the company presents a great opportunity for potential investors to buy this winning stock at a discount.

This article was written by

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"A fade is a contrarian investment strategy that involves trading against the prevailing trend."  We look at low-cap stocks that are not covered by mainstream investment firms in search of early opportunities spanning a variety of investment philosophies. The best opportunities are found when looking where others won't. Let us know if you want us to cover any specific tickers and we'll be sure to take a look! Formerly Moonshot Equity Analysis.
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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. Business relationship disclosure: This article was researched and written by Waleed M. Tariq.

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