NWPX - Northwest Pipe: Near-Term Headwinds Keep Me On The Sidelines

2023-09-20 13:19:46 ET

Summary

• Northwest Pipe Company's revenue growth is expected to face near-term headwinds from lower backlog in the SPP segment and moderating steel prices.
• Reduction in order bookings in the Precast segment due to rising interest rates on the U.S. construction market should also negatively impact revenue growth.
• While there are some good long-term drivers like aging water infrastructure and market share gain potential in the Precast business, I prefer waiting for the near-term headwinds to subside.

Investment Thesis

Northwest Pipe Company's (NWPX) revenue growth is expected to face near-term headwinds from a slow bidding market in the first half of this year in the Engineered Steel Pressure Pipe ((SPP)) segment and a reduction in order bookings due to the impact of rising interest rates in the Precast business. The margin performance has been good so far, but I see some potential contraction there as well. While the company's long-term outlook looks favorable with revenue benefiting from secular trends such as aging water and wastewater infrastructure and the valuation is lower than the historical average, I would prefer to remain on the sidelines until the near-term headwinds subside. For now, I have a neutral rating on the stock.

Revenue Analysis and Outlook

After seeing good growth over the last couple of years due to a strong bidding market as well as acquisitions, the company's sales have seen a meaningful slowdown in recent quarters. In the second quarter of 2023, the company's sales in the Engineered Steel Pressure Pipe segment increased 0.2% Y/Y to $77.3 million, driven by a 7% increase in selling price per ton due to product mix, partially offset by a 6% decrease in tons produced as a result of changes in project timing. However, the Precast Infrastructure and Engineered System (Precast) segment's sales declined 5.6% Y/Y to $39.1 million, driven by a 13% decrease in volume shipped due to the lower demand due to the high-interest rate environment affecting the U.S. construction market. The decline in sales was somewhat offset by an 8% increase in selling prices due to the higher raw material input costs.

Looking forward, I expect the company's revenue to remain under pressure in the near term.

After a strong last couple of years, the SPP segment's backlog was impacted by lower levels of project bidding in the first half of 2023. This led to a sequential decline in SPP backlog (including confirmed orders) from $372 million at the end of FY22 to $343 million at the end of FY23. A company's backlog is a leading indicator of its revenues and the sequential decline in backlog indicates a tough next few quarters for the company's SPP segment. In addition to lower demand, this segment's revenues should also see some pressure from moderating steel prices.

The company is also seeing similar pressure in the Precast Segment as well as a high-interest rate environment impacting the U.S. construction market. The order book of the company's Precast segment declined 22.7% Y/Y as a result to $58 million at the end of Q2 FY23. Over the last couple of years, this segment saw good growth thanks to the acquisition of Geneva Pipe and Precast as well as ParkUSA. However, management is focusing on ParkUSA integration currently, and until that is complete, another acquisition is unlikely in the near term.

The company's long-term growth prospects are much better though with secular drivers like aging water and wastewater infrastructure which is driving the need for upgrades, repair, and replacement; rising population and new population centers which are driving the need for new water infrastructure; and drought conditions and climate change which are stressing existing water resources.

Management is also eyeing meaningful growth in the Precast segment and intends to increase its revenue to a level comparable to the SPP segment through both organic and inorganic routes.

On the organic side, the company is focused on increasing capacity utilization at its Texas-based ParkUSA plants. And the company is diversifying outside the Texas market to get more orders. Over the last twelve months, the company has booked ~$8 million worth of orders from outside Texas. Management also intends to produce and ship ParkUSA products out of legacy Northwest Pipe Plants and is conducting a pilot project for it.

There is a good inorganic growth opportunity in this market as well. Unlike the steel pressure pipe market which is already consolidated and the company has a majority market share, the Precast market is fragmented and there are good M&A opportunities. According to management, the total addressable market for concrete pipe and precast is between $2 billion and $5 billion and the company currently holds only 4% market share in this market. So, there is a good opportunity for market consolidation through M&As in this market.

Overall, the revenue outlook for the company is mixed with near-term headwinds and long-term growth opportunities, especially in the Precast business.

Margin Analysis and Outlook

In Q2 2023, the SPP segment's gross margin expanded by 200 bps Y/Y to 16.3% driven by the conversion of high-margin backlog booked last year. However, in the Precast segment, the gross margin decreased by 600 bps Y/Y to 25.3%. The decline in margin was due to higher production costs related to lower levels of production, and increased raw material costs. The decline in gross margin in the Precast segment outweighed the margin improvement in the SPP segment and as a result, the consolidated gross margin declined 90 bps Y/Y to 19.3%. A lower gross margin and higher SG&A led to a 190 bps Y/Y decline in operating margin to 9.9%.

Looking forward, the company's margins are expected to be under pressure. The healthy bidding market over the last couple of years helped the company book orders at higher margins in the SPP business and as the company is executing these orders, its margins are benefiting. However, with the market conditions much weaker now, I don't think the company will see similar levels of margins in the current orders which doesn't bode well for future profitability.

Further, given the near-term demand headwinds, the company might see some under-absorption in the coming quarters which may put some pressure on margins in both segments.

Longer-term management is focusing on incremental cost reduction, lean manufacturing, and prioritizing margin over volumes to improve the company's margins, but I prefer to wait for these initiatives to gain traction before becoming more optimistic on the margin growth prospects.

Valuation & Conclusion

NWPX is currently trading at a ~12.73x FY23 consensus estimate of $2.42, which is a discount as compared to its 5-year historical average P/E of 14.10x. While the valuation is cheap and there are some good long-term growth drivers for the business, the near-term revenue headwinds worry me. There is also a risk of margin decline as the mix benefits from higher margin projects booked in the last year fade. I would take a cautious approach here and wait for the revenues to bottom before becoming more optimistic about the stock. So, I have a neutral rating despite the cheap valuation.

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