IIIN - Insteel Industries: Monitoring The Leading Construction Indicators Into 2024

2023-10-21 23:32:22 ET

Summary

• Insteel Industries reported Q4 earnings highlighted by weaker margins and lower steel prices pressuring growth.
• Industry indicators like the Architecture Billings Index and Dodge Momentum Index point to an ongoing slowdown of nonresidential construction activity in the U.S.
• The company benefits from solid fundamentals, but we expect shares to remain volatile against ongoing macro headwinds.

Insteel Industries, Inc. ( IIIN ) is recognized as the largest manufacturer of steel wire reinforcing products for concrete construction. These are engineered structural meshes and precast concrete elements that are often used in major infrastructure projects and some residential applications. Naturally, the company is cyclical with demand following the flow of construction activity.

The good news is that following a record period during the pandemic, Insteel just reported its latest quarterly results capping off a year highlighted by the resiliency of the U.S. economy. On the other hand, we're eyeing signs of softer trends in nonresidential building construction adding uncertainties into 2024.

While Insteel benefits from overall solid fundamentals, we expect shares to face increasing levels of volatility with a weaker outlook going forward. The stock is up over the past year, but we see the upside as limited from the current level over the near term.

IIIN Q4 Earnings Recap

IIIN reported its fiscal 2023 Q4 earnings with EPS of $0.29 representing $5.6 million in net income, down from $24.3 million in the period last year. Net sales at $157.5 million declined by 24% year-over-year, largely reflecting lower average prices connected to steel benchmarks even as total volume shipments were up by 5%.

The context here is that 2022 was a record year for the company capturing the tail end of the pandemic construction boom. Elevated commodity prices in 2022 allowed the company to charge more for its manufactured welded wire reinforcement ((WWR)) and prestressed concrete strand "PC Strand" products, with market pricing cooling in 2023.

So the financial volatility is evident with the gross margin in 2023 sharply lower at 10% compared to 24% in 2022 against the weaker top-line and ongoing cost pressures.

At the same time, the key to recognize is that even with the decline in net sales, the year total was still up on a 2-year basis and well above pre-pandemic benchmarks. 2023 EBITDA at $50.4 million compared to $40.7 million achieved in 2020.

Finally, we can mention that the company ended the year with $126 million in net cash against effectively zero long-term debt. We view the balance sheet as a strong point in the company's investment profile.

What's Next For Insteel?

While not offering official financial guidance, the tone of management in the earnings press release and during the earnings conference call painted a picture of some cautious optimism.

Citing the recent surge of interest rates and the potential implications to construction markets, the spending associated with the Infrastructure Investment and Jobs Act from 2021 is still seen as a growth drive over the next several years balancing other areas of weakness.

For reference, the $1.2 Trillion spending bill is expected to allocate upwards of $550 billion directly to infrastructure which translates into a high level of underlying demand for the core products of Insteel Industries. Notably, the spending is expected to accelerate going forward based on the authorization, irrespective of the economic environment.

That being said, the more real-time indicators are showing a broader slowdown of construction activity. Insteel Industries notes the "Architecture Billings Index" as a key leading indicator for its business measuring design contracts for new projects by major firms.

The latest data for September shows a sharp decline with the data from the industry group suggesting "reluctance among clients to sign contracts committing to new projects".

The separate monitoring point here is the Dodge Momentum Index which measures planning for construction spending for nonresidential buildings for the year ahead.

The index declined by -6.5% in August with the report noting tightening lending standards and high interest rates have begun to affect institutional planning for major construction projects. We view these as poor signals for Insteel's operating environment heading into 2024.

Final Thoughts

We rate IIIN as a hold balancing its underlying profitability and strong balance sheet position against an expectation for weaker operating conditions going forward.

With the stock trading around $30.00, we believe the current enterprise value of just under $500 million representing a 10x EBITDA multiple is fair for the company under the current circumstances. On the upside, we'd like to see some evidence that demand and sales are re-accelerating over the next few quarters and stronger margins.

In terms of risks, beyond a deeper deterioration in the economic outlook, weaker earnings would open the door for a deeper selloff in the stock. The ABI Index and Dodge Momentum Index are key monitoring points.

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