Atkore: The Party Is Over With The Declining Prices

seekingalpha06-20

Atkore experienced double-digit revenue growth post-2016 IPO, mainly due to extraordinary product price spikes in 2022/23.Its growth strategy relied on acquisitions, with the majority of revenue and ...

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(NYSE:ATKR) achieved double-digit revenue growth since its 2016 IPO, this was due to the extraordinary product price spikes in 2022/23. Prices are declining and I would expect the company's performance to follow suit. Nevertheless, before the price spikes, Atkore was profitable with returns that were greater than its cost of funds. It is financially sound and I would consider it fundamentally sound. The problem is that there is not enough margin of safety at the current market price. So it is not currently an investment opportunity. Business background Atkore undertook an IPO in 2016 based on 2 product categories - electrical raceways and mechanical products & solutions. The company has since grown such that in 2021, Atkore reorganized its reporting segments into:  Electrical segment. This was formerly the electrical raceway segment and its products included metal electrical conduits and fittings, plastic pipes and conduits, and flexible conduits.  Safety & Infrastructure segment. This covered the formerly mechanical products & solutions products. Products here included mechanical pipes, and metal framing & fittings.  The Electrical segment was the biggest revenue and adjusted EBITDA contributor over the past 9 years. Refer to Chart 1. In 2023, this segment accounted for 76 % of the total revenue and 91 % of the total adjusted EBITDA. The Electrical segment also had the faster revenue growth. From 2016 to 2023 the segment revenue grew at 15% CAGR compared to the 7% CAGR for the Safety & Infrastructure segment. You can infer from Chart 1 that the Electrical segment also had an improving adjusted EBITDA margin growing from 18 % in 2016 to 38 % in 2023. This explained why this segment accounted for most of the adjusted EBITDA in 2023. In contrast, the adjusted EBITDA margin for the Safety & Infrastructure segment declined from 16 % in 2016 to 12 % in 2023. Chart 1: Segment Revenue and Adjusted EBITDA (Author) Atkore is a US-centric business. In 2023, the US accounted for about 90% of its revenue with another 8% from Europe. The balance came from the Other Americas and Asia-Pacific regions. One key characteristic of Atkore is that its growth strategy relied on acquisitions as acknowledged by the company: \"Acquisitions are a component of our growth strategy\" 2023 Form 10k Operating trends From 2016 to 2024, the PAT growth rate was a bit more than 3 times the revenue growth rate. Refer to the left part of Chart 2. There were 2 main reasons for the higher PAT growth rate.  Improved gross profit margins. The gross profit margins improved from an average of 24 % for 2016/17 to an average of 37 % for 2023/24. Improvement in the SGA margin. This averaged 13 % for 2016/17 but was reduced to an average of 11 % for 2023/24.  You can see that there was a spike in revenue in 2022. As will be explained later, this was due to the USD 308 million cash acquisitions incurred for the year. Chart 2: Performance Index and Returns (Author) Note to Chart 2: The 2024 performances were based on the Mar 2024 LTM results. The profit improvements led to improving returns as shown in the right part of Chart 2. Note that the spike in ROE in 2018 was because of the stock buyback program that reduced the common equity from USD 361 million in 2017 to USD 122 million in 2018. More importantly over the past 9 years, the ROIC averaged 28 % while the ROE averaged 53 %. These were higher than the current 11 % WACC and 12 % cost of equity. In other words, shareholders' value was created. Before you get excited and think that this is a wonderful company in the Buffett sense, I would like to point out that its performance post-2020 was due to extra-ordinary price spikes that may not be sustainable. Product prices Chart 3 shows the FRED's Producer Price Index for noncurrent-carrying electrical conduits including plastic conduit and fittings. While not exactly a 100 % match for Atkore's products, I think it is a good proxy. You can see prices spiked in 2022 and 2023 but has since declined. But the current price is about double the pre-2020 levels. The unknown is whether prices would revert to the pre-2020 level or be at some elevated prices between the pre-2020 and current levels. Given this price picture, I posit that the improved gross profit margin and SGA margin were externally driven.  From 2020 to 2022, the FRED price index as shown in Chart 3 increased by about 2.3 times while the Atkore price index increased by 2.1 times. Refer to the Notes in Table 1 for how I derived the Atkore price index. At the same time, from 2016 to 2019, there was no significant change in Atkore's gross profit margin, gross profitability, or contribution margin.  While these are simple analyses, they show that Atkore had a lucky break. It did not deliver any improved internally generated operating efficiency. Better performance post-2020 came from price spikes. Chart 3: Producer Price Index (FRED) Revenue growth components The company provided annual data on the changes in net revenue due to volume, price, acquisition, and others. Based on this data, I found that from 2016 to 2023, most of the growth was due to price changes. Refer to Table 1. It is interesting that despite spending about USD 700 odd million on cash acquisitions from 2016 to 2023, the revenue growth from acquisitions was very low. Note that the acquisition growth for the year following the acquisition was captured as part of the growth from volume, price, and other components for the year. Given this, the negative volume growth makes you wonder about the contribution of the companies acquired. The price growth probably explained the growth in gross profit margins and contribution margins. Table 1. Growth components (Author) Note to Table 1: To derive the CAGR I computed the indices for the respective components with 2016 as base 100. The indices for the various years were based on the respective annual growth rates. An analysis of the price growth showed that the bulk of it occurred in 2021 and 2022. Given the price spikes, it may be better to view Atkore's performance in 2 parts - pre-2020 and post-2020 as shown in Table 2. You can see that the price spikes made a significant difference to most of the metrics. But there were not many changes in gross profitability growth and ROE:  The gross profitability picture showed that there was no improvement in capital efficiency. The almost similar ROE for both periods showed the impact of share buybacks.  Table 2: Two Periods Performance (Author) To get more insights into the operations, I broke down the operating profits into fixed and variable components. Refer to Chart 4. Again, you can see the difference in performance pre and post-2020. I have stated earlier that there were improving SGA margins ie it is currently lower than that in 2016. However, the fixed cost as a % of the total cost got worse from 2016 to 2024. It averaged 20% for 2016/17 but increased to 23 % for 2023/24. This meant the lower SGA margin in 2023/24 was due to higher revenue that in turn was due to higher product prices. Chart 4: Operating Profit and DuPont Analysis (Author) Note to Op Profit. I broke down the operating profits into fixed costs and variable costs.  Fixed cost = SGA, Depreciation & Amortization and Others. Variable cost = Cost of Sales - Depreciation & Amortization. Contribution = Revenue - Variable Cost. Contribution margin = Contribution/Revenue.  Market demand The cable tray market (which is part of the Electrical segment market) is not a high-growth one. At best it is a low double-digit growth market as exemplified by the following market research reports. \"The global cable tray market was valued at USD 5 billion in 2022 and is projected…growing at a CAGR of 6.1 % from 2023 to 2023\" Allied Market Research \"The U.S. cable tray market size was worth USD 818.89 million in 2022 and is projected to grow at a CAGR of 12.02% during the forecast period (2023 to 2030\". Fortune Business Insights \"The America and Australia Cable Trays Market Size is expected to reach USD 1,859.24 Million by 2033, at a CAGR of 7.95% during the forecast period 2023 to 2033.\" Spherical Insights The above market reports suggest that to sustain its double-digit growth rate, Atkore will need to continue with its acquisition program. Financial position I would rate Atkore as financially sound considering the following criteria. As of the end of Mar 2024,  It had a debt-capital ratio of 37 % compared to its 2018 high of 87 %. It had 12% of its total assets as cash and cash equivalents.  It was able to generate positive cash flow from operations every year over the past 9 years. It generated USD 3.7 billion in cash flow from operations during this period compared to the USD 3.4 billion PAT. This is a reasonable cash conversion ratio. It had a good capital allocation plan. Refer to Table 3 where I have shown the sources and uses of funds for the whole 9 years and from 2016 to 2020. About ¾ of the total cash flow from operations over the past 9 years came from the post-2020 period. You can see that for both periods, it was able to cover the CAPEX and acquisitions with the cash flow from operation. Excess was returned to shareholders as dividends and share buybacks. Table 3: Sources and Uses of Funds (Author) Summary of fundamentals What are the key takeaways?  While the cable tray sector is not a high-growth sector, Atkore has managed to deliver double-digit growth due to its acquisitions. While acquisitions can have a significant immediate revenue impact, the bigger contribution seems to be enabling Atkore to \"multiply\" the post-2020 price gains. While there are no clear signs of improving operating efficiencies, Atkore is financially sound. It has a profitable business with good returns. Even the pre-2020 ROIC and ROE were higher than the current respective cost of funds. It is a cash cow, generating cash flow from operations far in excess of what was required for CAPEX and acquisitions. The company had a good record of returning the excess funds to shareholders.  Valuation I have shown that Atkore's performance especially over the past 3 years was due to exceptional product prices. The challenge then is forecasting the product price levels to be used in the valuation. I do not have a crystal ball to see the future price levels. As such I looked at 2 Scenarios:  Scenario 1 - based on the current 2024 price level assuming no further acquisitions. Scenario 2 - based on a price level that is halfway between the 2024 and pre-2020 levels. I also assumed that the company would continue with its acquisition plan to double its revenue in Year 5.  I obtained an intrinsic value of USD 203 per share under Scenario 1 and USD 96 per share under Scenario 2. The market price of Atkore as of 18 Jun 2024 was USD 136 per share. I do not think that Scenario 1 is realistic given the declining price trends. I am more inclined to think that Scenario 2 is more realistic. Since there is no margin of safety under Scenario 2, Atkore is not an investment opportunity. Valuation model - Scenario 1 The valuation is based on the single-stage Free Cash Flow to the Firm (FCFF) model where: Value to the Firm = FCFF X (1 + g) / (WACC - g). FCFF = EBIT(1- t) X (1 - Reinvestment rate). EBIT(1-t) was estimated based on the operating profit model as shown in Chart 4. The Reinvestment rate was based on the fundamental growth equation. In this valuation model, I assumed the base revenue to be the 2024 LTM revenue with a 4 % perpetual growth rate. Details of the computation are shown in Table 4. Table 4: Valuation model - Scenario 1 (Author) Notes to Table 4: There are 2 key parameters - contribution margin and capital turnover (revenue/total capital employed). For these 2 parameters, I used the 2024 LTM values. The WACC was based on the first page results of the Google search for \"Atkore WACC\" as shown in Table 5. Table 5: Cost of funds (Various) Valuation model - Scenario 2 The valuation model is illustrated in Table 6. It is a multi-stage growth model. The growth rate was assumed to be reduced proportionately to double the 2023 revenue in Year 5. The base revenue was derived from 2024 revenue divided by 1.5 in line with the halfway price level. This was because the 2024 revenue was about 2 times that of the pre-2020 level. The contribution margin and capital efficiency were assumed to be the respective 2016 to 2020 average values. Table 6: Valuation model - Scenario 2 (Author) Notes a) Straight-line reduction. b) Pegged to the growth rate. c) Assumed 2016 to 2020 average and there is no improvement. d) Assumed Scenario 1 as a start. Assumed growth at a terminal rate. e) Revenue X Net Margin and after accounting for Fixed costs. f) Assumed 2016 to 2020 average and there is no improvement. g) Revenue X (Revenue/TCE) ratio. TCE = total capital employed. h) Based on the growth equation. i) FCFF for each year = e X (1-h). j) Refer to the WACC table k) NPV for each year = (i X j) Risks and limitations There are 3 challenges in the valuation  Product price. Acquisitions. Buybacks.  Many sectors experienced significant price hikes following COVID-19. These were attributed to supply shortages and geo-political conflicts. But prices are coming down. However, I doubt anyone has a clear idea of where the long-term price level relative to pre-2020 will be. My Scenario 2 price level (and hence the revenue) is merely a guess. But it is better than assuming a continuation of the current prices as this will lead to a high intrinsic value as shown under Scenario 1. The price spike impacted not only revenue but also the contribution margin and capital efficiency. The impacts were different. For example, while revenue grew at 10 % CAGR from 2016 to 2024, contribution margin grew at 5% CAGR and capital efficiency reduced by 1% CAGR. While I reduced the 2024 revenue by 1.5 to estimate the base revenue, I used the 2016 to 2024 average values for the contribution margin and capital efficiency. This was because it was too complicated to factorize the 2024 contribution margin and capital efficiency. Secondly, I assumed that the revenue growth in Scenario 2 was such as to double the base revenue in 5 years. This was because I noticed that Atkore's revenue doubled from 2016 to 2021. A higher growth rate would increase the computed intrinsic value. Finally, over the past 9 years, the company spent about USD 2 billion on share buybacks. I estimated that this was equal to a share buyback cost of about USD 82 per share. The market price of Atkore is today higher at USD 136 per share. Any share buyback at today's prices would mean buying at prices greater than the intrinsic value. This would destroy shareholders' value. While the buyback in the past had boosted returns, I am not sure that it is the appropriate thing to do at the current price. As such I did not consider future buybacks to boost the market price. Conclusion While Atkore is financially sound and profitable, its growth came from acquisitions. Despite the acquisitions, the bulk of the revenue growth over the past 9 years was due to price growth. Price growth in turn was attributed to market forces. The high prices have been declining and I would expect the performance of Atkore to follow suit. To be fair, excluding the price spike years, the company delivered returns greater than the cost of funds from 2016 to 2020. During this period, its cash flow from operations was more than sufficient to fund its CAPEX and acquisitions and there was excess that could be returned to shareholders.  As such even without the price spikes, I would consider Atkore fundamentally sound. But there is no margin of safety at the current market price. As such I do not consider Atkore an investment opportunity.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":1,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.28.3","shortVersion":"4.28.3","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2444409006"}