- No debt and no goodwill with a strong competitive position
- High short interest ~20.58% of the float
- Authorized buyback program of ~6.6% of shares outstanding until March 2023
- P/E of 9 based on EPS estimates for 2023
- It has outperformed the S&P 500 over the last 25 years.
Encore Wire (NasdaqGS: WIRE) is an electrical wire manufacturer, and its products are used in the construction of residential, commercial, and industrial properties. With the recent surge in house prices, and construction permits, the company benefited and doubled its revenues from 2020 to 2021, and so far, in 2022, it has been able to maintain the same level of revenues.
With housing prices declining due to higher interest rates, many short sellers have targeted the company, expecting its sales and profits to decline. The current short interest is ~20.58% of the float, which shows the negative view most investors have of the short-term future of the company.
Encore Wire has no debt and no goodwill, and it is still generating ~$515M TTM, with a market cap of just $2.73B. The company also sits on $573.58M in cash and cash equivalents, which is more than enough to cover its Capex expenses for the next 2 years, estimated to be $270M, as the company tries to expand.
Additionally, the management intends to acquire 6.6% of the outstanding shares, which at the current stock price equates to ~$182M. The current assets allow the company to continue its buyback program and still have enough funds for its planned capital expenditures in 2023 and 2024.
Overview of Encore Wire
Encore Wire is one of the most interesting companies in the space, and it benefits from the fact that it has all the plants on the same plot of land, which makes it easy to run operationally, and saves on costs. This is one of the reasons why it has been able to maintain itself as one of the lowest-cost producers.
With the current gross margins close to 40%, the management has excelled at allocating capital, with a return on equity of 48.8%. Earnings estimates for Encore Wire have been too conservative, and over the last 4 quarters, the company has managed to beat analyst EPS expectations in some cases by over 100%.
Source: Yahoo Finance
The management has done a terrific job over the last decade. Since 2011, Encore Wire has grown EBITDA at a CAGR of 23.1%, net income at a CAGR of 26.9%, and book value at a 22.6% CAGR. The stock has also outperformed the S&P 500, and the current valuation presents an opportunity.
Encore Wire has outperformed the S&P 500 over the last nearly 30 years, and while past performance is no indication of future returns, it is undoubtedly a positive sign.
The company also has an excellent track record of beating the S&P 500 and its industry peers.
Outstanding shares reduced by 12.34% in nearly 4 years, and over the last 3 quarters, Encore Wire has repurchased 1,893,769 shares, or the equivalent of 9.4% of its outstanding shares at the end of 2021. An impressive buyback program has kept the stock elevated and made it difficult for short sellers to make profits.
Source: Investor Presentation
While the company’s buyback program has been conducted at an impressive pace, it doesn’t stop here, and according to the latest 10-Q, management can still buy 6.6% of outstanding shares until March.
“As of September 30, 2022, 1,214,253 shares remained authorized for repurchase through March 31, 2023.”
Estimates for 2023
Due to the lower demand for housing and higher interest rates, analysts expect Encore Wire’s revenues and profits to decline in 2023. Revenues are expected to be 15.6% lower, and EBITDA is expected to take a nose dive and be 52.7% lower at $421.6M . However, FCF is still expected at $130M, which puts the company’s valuation at 21x 2023 FCF, which is far too high to be in value territory.
However, EPS estimates for 2023 are 16.09, which puts the stock trading at a price-to-earnings of 9. This is still attractive, considering how well the company is managed, and the current P/E ratio for the S&P 500 is still 20.58.
Encore Wire’s current low valuation reflects the expected revenue and earnings decline over the coming years. It has $573.58M in cash and cash equivalents, which is 21% of the market cap ($2.73B), and it is enough to cover the Capex for the next 2 years expected at $270M and finish the buyback program of $182M. Additionally, the annual maintenance CapEx is just $40M to $60M, so the company is allocating a lot of capital to improve its operations and grow.
With the expected earnings per share in 2023 of $16.09, considering the current stock price of $142, you get $29.82 in cash and equivalents and an expected EPS of $16.09 in 2023
Encore Wire also has ~$561.7M in accounts receivable against a meager ~$151.6M in current liabilities. This equals ~$410.1M, which the company is expected to receive in the next 12 months, which is over 15% of the market cap.
Considering the cash and cash equivalents, plus the accounts receivable minus the total liabilities, and considering the expected EPS of 16.09, Encore Wire is trading at 5.7x 2023 EPS, which is an extremely low valuation.
At this point, the company’s valuation is highly dependent on the results in 2023, and the stock price may be volatile to reflect that. On the one hand, the buyback program should keep the share price elevated until the end of 1Q23, and possibly the management will continue to aggressively buy back more shares, as the current undervaluation of the company.
Investing now in the stock could be a bumpy ride, and it wouldn’t be a surprise if the stock price declined by under $100 if the results for the first half of 2023 were worse than expected. Despite that, the company has a track record of beating analyst estimates, and if it continues, the results in 2023 might be better than expected.
Moreover, the high short interest could also make the stock move higher unexpectedly. If the continued buyback program keeps adding pressure to the stock, we could see short sellers being forced to cover.
To a certain extent, it is debatable whether or not the buyback program was the best way to allocate capital. Sure, buying a large percentage of the outstanding shares helps the stock price remain elevated. Still, the company has already spent $225.2M since the beginning of the year and intends to spend an additional $182M, which totals over $400M in buybacks since the start of the year.
The current free cash flow is enough to cover this massive buyback program, but some investors might wonder if the capital shouldn’t be allocated in a different way. It could have been used to make an acquisition or expand the company further, perhaps diversifying its operations even more.
While buybacks are welcomed when the stock is trading below its fair value, with the current levels of short interest on the stock due to its expected declining revenues and profits over the next year, the buyback might not be able to maintain the stock price around the current levels.
The slowdown in the real estate market is a risk for the company. However, the segment only represents 28.3% of sales as of 3Q22, and the company can shift its manufacturing capability from the residential sector to other sectors.
Encore Wire is boring, and it probably won’t grow a lot, but given the current market, it is an attractive value pick with a long-term growth thesis that has outperformed the S&P 500 in the past, and it may continue to do so in the future.
In the current market, where every single stock seems to be going down due to interest rate hikes, Encore Wire stands out as a defensive play. It has no debt, which makes it less susceptible to interest rate changes.
It has a very strong balance sheet, with plenty of cash to continue its expected Capex until 2024 while keeping its massive buyback program that should keep pressuring short sellers.
At this point, it is worth considering opening a small position in the stock. The lower expected performance in 2023 will undoubtedly keep the selling pressure on the stock. A large number of shorts will also add some volatility to the stock, which tends to be stable.
While the company’s revenues and free cash flow are expected to decline over the coming year, the valuation has become very attractive. It is worth keeping this stock on your watchlist over the coming months.