2023-09-24 10:00:00 ET
Summary
- Atkore has several competitive advantages.
- The company benefited from windfall profits, but long term tailwinds remain positive.
- By leveraging its Atkore Business System, they drive continuous improvements and growth.
- Even after its run up, the stock still looks cheap.
Atkore ( ATKR ) manufactures and distributes electrical, safety and infrastructure products in the United States and internationally. The stock has been on a massive run since the start of the pandemic, driven by favorable end-market dynamics and several competitive advantages. The business is still relatively new to the public market, after its IPO in 2016 by PE company Clayton Dubilier & Rice, but has been on a steady uptrend so far. I believe that long-term secular growth trends and Atkore's competitive advantages will continue to drive positive returns for owners like myself.
Atkore's moat
Atkore has several competitive advantages or moats:
- Atkore Business System
- One stop shop
- Low-cost production
Let's dive into them.
Danaher DNA
If you've been following me in the past, you might know that I am a big fan of Danaher ( DHR ) and its operating system. I recently made Danaher my largest position, as the company is experiencing a correction due to its end market. If you want to read more about it, check out my coverage .
Its Danaher Business System ("DBS") makes Danaher special. This system helps Danaher to continuously improve its business and grow. Atkore's culture and business system were shaped by its former CEO, John Williamson, who spent over a decade at Danaher. The "Atkore Business System" heavily borrows from DBS and is a tool to drive continuous improvements through Atkore. So far, this has worked out well.
Atkore Business System (Atkore Investor Presentation)
Atkore grows organically through category expansion and innovation and inorganically through strategic M&A. Over the last twelve months, the company invested $176 million in capital expenditures ("capex"), of which around half should be growth capex.
M&A has been a larger focus over recent years. Below is a slide explaining Atkore's approach. Atkore searches product category expansion opportunities with macro growth trends (secular tailwinds). It aims to improve the acquired businesses by leveraging the ABS and integrating the culture into the business.
Atkore M&A strategy (Atkore Investor Presentation)
One Stop Shop
Per Atkore's 10k, the company sees its vast product portfolio and oligopolistic market position as a competitive advantage:
We believe we hold #1 or #2 positions in the United States by net sales in the vast majority of our products. The quality of our products, strength of our brands, our scale and national presence provide what we believe to be a unique set of competitive advantages that position us for profitable growth.
Below is an overview of Atkore's product portfolio and self-proclaimed market positions for each. Atkore aims to be a one-stop shop for its customers, which includes large distributors like Fastenal ( FAST ) or Wesco ( WCC ) but also large retailers like Home Depot ( HD ). Atkore has a US-wide network of distribution partners, which account for 84% of sales according to the 10k. Most of Atkore's products represent must-stock items for these distributors. The remaining 14% of sales are direct to OEMs ("original equipment manufacturers"). Atkore can offer its entire portfolio with a single order, making the process easy for its customers via a mobile app for tracking and scheduling orders.
Atkore's market positions (Atkore Investor Presentation)
Low-cost production
Most products are relatively cheap and around 65% of COGS are input materials like steel or resin. This makes transportation one of the essential costs to serve these products and means that international exports, i.e., from China, have a competitive disadvantage. We already discussed the leading market positions, which give Atkore economies of scale against smaller players and the large distribution network, which drives down transportation costs. This means that Atkore has a low-cost production advantage against most competitors, depending on the product.
Windfall profits
The biggest question mark regarding the Atkore investment case is how much the business will contract soon. Covid and the supply chain disruptions created a lot of windfall profits for Atkore, illustrated in the graphic below. A lot of the operational development between 2017 and 2022 was driven by price. At the end of FY22, Atkore estimated that out of the $985 million in EBITDA growth driven by price, about $585 could have been outperformance and therefore not sustainable. This leaves around $400 million of sustainable performance. Atkore's management has a history of underpromising and overdelivering. Initial FY23 guidance expected a conservative $850-950 million in AEBITDA, but guidance has continuously been raised to $1025 million throughout the year. EPS guidance was a very conservative $13.10-14.9 and has since been revised to $18.9-19.3.
Atkore windfall profits (Atkore Investor Presentation)
Several secular tailwinds or megatrends like Electrification, grid hardening, digital infrastructure and renewable energies underline this development. Atkore is playing in all of these markets and is also a beneficiary of the Inflation Reduction Act.
Atkore's secular tailwinds (Atkore Investor Presentation)
Atkore still looks cheap
To value Atkore, I'm using an inverse DCF model. I rely on cash flows because I believe that only cash flows drive long-term value for shareholders. Accounting profits only matter if they translate into cash on to balance sheet to be reinvested or distributed. I use Owner Earnings besides normal Free cash flows defined as follows.
Owner Earnings = FCF - SBC + Growth Capex +/- NWC changes
I used $70 million out of the $176 million in capex as a conservative growth capex estimate. Below is a quote from Atkore's CFO regarding growth capex. "A large portion" is not defined, but I believe 40% should be a good assumption.
We invested more than $120 million in capital expenditures this year [this excludes Q4], with a large portion of that investment going to our facility expansions and growth initiatives that we believe will drive positive results for many years to come.
David Johnson, Atkore CFO at Q3 2023 Earnings call
We can see that Atkore trades at a very high 15% Cash flow yield and thus does not require growth to be a good investment (a return above 10% per year). Yet I expect the company to grow mid-single digits over the long term by leveraging its ABS. The company also is a share cannibal and has reduced shares outstanding by around 10% this year.
The main risk for Atkore is slowing construction and a worse-than-expected normalization in price, but over the long term, I expect good management, ABS and secular tailwinds to help the company grow. Even factoring in normalization, the stock looks cheap. Additionally, we can look at historical valuation multiples . Atkore trades at a 7.4 forward PE, significantly below the sector median of 17.3 according to Seeking Alpha.
Atkore is a top 10 position for me and I am a buyer at these levels.
Atkore Inverse DCF model (Authors Model)
For further details see:
Atkore: Deep Value With A Moat