ASTE - Astec Industries: A Firm I Overestimated

2023-11-13 09:08:51 ET

Summary

• Astec Industries, a road building equipment company, has seen a decline in shareholder optimism and a drop in revenue and profits.
• Recent financial performance has been mixed, with revenue increasing in the first nine months of 2023 compared to the previous year, but declining in the third quarter.
• Backlog for the company continues to drop, and further declines in profitability are expected, leading to a downgrade to a 'sell' rating.

Although I pride myself in having a pretty solid track record when it comes to my investment calls, nobody is perfect. Perhaps my biggest weakness as an investor is that I am too flexible sometimes when it comes to companies and, as a result, I become hesitant to become pessimistic enough to rate a business a ‘sell’. After all, over the long run, most publicly traded companies should do alright. The downside is that when I am wrong it can result in some pain.

A great example of this can be seen by looking at Astec Industries ( ASTE ), an enterprise that's focused on the production and sale of equipment and components that are used in road building and other construction related activities. Back in the middle of February of this year, I ended up writing an article about the company wherein I mentioned its mixed operating history. More recent financial performance on the revenue side had been impressive, but both profits and cash flows were coming under pressure at that time. I acknowledged that shares of the company were nowhere close to being cheap. But at the end of the day, I wasn't so bearish as to rate it anything worse than a ‘hold’.

Since then, the stock has taken a step lower. Continued backlog declines and a drop in both revenue and profits has led to a decline in shareholder optimism. The good news is that shares are no longer looking expensive. But because of the weaknesses that the company has been experiencing, what might have turned it into a ‘buy’ from a ‘hold’ is now causing me to downgrade it from a ‘hold’ to a ‘sell’.

A tough road has been paved

Recent financial performance achieved by Astec Industries has been quite mixed. If we look at the first nine months of the 2023 fiscal year compared to the same time of last year, the picture for the company looks quite a bit better. For instance, revenue in the first nine months of this year came in at $1 billion. That represents an increase of 8.3% over the $924.6 million the company generated one year earlier. An increase in volume, pricing, and mix of sales led to higher equipment revenue during this time of $46.6 million. Service and equipment installation revenue grew by $22.9 million, while parts and components revenues increased $12.6 million.

On the bottom line, the picture also looked much better. Revenue skyrocketed from $0.9 million in the first nine months of 2022 to $18.6 million the same time this year. Other profitability metrics followed suit. Operating cash flow, for instance, went from negative $56.8 million to negative $18.8 million. If we adjust for changes in working capital, we would get an increase from $25.6 million to $51.4 million. And finally, EBITDA for the company expanded from $48.6 million to $77.4 million.

At first glance, you would expect this kind of performance to result in share appreciation, not a decline. But when you look at the most recent quarter, which is the third quarter of 2023, you start to understand why the market is turning bearish. In that quarter alone, revenue came in at $303.1 million. That's 3.8% lower than the $315.2 million reported one year earlier. The same things that resulted in higher revenue for the first nine months resulted in lower revenue for the third quarter. In discussing this performance, management stated that new orders were strong last year and strong earlier this year because of customer demand, logistics, and manufacturing throughput disruptions. High inflation and increased interest rates aimed at bringing inflation to heal were major factors in reducing activity this year. This is in spite of the fact that the company should continue to be a beneficiary of the $548 billion in government spending that was dedicated to new infrastructure back in 2021 and that will extend through 2026.

To make matters worse, the picture might continue to deteriorate from here. The fact of the matter is that backlog for the company continues to drop. It ultimately peaked in the third quarter of 2022 at $969 million. In every quarter since then, it has dropped. And as of the end of the third quarter of this year, it managed to fall to $615 million. Management tries to paint this in a different light. Unusual economic circumstances a couple of years ago resulted in backlog numbers growing significantly. Now, the company is describing the current decline as a return to more normal historical levels. Typical backlog will likely be somewhere between $400 million and $500 million if the past is any indication of what the future holds. So it wouldn't be surprising to see further declines on this front.

Naturally, the drop in revenue for the company has resulted in lower profitability. In the third quarter, the firm generated a net loss of $6.6 million. That compares to the $0.7 million in profits generated at the same time last year. While operating cash flow actually worsened from negative $14.9 million to negative $16.3 million, the adjusted figure for this actually remained flat year over year at $8.1 million. Meanwhile, EBITDA for the company contracted from $16.6 million to an even $10 million.

This does put us in quite a quandary. Relying on financial performance from 2022 almost certainly will result in shares looking cheaper than they will be moving forward. But we also don't know what to expect. For instance, annualizing financial results for the first nine months of this year relative to the same time last year would actually make the stock look even cheaper than if we relied on data from 2022. A better solution might be to assume that data from the third quarter is indicative of what the future holds. This would mean that adjusted operating cash flow would remain unchanged at $31.7 million on a forward basis, while EBITDA would decline from $70.8 million last year to $42.7 million this year.

Using these estimates, I created the chart above. In it, you can see how shares look more expensive on an EV to EBITDA basis. In the table below, meanwhile, I compared the company to five similar firms. On a price to operating cash flow basis, four of the five companies ended up being cheaper than Astec Industries. Using the EV to EBITDA approach, meanwhile, our prospect was the most expensive of the group.

Takeaway

Based on the data that we have right now, I must say that the picture for Astec Industries has been better. I would argue that the company, even in spite of declining significantly since February, is rather pricey. It's also possible that further declines in profits will occur. Long term, I think that the company will probably be fine. But it is clear to me that it is not a great prospect. Because of that, I have decided to downgrade the company to a ‘sell’ for now.

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