A common theme in building products and other industries has been cost inflation this year compared to last. Some companies have great raw material pass-throughs and are able to maintain margins well, others are important enough to their customers to pass price in when needed and ad hoc, and others are less lucky.
Back when I wrote about ATKR first, I was skeptical that it had anything “magic” in its business… it was just a stupid cheap stock. But based on this Q’s results, its clear that their strong market share in electrical raceways has pricing power. While Mechanical products isn’t as lucky, it also is experiencing strong volume growth.
The Electrical Raceway segment is pictured on the left and the MP&S segment is on the right.
As you can see below, ATKR gained meaningful margin in ER which helped offset the decline in MP&S.
Bottom line: We’re up 25% in a short time period since I wrote about ATKR, but I still think this is a mid-$30 stock on reasonable estimates. I think we still have at least 30% more upside to go!
I’ve written previously about competitive advantages, moats, and investing in high quality businesses. That’s the ideal scenario. But sometimes, the valuation can be so attractive that the investment case is still strong.
I posit that Atkore International (ticker: ATKR) is now too cheap to ignore. Management seems focused on this as well, having repurchased a large portion of stock (26.5% of shares outstanding) from the former Sponsor owner, CD&R.
Atkore is a leading manufacturer of electrical raceway products and tubes that are used in a variety of construction applications. The Electrical Raceway segment (65% of sales) is a leader in products that isolate, deploy, and protect electric circuitry as it moves through a building. The products include armored cable & fittings, steel and PVC conduit, and flexible conduit and cable trays. The Mechanical Products & Solutions segment (the balance of sales) manufactures in-line galvanized tube, metal framing and fittings, and other mechanical products used in non-residential construction.
I think it helps to see what these products include, as shown below.
Atkore generates roughly 85% of its sales from markets where it is the No. 1 or No. 2 player. Products are distributed through national electrical distributors such as WESCO, Rexel, and Graybar, independent electrical distributors, industrial distributors including Grainger and Fastenal, and big box retail including Home Depot, Lowe’s, and Menards.
When you look at these products, its really hard for me to see how “secret sauce” is involved with manufacturing these products. However, you would probably be surprised to learn the company has 15% EBITDA margins and capex has averaged <1.5% of sales for the past 5 years. That brings me to one of the metrics I tend to follow and that is unlevered FCF conversion. And by that I mean, (EBITDA-Capex)/EBITDA as a percent. The reason why I like to look at this is to move beyond some business that might have lower EBITDA margins (like distributors with 3-7% margins), but convert a lot of that EBITDA into FCF. Typically FCF conversion greater than 80-85%+ is a really solid business. ATKR averages 90%.
Now you can see that 2015 was not as high as the past 2 years. That is because ATKR undertook a significant portfolio restructuring, as summarized in the company’s slide below. The company divested low margin product and focused on higher margin product where it had strong market share and areas where it could raise price. Raising price is important part of the story here, as that extra price drops straight to the bottom line. EBITDA margins were less than 6% in 2011, moved to 15% by 2017 and their long-term goal is to reach 20% EBITDA margins.
Now to valuation. ATKR trades at a significant discount to peers. Most building products companies right now are trading at 10-12x and a FCF yield of about 5%. As can be seen below, ATKR is trading well below that and will generate a significant amount of its market cap in FCF. This provides flexibility for the company to pay a dividend, acquire additional companies, buy back stock, or even down debt (which builds equity value).
One quick comment about the projections – the top line growth expected in 2018 is mainly due to an acquisition and the moderation in 2019 is due to a divestiture. I do not expect much growth in 2020 just as we get to a more mature place in the cycle. Either way, the stock is too cheap to ignore.
Even using a 7% FCF yield, which foots to less than 9x EV/EBITDA, the stock has significant upside.
Now, the risk here is really the non-residential cycle. It could quite possibly be near peak or slowing down, but I don’t think my assumptions are too aggressive.
