With Quiver Quantitative’s recent institutional holdings data, we can see that several hedge funds and asset managers have been increasing their holdings in Encore Wire Corporation (NASDAQ: WIRE). Firms such as LSV Asset Management, JP Morgan Chase, and Tudor Investment Corporation have all added to their WIRE positions recently. Most notably, LSV Asset Management increased shares held by 125% (as filed on 6/30), bringing their total WIRE holdings to 472,766 shares worth around $75.6 million dollars at current market prices. With this in mind, we took a closer look at some of the reasons why many investors may be bullish on Encore Wire Corporation.
In July, Encore Wire Corporation posted second quarter earnings results for fiscal year 2023. Net sales in the second quarter of FY23 were $636.5 million dollars, compared to net sales of $838.2 million dollars in the second quarter of FY22. Net Income for the second quarter of FY23 was $104.7 million dollars, compared to $210.5 million dollars in the second quarter of FY22. Additionally, gross profit margins fell from 31.1% in the second quarter of FY22 to 26.1% in the second quarter of FY23. While these earnings results may not seem positive, it is important to note that Encore Wire Corporation engages in the selling of wires, a product that acts like a commodity in the fact that price fluctuations are frequent. Additionally, the price of wires are tied heavily to the price of copper and aluminum, both of which are metal commodities that are prone to large price fluctuations. It is important for investors to understand that this business has large ties to commodity prices, which can bring cyclicality to the business’ sales.
However, on a more positive note, CEO Daniel L. Jones announced some positive capital allocation initiatives. During the second quarter, Encore Wire Corporation declared a $0.02 cash dividend, along with an increased share repurchase authorization of up to 2,000,000 shares (nearly 12% of their current shares outstanding) until March 31, 2024. Additionally, the business announced that it planned to spend around $160 - $180 million dollars on capital expenditures in 2023, with capital expenditures expected to be in the range of $150 - $170 million dollars and $80 - $100 million dollars in 2024 and 2025, respectively. With Encore Wire Corporation operating with a relatively high ROIC figure, this is great to see, as they are able to efficiently reinvest cash back into investments and projects at high rates of return.
Encore Wire Corporation manufactures a broad range of electrical cables and wires. The business offers an electrical building product line that consists primarily of NM-B cable, UF-B cable, THHN / THWN-2, XHHW-2, USE-2, RHH / RHW-2, and other types of wire products (tray cable, metal-clad and armored cable, photovoltaic, SEU, SER, etc.). The business’ diversified product portfolio and low-cost of production positions Encore Wire Corporation very well to play a key role in the transition to more reliable and sustainable energy infrastructure. All of Encore Wire Corporation’s products are manufactured in the United States, at a single vertically-integrated campus in Texas.
Encore Wire Corporation operates within the electrical wire and cable industry, an industry that is quite competitive. The business primarily competes with AFC Cable Systems Inc., General Cable, Southwire Company LLC, and Cerrowire (a Berkshire Hathaway company). Relevant competitive factors within the industry include order fill rate, pricing, quality, and breadth of product line, and management believes that they are competitive in each of these factors.
Management is solid, with capital allocation priorities that align management and shareholder interests well. In November of 2006, Encore Wire Corporation’s Board of Directors approved a share repurchase authorization, with many increases and annual extensions to this share repurchase authorization. In August of 2022, a new authorization allowed for the repurchase of up to 2,000,000 shares, with 1,052,552 shares remaining under that authorization as of December 31, 2022. However, as of the business’ second quarter earnings in July, there was yet another reauthorization that allowed for the repurchase of up to 2,000,000 million shares by March 31, 2024. Under these share repurchase programs, Encore Wire Corporation repurchased 2.1m, 476k, and 441k shares of common stock in 2022, 2021, and 2020, respectively. While management likes to reward shareholders with aggressive share repurchases, they also periodically offer a quarterly cash dividend. As mentioned above, Encore Wire Corporation declared a $0.02 cash bonus per share for the second quarter of fiscal year 2023, further showcasing the business’ capital allocation priorities that strive to increase shareholder value.
As for management incentives, management is incentivized well, with a compensation structure that does a good job of aligning shareholder and management interests. According to Factset, around 5.25% of the business is insider owned, with CEO Daniel Jones holding around a 4% stake (worth around $107 million dollars at current share prices) in the business. The compensation structure for the CFO and CEO puts 95% and 94%, respectively, of total compensation at risk, with 65% of the CFO’s total compensation coming from restricted stock units (RSUs) and 59% of the CEO’s total compensation coming from RSUs as well. For the CFO and CEO, only 5% and 6%, respectively, of their total compensation comes from a base salary, with the remaining 30-35% of the total compensation coming from an annual cash bonus. As we can see, this compensation structure not only does a good job of aligning shareholder and management interests (when management has ownership in the business, they are incentivized to maximize share performance as it directly ties into their total compensation), it also does a good job of retaining executive talent over the long term. With a large amount of total compensation coming in the form of equity rewards (which are subject to vesting), NEOs are incentivized to stay and grow with the business. As an investor, it is always important to invest into businesses’ where management feels like a partner with shareholders, and we believe that this is the case with Encore Wire Corporation.
Encore Wire Corporation is a very efficient business. The business currently operates at a LTM ROIC of 38.4% and a LTM ROE of 33.7%. With a WACC of 10.6%, Encore Wire Corporation operates at a ROIC to WACC ratio of around 3.6x, showcasing the business’ ability to generate returns on cash reinvested back into the business far greater than the business’ weighted average cost of capital. With such a high ROIC to WACC ratio, Encore Wire Corporation is able to rapidly compound intrinsic value over the long-term, handsomely rewarding shareholders in the process. Looking further at efficiency metrics, we can see that this ROIC figure has expanded over time, potentially showing the business’ strong moat within the industry that it operates in. In 2013, Encore Wire Corporation operated with a ROIC of 14.8%, compared to today where the business operates at a LTM ROIC of 38.4%.
Analyzing Encore Wire Corporation’s income statement, we can see some stellar sustained growth in revenue, gross profit, and earnings within the last decade. Since 2013, Encore Wire Corporation has grown revenue at a CAGR of around 8.2%, with gross profit growing at a CAGR of 19% in that same time period. This growth in gross profit can largely be attributed to expanding gross margins. In 2013, Encore Wire Corporation operated with a gross margin of 11.7%, compared to today where the business operates at a LTM gross margin of 33.4%. In terms of earnings, Encore Wire Corporation has grown EBITDA at a CAGR of 21.7% since 2013, with EPS growing at a CAGR of 27% in that same time frame. This growth in EPS can largely be attributed to share repurchases. Encore Wire Corporation is a cannibal, decreasing shares outstanding by around 19% since 2013. However, it must be noted that these aggressive share repurchases didn’t start occurring until 2019, with very minor share dilution happening from 2013 to 2019. From 2019 to today, Encore Wire Corporation has decreased shares outstanding by nearly 20% at a CAGR of -4.35%, showcasing the business’ aggressive share repurchase program.
Looking at Encore Wire Corporation’s balance sheet, we can see that the business is operating in good financial health. The business currently holds around $668 million dollars worth of cash and equivalents on hand, coupled with no long-term debt or short term borrowings. With $668 million dollars worth of cash on the balance sheet and virtually zero debt, Encore Wire Corporation has plenty of operational runway. This cash build up can be used to repurchase shares (which makes sense given how cheap the business is currently valued at by the market), reinvest cash back into the business at high rates of return relative to the business’ weighted average cost of capital, or offer a dividend.
Looking at Encore Wire Corporation’s cash flow statement, we can see some stellar sustained growth in free cash flow and net income, showcasing the business’ operational efficiency. Since 2013, Encore Wire Corporation has grown net income at a CAGR of 25.5%, with free cash flow growing at a CAGR of 62.6% in that same time frame. This growth in free cash flow within the last decade can largely be attributed to rapidly expanding free cash flow margins. In 2013, the business operated with a free cash flow margin of 0.2% of revenue, compared to today where the business operates at a LTM free cash flow margin of 20.7%. With such a large expansion of free cash flow margins within the last decade, the business is able to generate free cash flow much more efficiently from revenue. With more free cash flow, the business can use the cash to repurchase more common shares, offer a dividend, or reinvest the cash back into the business at high rates of return.
After conducting a reverse discounted cash flow analysis, we can see that Encore Wire Corporation is trading at share prices that imply a -16.15% growth rate (CAGR) in free cash flow over the next 10 years, using a perpetuity growth rate of 3% (largely in line with US GDP growth) and a discount rate of 10%. As we can see, this growth rate is extremely cheap, and Encore Wire Corporation is trading at a very low valuation. Encore Wire Corporation shares are currently trading at 4.7x LTM free cash flow and 0.97x LTM revenue, showcasing how cheap the business is, especially in relation to their ability to generate cash. To put things into perspective, Encore Wire Corporation could fully repurchase all outstanding shares of common stock within 5 years, assuming that they only spent the cash on share repurchases. Additionally, with a book value of $107.10 dollars per share, investors are quite protected, with a 33% downside to this book value. In the reverse DCF model, assuming zero growth in free cash flow from today to 2033 (ten years), we get an intrinsic value of around $400 dollars, implying a 150% increase from current market prices. While this valuation does seem cheap, it is important to remember that valuation is only one piece of the puzzle, and other investors may place a different value on the business’ intrinsic value. While we believe that the business is currently undervalued, we encourage everyone to do their own due diligence before entering a position, especially as equities have rallied within the last few weeks.
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