Apogee Enterprises: Market Is Too Conservative On Glass Segment Margins, Resulting In Undervaluation

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Apogee Enterprises has significantly improved its margins through cost reduction and premiumization, particularly in the Architectural Glass segment, which reached 23.4% operating margin last quarter....

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You can become one too!","collect":0,"end_time":0,"defaultTopTitle":"seekingalpha.com","property":[],"viewcount":null,"language":"en","relate_stocks":{"APOG":"Apogee Enterprises","BK4086":"建筑产品"},"translate_title":"Apogee Enterprises：市场对玻璃板块利润率过于保守，导致估值被低估","themeId":null,"isJumpTheme":false,"ttsUrl":null,"symbols_score_info":{"APOG":0.9},"content_text":"Apogee Enterprises has significantly improved its margins through cost reduction and premiumization, particularly in the Architectural Glass segment, which reached 23.4% operating margin last quarter.Despite sell-side expectations of margin reversion, I believe the improvements are sustainable, and management is likely to revise long-term margin targets upward.APOG's bolt-on acquisition strategy, starting with UW Solutions, should drive growth and market outperformance, with a reasonable valuation multiple due to market concerns about EPS decline.I project higher EPS for FY26 than consensus estimates, driven by sustained margin improvements and strategic initiatives, suggesting significant stock upside potential.Editor's note: Seeking Alpha is proud to welcome ABI Invest as a new contributing analyst. You can become one too! Share your best investment idea by submitting your article for review to our editors. Get published, earn money, and unlock exclusive SA Premium access. Click here to find out more » MICHELANGELOBOY/E+ via Getty Images Investment Thesis Apogee Enterprises, Inc. (NASDAQ:APOG) has done a good job in terms of transforming from a mid-single-digit operating margins business a couple of years back to low double-digit operating margins currently by implementing its continuous improvement initiative. In particular, the company's Architectural Glass Segment margins have seen a massive improvement, increasing from 2.6% operating margin in Q1 FY22 to 23.4% operating margin in the last quarter, and is running much higher than management's long-term target of 10-15%. While the sell-side is modelling this margin to revert to the long-term target range, I believe cost reduction and premiumization initiatives have resulted in sustainable improvement in margins and there is a good likelihood of management's long-term margin targets getting revised upwards rather than margins reverting to the current target levels. This should help the company post better-than-expected earnings and drive the stock re-rating. The recently commenced bolt-on M&A strategy should also improve growth prospects and help the stock become a good compounding story moving forward, driving the stock upside. Revenue Analysis and Outlook Apogee manufactures architectural glasses for commercial buildings (office buildings, hotels and retail centers), institutional buildings (education facilities, health care facilities and government buildings), transportation facilities (airports and transit terminals), and multifamily residential buildings. It also sells architectural frames for glasses and has an architectural services business under which it provides services like installation of glasses and frames, etc. In addition, the company has a small LSO segment in which it provides value-added coated glass and acrylic used in the custom picture-framing market, museum market, and various technical glass applications. The revenue story over the last couple of years is pretty generic on the face of it. After seeing good growth in FY22 and FY23 when the interest rates were low and non-residential construction activities somewhat healthy, the company's revenue growth turned negative in recent quarters as higher interest rates and tighter lending standards impacted the commercial segment of the non-resi construction market. However, what is interesting is that the company has done a good job in terms of focusing on premium products in recent years and thanks to the premiumization focus it has seen a good price/mix increase. The company has also focused on increasing its revenues from institutional (education, healthcare) and transportation (airport) markets, which are doing reasonably well. In the second quarter of 2024, the company continued to see softness in key end markets like commercial, office, and multifamily residential construction markets, resulting in lower volumes. The company also exited some low-margin product lines under its \"Project Fortify\" strategy, which also impacted its sales growth. These negative factors were partially offset by improved pricing and product mix in Architectural Glass and favorable project mix in Architectural Services. As a result, the company's net sales declined by 3.2% Y/Y to $342.4 million. Segment-wise, the Architectural Framing Systems segment's sales decreased by 11% Y/Y due to lower-end market volumes and the impact of moving away from the lower-margin product lines under Project Fortify. In the Architectural Glass segment, sales declined by 4.2% Y/Y due to lower end-market demand, partially offset by stronger-than-expected pricing and mix. In the Large-Scale Optical (LSO) segment, sales were down 16.1% Y/Y as a result of lower volume in the retail channel, which more than offset the positive impact from a more favorable mix. On the other hand, in the Architectural Services segment, sales increased by 11.3% Y/Y attributed to higher volumes and favorable project mix. Architectural Services backlog last quarter was $792 mn (up 17.5% Y/Y.) APOG's Historical Revenue Growth (Company Data, Author's Research) Moving forward, the near-term headwinds are expected to continue as the company has exposure to the completion of non-residential buildings like commercial offices and multifamily homes (architectural frames/glasses are installed near the time of completion) and the non-residential starts over the past year have been impacted by high-interest rates indicating a slowdown in completions ahead. However, I am not too worried about it as the interest rate cycle has started reversing, and the company can see a swift recovery in its end-markets in the coming years. Further, if we look at management's revenue guidance closely, they have guided for a 4% to 7% decline in sales (ex-UW Solutions acquisition) for the full fiscal with a 2 percentage point impact from one less week this fiscal year. This year will have 52 weeks instead of 53 weeks last year, and this one less week impact Y/Y growth number in the last quarter of the fiscal year. So, on a like-by-like basis, sales should be down between 2% and 5% for the full year. In the first six months (where like-by-like sales and actual sales were the same) sales were down ~5.8% Y/Y. So, the second-half sales trends on a like-by-like basis should be slightly better than the first half as per management's revenue guidance. The company's sales should also see fewer headwinds as the Project Fortify initiative gets completed. Under this initiative, the company is divesting less differentiated, low-margin project lines and has completed most of the restructuring over the last two quarters. While Y/Y impact will continue to show over the next couple of quarters, as Apogee eventually laps these divestitures next year, sales growth should improve. According to management, this initiative is expected to negatively impact sales by 100 bps this fiscal, with most of the divestitures already completed. The company is also doing a good job in terms of increasing its geographic presence, especially West of the Rockies. This geographic expansion should help the company's organic growth and market share. One exciting development on the revenue side is that the company made its first major acquisition - UW Solutions - recently, after a gap of seven years. Management has communicated its strategy around bolt-on M&As to drive growth and market outperformance, and this acquisition marks the start of it. The valuation was reasonable ~8.5x FY26 estimated EBITDA (management estimates), and the EBITDA margins of UW Solutions are ~20% which is higher than Apogee's and in line with the management's plan to actively manage the portfolio and shift towards higher margin business. The acquisition should close sometime in Q3 and contribute ~$30 mn in sales in FY25 and $100 mn in FY26. the company ended last quarter with a leverage of 0.1x and even after the completion of this acquisition, its leverage would be ~1.5x, giving ample leeway for future M&As. Over the long term, management has guided for revenue growth to be 1.2x its end market growth. Over the last few years, the company has done a good job optimizing its processes and developing and implementing the Apogee Management System (AMS) to improve productivity. With the interest rate cycle recovering helping the end market and the company implementing its organic and inorganic plans, I believe we should see good growth from the next year onwards. Margin Analysis and Outlook The margin story for the company is impressive, and the company has achieved a significant improvement in margins through cost-cutting and focusing on high-margin premium categories. In Q2 2025, the company's margins benefited from higher pricing, a more favorable mix of projects in Architectural Services, low material costs, and lower insurance-related costs. These positive factors were somewhat offset by the unfavorable operating leverage on lower volume, increased compensation and benefits expense, and higher restructuring costs related to Project Fortify. The company posted a 110 bps Y/Y increase in total adjusted operating margin to 12.6%. On a segment basis, the adjusted operating margin expanded by 90 bps Y/Y in the Framing segment, 390 bps Y/Y in the Glass segment, and 450 bps Y/Y in the Services segment. Conversely, in the LSO segment, adjusted operating margin contracted by 100 bps Y/Y due to unfavorable operating leverage on lower volumes, partially offset by the benefits from an improved mix and cost savings initiatives. APOG's Segment-Wise and Total Company Adjusted Operating Margin (Company Data, Author's Research) Moving forward, the company's margins for Architectural Framing Systems and Architectural Services should benefit from savings from Project Fortify. Management initially guided for $12 mn to $14 mn in run-rate savings from this project, which they have increased to $13 mn to $14 mn on the last earnings call, with ~60% expected to be delivered in FY25 and the rest in FY26. The majority of these savings will be reflected in Architectural Framings Systems and Architectural Services. The company has also done a good job in developing and implementing its continuous improvement initiative - Apogee Management Systems - over the last few years, and I expect continued focus on productivity improvement moving forward should also help margins. The margins in the company's Architectural Services are still lower than management's long-term target range of 7% to 9%, and I expect the company to reach this range in the coming quarters. The company's Large-Scale Optical business has seen some decline in margins in recent quarters due to volume deleverage as well as investment in its capacity expansion project. The new capacity is expected to come online during the second half of this fiscal year, and additional volumes from it should help margins. Further, the recently acquired UW Solutions business will be clubbed with the LSO segment and this segment should benefit from cost and cross-selling synergies. The story so far is well understood. However, the good execution and future cost improvement and growth prospects are not completely getting reflected in the stock price. The main reason behind it is concern around Architectural Glass segment margins, with sell-side modeling significantly lower margins for the segment in coming years, resulting in consensus EPS showing a decline next year. This is where we differ! Management has done a good job in terms of taking cost out of the business and focusing on premium high-margin products, which has significantly improved the Architectural Glass segment's margins in recent years. The last quarter's margin of 23.4% was much higher than the long-term target of 10-15% that management shared. With near-term demand headwinds expected to continue in the back half, analysts are expecting it to reverse to management's target range. Management has also guided for margins to ease in the back half to the upper end of its target range. But management has also said that they have \"limited visibility\" and they \"love being wrong in the right way\". Answering a question on the margin guidance on the last earnings call, the company's CFO Matthew Osberg commented: ...I mean, look, I love being wrong in the right way, and I've been wrong a few times on glass, but thankfully in the right way. As I tried to call out really just to give people some insights into that business, it's such a high variable contribution margin that as you look at what's in our pipeline and how that work will flow, it can really have a significant impact. And the good news for us is we've seen an extended hold-up of price and mix that's really buoyed those margin rates over the past couple of quarters. So as we look into the pipeline that we see now, which is limited, we've got some insights, but we can't still see the rest of the year.\" I understand management is being conservative in terms of their guidance given the limited visibility. However, I find it problematic that the sell-side is just mimicking what management is saying without analyzing the situation for a more reasonable outcome. What makes the situation worse is that the sell-side is extrapolating trends in the back half of this year to future years as well. In addition to the back half of this year, sell-side analysts are also projecting margins to decline to management's long-term target range of 10% to 15% next year. This is resulting in the next year's estimates being too low (EPS showing Y/Y decline). I believe this situation warrants a deeper look. Management has done a good job in terms of taking costs out and focusing on high-margin premium offerings to improve margins. Why would they suddenly give away so much margin, especially when the recovery is in sight with the interest rate cycle reversal already started? It's not that revenue trends are getting meaningfully worse. In fact, as discussed in the revenue section, like-for-like revenue trends are actually expected to get slightly better (or less bad) in the second half as per management guidance. I do sometimes understand it makes sense to give away margins to gain additional revenues in order to maximize EBIT dollars. But a reversal to management's long-term target range, even at the upper end, would mean an 840 bps decrease in margins from Q2 levels. This doesn't make business sense. If we do the math, to get similar EBIT dollars, revenues at 15% EBIT margins need to be 56% higher than revenues at 23.4% EBIT margins. I understand the high variable contribution margin in the glass segment impacting on the downside. However, with recovery in the end-market demand in sight with interest rate cycle reversal, wouldn't the Glass segment start seeing meaningful margin benefits in FY26 as revenues recover? Most of the company's initiatives like focusing on high-margin premium products, and cost takeouts are permanent in nature and there is no logical reason to believe that these benefits would not continue in the future years. The sell-side projections of the Glass margins reverting to the 10-15% target range for FY26 make little sense, especially with volume recovery in sight. Even if we try to justify low glass segment margin assumptions for the back half (which I don't agree with), there is no way margins can stay at those levels in the future years as revenues recover. Management has not said anything about FY26 margins, and the sell-side is assuming the margins to remain low based on management's long-term targets. However, management has revised their long-term margin targets upwards multiple times, and the sell-side is likely in for a surprise again. One argument behind lower margins in the back half is the demand slowdown and volume decline. However, volume has been declining for the last few quarters, but margins have seen a nice growth. The margins were up 270 bps Y/Y for the glass segment with a double-digit revenue decline in Q1 and up 450 bps Y/Y in Q2 with a mid-single-digit revenue decline. With continuous improvement initiatives continuing to help in productivity improvement, why would the margin decline significantly and stay lower in future years? Overall, I see a good likelihood of management revising their long-term Architectural Glass margin target upwards. Management has a good track record of delivering better than promised and has already revised upward their long-term margin goals a few times. Last year, in Q4, management revised upwards the long-term margin targets for Architectural Framing Segment from 9-12% to 10-15%. Before that, in Q1FY24, management revised the long-term margin target range for Architectural Glass from 7-10% to 10-15%. I believe further positive revisions are likely. The company has a good track record of beating sell-side estimates and given where the current projections are I expect this trend to continue. APOG Earnings Surprise (Seeking Alpha) Even if we assume, the company gives a couple of hundred basis points of margins to gain share and maximize EBIT dollar as demand remains slow over the next couple of quarters, in my opinion, there are no reasonable scenarios of glass segment margin reverting to management target levels of 10-15%. Given the recent progress that management has made in margin improvement of the glass segment, the medium to long-term operating margin target for the Glass segment should at least be 20% plus with a reasonable base-case scenario of it being in line with the last quarter levels (~23%), especially as the revenue recovery takes hold. Overall, I am optimistic about the company's margin growth prospects. I believe the sell-side here is not definitely up to the mark in their analysis, and assuming the margin to revert to the long-term target range provided by management, rather than management increasing the margin target range, is resulting in too low EPS estimates. Estimates and Valuation If we look at the current EPS estimates, the sell-side is modeling $5.08 in EPS for FY25 and $5.01 in EPS for FY26. The company has already posted an adjusted EPS of $1.41 and $1.44 in Q1FY25 and Q2FY25, respectively. So, analysts are expecting a sharp slowdown in EPS growth in the back half. The sell-side estimate also implies EPS reduction in FY26 despite UW Solutions business being accretive to EPS next year, continued incremental savings in Project Fortify (60% of $13 mn to $14 mn run-rate cost-saving target to be realized this year, and remaining incremental savings next year), improving margins for both Architectural Framing and Architectural Services segment (which are the two largest segment in terms of revenues), and improved revenue outlook with the interest rate cycle reversal helping next year revenues. APOG Consensus EPS estimates (Seeking Alpha) APOG Consensus Revenue estimates (Seeking Alpha) As explained before, the main reason for FY26 consensus estimates being lower is that the sell side is expecting the glass segment margin to revert to the management target range. This is unlikely, and I see a very slim chance of glass segment EBIT margins being lower than 20% in FY26 (my bear case scenario). My base case scenario for the glass segment EBIT margin is ~23% (similar to the last quarter's levels.) Below I present a simplified model for FY26 P&L with consensus estimates (reverse-engineered, so may not be perfectly accurate but should be in the ballpark) as well as my bear and base case scenarios. I expect the UW Solution to be only marginally accretive. So, I have removed its Revenue/EBITDA contribution and its corresponding debt/interest expense for simplicity. Excluding a $100 mn revenue contribution from UW, the current consensus revenue estimates are building in $1.35 bn in revenue for FY26 and I have taken this same number in all three cases as the main difference between my thesis and consensus opinion is not about revenues. I have assumed EBIT margin improvement for both Architectural Framing and Services segments, with \"Project Fortify\" and continuous improvement helping. For LSO, I have kept margins at 20% with the new plant opening expected to help. Interest, and other income numbers are annualized from the last quarter, while the tax rate is assumed to be 25%. The only difference is the Glass segment EBIT margins. It seems consensus is building it around 14% for FY26, while I have shared my calculations with 20% and 23% EBIT margins. APOG Base and Bear Case Vs. Consensus (Author's Research) We can see my EPS estimates are higher than consensus by $0.73 and $1.10 in bear and base case scenarios. The stock has traded at 13.4x average forward P/E over the last 5 years. However, it has come a long way in the last couple of years from a mid-single-digit margin business to a low double-digit margin business which is seeing further ongoing improvements. With margin slated to improve further and the company's recent focus on bolt-on M&A strategy to drive growth, I see further potential for re-rating. Below are my valuation scenarios, Bear case: The stock continues to trade at the current P/E of 15.40x (around the current levels) with the architectural segment posting ~20% EBIT margins in FY26 and the company posting $5.74 in FY26 EPS (see table above). This gives a target price of $88.4. Base case: The stock re-rating continues further as the market realizes the sustainability of margin improvement across the segments and the company's bolt-on M&A strategy accelerates growth. High-quality industrial compounders with similar bolt-on acquisition strategies and continuous improvement initiatives have given investors phenomenal returns in the past - Danaher (DHR) being the best example. Usually, as these companies continue to execute well and the market realizes their potential for long-term compounding growth, they trade in P/E in the mid-to-high 20s. Apogee's execution so far has been impressive, and the stock has seen some re-rating. However, worries about margin compression in the Architectural Glass segment are still resulting in investors' hesitancy in giving the company full credit for this impressive execution. In my base case scenario, I am not expecting the company's P/E to re-rate to the mid/high 20s right away, but as APOG continues to post impressive margins and move forward with bolt-on M&As, I believe it is reasonable to assume the P/E multiple can re-rate to the low 20s. I see a 23% EBIT margin for Apogee likely in my base case, with the interest rate cycle helping the end market recovery. We have $6.11 in EPS in this case (see table above). Applying 21x P/E, we get a price target of $128.31. Bull case: As APOG continues to execute well, the stock should re-rate in line with high-quality industrial compounders to mid-20s P/E. Applying 25x P/E to $6.11 in EPS (same as the base case scenario), we get a target price of $152.75. Catalysts I see a good likelihood of upward revision in earnings estimates and earnings beat. Further, as investors realise the sustainability of the glass segment margins and management revises their long-term targets upwards, the stock should see a re-rating in its valuation multiple. In addition, as the company announces further bolt-on acquisitions, investors' perception of the company's longer-term growth prospects should improve. I expect these factors to serve as a catalyst for the stock moving forward. Risks Bolt-on M&As are relatively riskier than organic growth as there are integration risks, risks related to overpaying, and from leverage taken for acquisition. The company's recent acquisition was at a reasonable valuation, and the cost synergy targets of ~$5 mn is not that high. So, I am not that worried about this acquisition. However, in the future, management needs to maintain this discipline with M&As, or else there can be a risk. Conclusion Apogee Enterprises' margin improvement in the Architectural Glass segment is sustainable and, even in the case of slower demand, only a modest decline in margins should be there. In the medium to long run, it is much more likely that the management revises their long-term margin targets for the segment upward, rather than the segment's margins reverting to the current long-term target levels. Management has a track record of executing better than targets and has already increased long-term targets for its Architectural Framing segment and Glass segment last year. I see further upward revision likely. The current sell-side estimates are modelling a decline in EPS next year as they model significantly lower glass segment margins. However, I believe next year's EPS number can be meaningfully better than the current estimates. Further, in addition to continuous improvement and cost-cutting, the company has recently started implementing a bolt-on acquisition strategy which should aid the growth and help Apogee become a good compounding story moving forward. The valuation multiple is still reasonable because the market remains worried about the EPS decline next year. Over the next few quarters, as the fears about glass segment margins fade and the company delivers better-than-expected results, the stock can see a significant upside.  Editor's Note: This article was submitted as part of Seeking Alpha's Best Value Idea investment competition, which ran through October 14.","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":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"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":"4.29.1","shortVersion":"4.29.1","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/2476979541"}