2023-03-06 14:49:43 ET
Summary
- Powell Industries, Inc. is diversifying away from oil, gas, and petrochemical industries to expand product and services offerings to benefit from Industry 4.0 trends.
- While it trades at a somewhat high valuation at the current price, Powell Industries is a long-term Buy for growth-oriented investors who wish to realize the future potential from those trends.
- Powell Industries compares well to other growth-oriented stocks that offer similar products and services.
The Fourth Industrial Revolution is here. In a recent headline from the World Economic Forum, that revolution is building upon the 3 previous industrial revolutions to leverage human behavior, biological/physical processes, and digital technologies in ways that are going to help everyone by converging these technologies together in a meaningful way that is beneficial to global society.
The previous industrial revolutions were:
- The rise of steam power in the late 18th century,
- The use of electricity to power machines at the end of the 19th century
- The shift to digital electronics that started in the 1970s.
The Fourth Industrial Revolution represents a fundamental change in the way we live, work and relate to one another. It is a new chapter in human development, enabled by extraordinary technology advances commensurate with those of the first, second and third industrial revolutions.
In other words, the electrification of vehicles, medical advances in technology, industrial buildout of data centers, AI integration such as what is occurring with Microsoft Corporation ( MSFT ), ChatGPT, Apple ( AAPL ) and C3.ai, Inc. ( AI ), renewable energy, utilities, sustainable infrastructure, robotics, and the general automation and digitalization of society all need to somehow converge meaningfully without disrupting the current social fabric too negatively.
There are some indications that the 4 th Industrial Revolution was stalled , put on hold due to the Covid-19 pandemic followed by supply chain disruptions, inflation, looming fears of recession, etc. What that means now, in 2023, is that there is an opportunity to resume the progress in marching toward the goals of this next revolution to advance the use of converging technologies to improve society.
Industry 4.0 technologies have a role to play in this transition. For example, the rethinking of global supply chains came about through a need to reduce labor costs.
Major advancements in manufacturing are one beneficiary of this latest industrial revolution. Connected physical and digital systems and assets, advanced automation, digital intelligence, and other key factors are delivering the benefits to various industrial processes and sectors. In his blog , Guide to the Fourth industrial Revolution (Industry 4.0), author Cem Dilmegani includes the graphic below to illustrate the concept.
The global industry 4.0 market was estimated at $70B in 2019 and is expected to reach $210B by 2026 as more manufacturing businesses are optimizing their digital transformation strategies. Industry 4.0, also known as the fourth industrial revolution, aims to create smart manufacturing machines and systems which are connected, automated, and analyzed thoroughly to improve production, reduce costs, and optimize processes.
In my research for growth stocks that can benefit from these growing trends and process improvements, several companies stand out that I feel are worth mentioning. One company that I wish to focus on in this article is Powell Industries, Inc. ( POWL ) based in Houston, TX. I believe that POWL is a long-term Buy given the strong balance sheet with zero debt, diversification of the business offerings, solid growth with an expanding total addressable market, or TAM, and an emphasis on Industry 4.0 solutions that require growing electrification requirements across a global landscape and domain expertise in large, complex projects. However, at the current price of about $45, I rate the stock a Hold due to the recent post-earnings runup in price.
Powell specializes in the design, manufacturing, and packaging of equipment and systems for the distribution and control of electrical energy. This slide from the February 2023 investor presentation provides an overview of their product and service offerings.
The company was founded in 1947 to focus on the growing petrochemical industry in Houston. Now a solutions provider for complex electrical applications with a global footprint, POWL offers products and services to oil, gas, and petrochemical industries as well as other light industrial and commercial sectors such as utilities, transportation, metals and mining, pulp and paper mills, and datacenters.
POWL currently has a market cap of just over $500M and has grown its share price over 120% in the past year. The stock trades at a forward P/E of 41x projected 2023 EPS of 1.09 and pays a 2.3% dividend yield. The company reported $522 million in revenues in FY2022 and has an unleveraged balance sheet with zero debt.
Although a forward P/E of over 40 seems expensive, the company has experienced outstanding growth in the past several years and is #1 rated on the SA Quant rating system in both the electrical components and equipment industry and the Industrials sector overall.
With that in mind, I wanted to dig a little deeper to understand what the company is doing right to achieve such high rankings. I also wanted to investigate whether POWL is simply experiencing another cyclical high point in their business growth, to be followed by another downturn as suggested in previous articles that covered the stock as long ago as 2017, and as recently as 2020.
While Powell started out as a company focused on the petrochemical industry in Texas, the business has grown into other end markets, and with the advent of the 4 th Industrial Revolution, new technologies and developing opportunities to expand even further are opening up new possibilities to move away from the cyclical oil and gas businesses that they served historically. For example, this slide from the February 2023 investor presentation illustrates multiple new near term and longer-term opportunities.
In FY2022 the revenue mix consisted of about 40% oil and gas related, 23% utilities, 13% petrochemical, 11% commercial and light industrial, 8% municipal, and 5% other. So far in 2023, the mix has shifted away from oil and gas by about 5% and into commercial and other industrial instead. This is an intentional move to get away from the more cyclical nature of oil and gas and diversify the business more broadly into other sectors that are less cyclical over the long-term including government, universities, and OEM relationships in addition to the others mentioned above.
The strategic focus areas for Powell include leveraging their expertise in electrical automation solutions to address the growing needs to protect, monitor and control high value assets; expand their services franchise to address geographically dispersed strategic opportunities to improve operational performance with digital technologies; and diversify the product portfolio to target tangential applications and expand scope into new electrical technologies while also de-risking the business via counter-cyclical product offerings.
Solid Earnings Results and Strong Financials
Heading into 2023, the FY2023 first quarter (quarter ending December 31, 2022) results as reported on January 31 were solid with record backlog of $680 million, a 63% YOY increase, and new orders of $212 million, compared to $108 million in the prior year period. Revenues increased 19% YOY to $127 million. Net income came in at $1 million or $.10 per diluted share, compared to a net loss of $2.8 million (-$0.24 per diluted share) in the prior year.
The company had cash and short-term investments of $111 million as of December 31, 2022 with no debt and no leverage currently being used. The steady growth in backlog each year since 2018, with the exception of the post-pandemic slowdown in 2021, demonstrates the growth trajectory that is ramping up as the company continues to grow both organically and through diversification and expansion of product offerings as explained above.
As Chairman and CEO, Brett A. Cope explained on the earnings call , the record backlog provides a diverse mix of project activities to help fuel future margin and earnings growth:
"Activity in our core Oil, Gas & Petrochemical markets continues to strengthen, as we booked another large industrial order to support the domestic production of Liquefied Natural Gas. Meanwhile, market conditions across our Utility, Commercial and Other Industrial sectors remain robust and are largely supported by steady volume of small to mid-sized project activity. Our current record backlog of $680 million provides a diverse mix of project activity that will help to facilitate margin and earnings growth as we focus on executing these projects in fiscal 2023, while continuing to build our backlog supporting fiscal 2024 and beyond."
Furthermore, the earnings growth is expected to continue and even improve over the next few years, with 2 upward earnings and EPS revisions issued in the last 90 days. The past 3 quarters have included earnings results that beat estimates and it is quite likely that future reports will continue to exceed estimates given the strong order backlog and excellent fundamentals with additional growth drivers in place due to the growing demand in the electrification and automation of markets as described above.
Comparison with Peers
For grins, I decided to compare Powell Industries, Inc. with several other strong growth-oriented businesses that are also benefitting from the 4 th Industrial Revolution, and although not all are direct peers or competitors, all have performed very well over the past year and are poised to continue to outperform in the future. Those companies include Atkore Inc. ( ATKR ); Kimball Electronics, Inc. ( KE ); Mueller Industries ( MLI ), which I have written about before here and here ; and Encore Wire ( WIRE ).
From a price perspective, POWL is the clear leader over the last year, but is the laggard over the past 3 years.
In terms of Ratings and Quant rankings, POWL and MLI are neck and neck, closely followed by KE.
I really like all 5 of these stocks, and I believe that all 5 are worthy of further due diligence if you are interested in growth stocks that are likely to benefit from the Industry 4.0 trends that I discussed above. I have previously owned both WIRE and MLI, and I currently own shares of ATKR. I have not yet done a deep enough dive on KE to decide whether I would buy it, but my initial look is encouraging. And of course, I like POWL a lot but have not yet pulled the trigger on it.
There are some risks with all 5 of these stocks that are primarily based on what happens with the overall global economy over the coming months. The trend so far in 2023 has been mostly bullish with signs of an improving economy but with continued persistently high inflation and no end in sight to rising interest rates, which would have a negative impact on most, if not all of these stocks.
I am cautiously watching for indications that the worst may be behind us before buying as the current valuations have run up a bit in the past few months and could retreat if the broader market goes back into bear mode in the next week or two. I rate Powell Industries, Inc. a Hold at the current price of about $45. I would suggest waiting for a market pullback to get a better entry point for the stock. Someone with more of a technical analysis background may be able to offer suggestions for what price to look for, but it appears to me that there is support around $38 and I would be a buyer if the price drops to that level in the next few weeks during a market pullback.
Longer term, and as earnings projections continue to be revised upward, I could envision Powell Industries, Inc. stock trading at 20x forward earnings of around $3 by 2025, for a $60 price target. In the meantime, expect some price volatility, as this is a small cap stock with a history of cyclical swings in the price action.
For further details see:
Powell Industries: A Growth Stock For The Fourth Industrial Revolution