2023-05-15 08:01:58 ET
Summary
- Apogee Enterprises generated good returns in FY 2023 but faces the challenge of continuing it in the future.
- APOG stock can generate good dividend income and potentially grow it.
- The dividend is safe, given the company's strong balance sheet.
Apogee Enterprises ( APOG ) has a safe dividend yield that can grow over time. The company has a good balance sheet and a conservative payout ratio. But the company may struggle to produce good consistent returns on its capital in a competitive environment in the face of a slowing economy. Investors may buy this stock during increased market volatility, pushing it back toward its 52-week low.
Apogee generated good returns on solid revenue growth in FY 2023
Apogee Enterprises is coming from a stellar performance in its fiscal 2023, which ended in February 2023. The company’s Q4 showed signs of slowing sales when revenue grew by 4.9% y/y, its slowest pace in six quarters (Exhibit 1) . Its Architectural Framing Systems division saw sales increase by 12.6% in FY 2023, mainly driven by price increases (Exhibit 2) . The company’s Architectural Glass segment saw revenue grow by 9% in FY 2023, driven by price increases and product mix. But, the Architectural Services division saw lower revenues in Q4 which led to a decrease in adjusted operating income and margin for the fiscal year.
Exhibit 1:
Apogee Enterprises Quarterly Revenue, Gross, Operating Profits, and Margins (%) (Seeking Alpha, Author Compilation)
Exhibit 2:
Apogee Enterprises Segment Performance in FY 2023 (Apogee Enterprises Investor Presentation)
The company has set a target of achieving over 12% in ROIC, greater than 10% in Adjusted Operating Margin, and a revenue growth greater than 1.2x the growth rate of non-residential construction (Exhibit 3) . The company achieved two of the three goals, with its Adjusted Operating Margin falling behind its 10% goal.
Exhibit 3:
Apogee Enterprises ROIC, Adjusted Operating Margin, and Revenue Growth Goals (Apogee Enterprises Investor Presentation)
The company’s quarterly gross margin fell below 23% in Q4, at 22.7%. Its gross margin of 23.27% was 11 basis points higher than its long-term average. Its annual gross margins have averaged 23.16% since 2014 (Exhibit 4) .
Exhibit 4:
Apogee Enterprises Annual Revenue, Gross, Operating Profits, and Margins (%) (Seeking Alpha, Author Compilation)
The company has forecasted flat to slightly declining revenue in 2024 but is spending more on CapEx to make productivity gains in its operations (Exhibit 5) . Any productivity gains may hold the key to increasing its margins. The company spent 3.1% of its revenue on CapEx in FY 2023. It may spend up to 4.2% or $60 million, a substantial increase, on CapEx in FY 2024, based on a consensus revenue estimate of $1.43 billion.
Exhibit 5:
Apogee Enterprises FY 2024 Outlook (Apogee Enterprises Investor Presentation)
Optimal inventory levels
The company has deftly controlled its inventory costs compared to many others in the building products industry (Exhibit 6) . The company carried 26 days of sales in inventory compared to its average of 29 days with a low standard deviation of 3 (Exhibit 7). Many other companies saw their operating cash flows deteriorate due to increased inventory costs. The company can reduce its working capital requirements and maximize its cash flow potential by carrying the optimal inventory level. Apogee Enterprises booked $102.7 million in operating cash flow in FY 2023, compared to $100.5 million in 2022 and $141.9 million in 2021.
Exhibit 6:
Day's Sales in Inventory Across Companies in Consumer Staples, Industrials, Materials, Consumer Discretionary, and Industrials Sectors. (Seeking Alpha, Author Compilation)
Exhibit 7:
Apogee Enterprises Day's Sales in Inventory (Seeking Alpha, Author Compilation)
Although the company’s FY 2023 operating cash flow was higher than in 2022, the company generated lower free cash flow in 2023 due to an increase in CapEx (Exhibit 8) . Since the company is projected to spend more on CapEx in 2024, its free cash flow may be lower than in 2023. The company’s free cash flow margin was 3.9% in 2023, likely lower in 2024.
Exhibit 8:
Apogee Enterprises Operating Cash Flow, CapEx, and Free Cash Flow (Seeking Alpha, Author Compilation)
Valuation
The company achieving an ROIC of 13.8% in FY 2023 is a good sign that it can generate a return above its weighted average cost of capital. I estimate its cost of capital between 9% and 10%. But, FY 2023 was a good year for the company in terms of revenue growth and profitability. The current fiscal year can be challenging. It may have limited options to increase prices without further deterioration in volumes. But the fading inflation may make further price rises unnecessary.
The Producer Price Index, less food, energy, and trade prices, climbed 3.4% y/y in April. The index peaked in March 2022 and has declined steeply since (Exhibit 9) . As measured by the PPI, this decline in inflation may be a sign that inflation caused by supply disruptions is fading, the demand is weakening, or both. A combination of improving supply chains and softness in demand may likely be behind this steep drop in inflation. One of the things to watch in the upcoming earnings release scheduled for June 20 is the management’s commentary on prices and volumes. If prices haven’t increased, but volumes have declined, that is a sign of deteriorating business conditions.
Exhibit 9:
Apogee Enterprises trades at a forward GAAP PE of 9.6x. The stock trades at $38.7, indicating the wide gap between its current and intrinsic value. A discounted cash flow model estimates a per-share equity value of $48 (Exhibit 10) . This model assumes a revenue growth rate of 3%, a free cash flow margin of 5.1% (the company’s average over the past decade), and a discount rate of 9%. This discount rate might be appropriate given the company’s low debt-to-EBITDA ratio of 1x (Source: Seeking Alpha) . The cash flow estimates are before taxes, so the per-share value estimate will be lower based on after-tax cash flows. If the company can consistently generate a rate of return above its cost of capital, the stock would be genuinely undervalued, as indicated by the discounted cash flow model.
Exhibit 10:
Apogee Enterprises Discounted Cash Flow Model (Seeking Alpha, Author Calculations)
I have stated recently that the stock market is docile, with the S&P VIX Index at 17 , given the myriad near-term risks in the economy. The best opportunity to buy Apogee Enterprises may be when the market’s volatility increases. The stock has a Beta of 1.09 ; any increase in the market’s volatility will impact the stock since the Beta shows the stock will move alongside the market. Apogee Enterprises has dropped 18% over the past three months, with a loss of 5.6% over the past year. The Vanguard Industrials Index ETF ( VIS ) has gained 9.1%, and the Vanguard S&P 500 Index ETF ( VOO ) has gained 4.8% over the past year. As measured by the Vanguard S&P 500 Index, the markets seem to have moved in the opposite direction compared to the building products industry.
Good dividend
The stock offers a 2.4% dividend yield, a good yield given that the Vanguard S&P 500 Index ETF provides a 1.2% yield and the Vanguard Industrials Index ETF provides a 1.1% yield. But, Apogee’s yield is less than the yield on the 1-year U.S. Treasury yields 4.7%. The payout ratio is safe at 22%. The company generates enough cash flows to cover its dividend. It paid $19.7 million in dividends over the past year while generating over $100 million in operating cash flow. The company has grown its dividend at a 9.8% CAGR over the past decade and has consecutively paid a dividend for 33 years. The stock’s 3-year yield-on-cost is 5.4% , and the 5-year yield-on-cost is 2.2%.
The company has spent $197.2 million on net share buybacks after accounting for the shares issued since August 2020 (Exhibit 11) . These buybacks have reduced its diluted outstanding shares by 4.2 million, with an effective repurchase price of $46.95, which is not a cheap price given the current stock price. The company generated $321.2 million in operating cash flow during this period. Over 60% of the company’s operating cash flows have been used for buybacks since August 2020.
Exhibit 11:
Apogee Enterprises Quarterly Shares Issued and Repurchased (Seeking Alpha, Author Compilation)
Apogee Enterprises is cheaply valued, but so are most building product companies due to the weakness in the construction industry. The company generated a good return on invested capital that exceeded its cost of capital in the fiscal year 2023. Still, the challenge is maintaining it in the face of a slowing economy. The potential lack of consistency in its returns is the primary reason to rate this stock a hold. Any increase in the market’s volatility may soon present such an opportunity. The stock yields a good dividend and has consistently paid its dividend over an extended period. When bought at a cheap valuation, this stock could be an excellent addition to a long-term portfolio.
For further details see:
Apogee: A Good Dividend Income Grower