2023-12-25 03:23:50 ET
Summary
- Valmont Industries is expected to benefit from the strength in the Infrastructure segment and improved end-market demand in the medium to long term.
- The company's revenue growth has been impacted by declining steel prices and softening demand in the agriculture segment.
- Valmont Industries is trading at a discount compared to its historical averages, making it an attractive investment opportunity.
Investment Thesis
Valmont Industries, Inc.'s (VMI) near-term revenue growth is poised to benefit from the strength in the Infrastructure segment, driven by ongoing secular trends. This positive momentum is expected to offset any near-term weaknesses in the agriculture segment. Looking ahead to the medium-to-long term, the company is well-positioned to capitalize on improved end-market demand, helped by a potential reversal in the interest rate cycle next year. Furthermore, long-term growth opportunities arising from secular demand trends, increased deployment of federal stimulus funds, and strategic entry into adjacent products and services in the Agriculture market are expected to contribute to sustained revenue growth.
On the margin front, Valmont Industries should benefit from volume leverage as sales recover, particularly in the second half of FY24. Additionally, the company should benefit from cost savings from its organizational realignment program, further boosting margins in FY24. The stock is currently trading at a discount compared to its historical averages. This combined with good near-term and long-term growth prospects makes VMI stock a good buy.
Revenue Analysis and Outlook
In FY21 and FY22, the company's revenue benefited from strong pricing implemented in response to rising steel prices, and good demand in the agriculture market due to elevated crop prices. However, as steel prices started declining and the agriculture demand started softening, the company's sales growth has turned negative in recent quarters.
In the third quarter of 2023, the company's Infrastructure segment witnessed flat year-over-year (Y/Y) sales. This was driven by increased volumes in the Solar, Lighting, and Transportation (L&T) and Transmission, Distribution, and Substation (TD&S) product lines, along with higher average selling prices across L&T, Solar, Telecommunications, and Coatings product lines. However, these gains were offset by lower volumes in the Telecommunications and coatings product lines and a reduced average selling price related to decreased steel prices in the TD&S product line.
In the Agriculture segment, sales experienced an 8.8% Y/Y decline, primarily due to reduced sales volumes of irrigation equipment. Notably, in North America, agriculture sales plummeted by 29% Y/Y, driven by farmers' decisions to defer capital investments amid general economic uncertainty and higher interest rates. Conversely, International sales surged by 15.5% Y/Y, attributed to increased project sales in the EMEA region, record sales in Brazil, and higher sales in Argentina.
On a consolidated basis, net sales declined by 4.3% Y/Y to $1.05 billion, as the flat Y/Y performance in the Infrastructure segment was outweighed by lower sales in the Agriculture segment. Excluding Other segment sales, which encompass sales from the offshore wind energy structures business divested in Q4 2022, net sales decreased by 2.3% Y/Y in the third quarter.
Looking forward, I am optimistic about growth in the company's Infrastructure business and while there are some headwinds on the agriculture side, I believe we are close to the bottom there as well.
In the Infrastructure business, the company is poised to benefit from several near-term and long-term drivers. The following pie chart shows the company's infrastructure segment sales by product line.
The transmission, distribution, and substation product line, constituting 39% of Infrastructure segment revenues, should benefit from the ongoing shift towards renewable energy, necessitating an increase in transmission capacity. Management expects a need for approximately a 60% increase in transmission capacity by 2030 to support clean energy deployment in the U.S. The federal government's allocation of around $100 billion under the Infrastructure Investment and Jobs Act (IIJA) for power grid infrastructure improvement and approximately $174 billion for electric vehicle (EV) adoption and infrastructure is expected to boost the company's end-market demand.
The Lighting and Transportation product line should also see positive impacts from increased spending on Infrastructure Construction, such as roads, highways, and bridges. However, there is a 9 to 12-month lag between project appropriation and the company realizing the benefits in terms of sales. So, the positive effects are likely to materialize in the latter half of 2024. The anticipated reversal in the interest rate cycle should further aid this business by improving the demand from single-family housing end market.
The outlook for the coating business is promising, with potential benefits from the recent reshoring trend, increasing demand from the manufacturing market, and IIJA contributing to higher demand from the Infrastructure Construction end market. The upcoming reversal of the interest rate cycle is also expected to lead to improvements in Industrial and Construction end markets, catalyzing growth in this sector. The company's peer company in coatings, AZZ ( AZZ ), has started seeing a positive order trend, prompting my recent upgrade . This improvement in order trends is expected for Valmont's coating business as well.
The Solar business has secular demand drivers supported by favorable policy initiatives globally. In the U.S., tailwinds from the Inflation Reduction Act and a 10-year investment tax credit extension should bolster demand.
Overall, the majority of product lines in the Infrastructure business are poised for substantial growth in 2024, especially in the latter half as interest rates reverse, and benefits from federal stimulus initiatives contribute to increased demand.
The only product line in the Infrastructure segment expected to experience a slowdown is Telecommunications, as wireless capital expenditure by carriers is normalizing after a couple of very strong years. However, the long-term story remains solid, driven by increasing data usage. Importantly, this constitutes approximately 8% of the Infrastructure segment revenue, and the strength in the remaining 92% of the business should easily offset any near-term weakness in this product line.
The outlook for the Agriculture segment is somewhat mixed. While farm income levels declined Y/Y in FY23 due to soft commodity prices after strong performance in FY21 and FY22, they remain above their long-term averages, and farm economics remain healthy. The recent farm income forecast by the USDA on Nov 30 exceeded the previous forecast, which the company relied on while sharing expectations on the last earnings presentation .
The company also noted some improvement in orders in October during its last earnings call. While a single month of improvement is too short a period to declare a change in trend, I believe we are close to the bottom in this market, and order trends are unlikely to worsen significantly from here. One thing that does worry me though is the company entered FY23 with an elevated backlog in this segment which helped the sales in the first half. However, with the backlog now at much more normalized levels, the first half of FY24 may see some headwinds from difficult comparisons. Growth should improve in the latter half as comparisons ease. Additionally, the anticipated reversal in the interest rate cycle should enhance the return on investment in farm equipment, spurring demand. International sales in this segment are performing well, with good exposure to agriculture markets like Brazil, where the long-term outlook is favorable. The company's focus on expanding into adjacent product lines related to on-farm infrastructure, services, and technology solutions for farmers positions it for above-market growth in the long run. The company has recently rebranded Valley Irrigation to Valley Agriculture to emphasize its focus on growing into adjacent product lines.
In summary, I am optimistic about both the near-term and long-term growth prospects of the company. In the near term, the strength in the Infrastructure segment is expected to offset the weakness in the Agriculture segment, particularly in the latter part of FY24. Furthermore, in the medium to long term, the company's sales should benefit from the anticipated reversal in the interest rate cycle, federal stimulus, secular growth trends, and strategic entry into adjacent products and services.
Margin Analysis and Outlook
In Q3 2023, the company's adjusted margins improved by 90 bps Y/Y to 11.5%. On a segment basis, the infrastructure segment's adjusted operating margin expanded by 200 bps Y/Y while the agriculture segment's adjusted operating margin contracted by 160 bps Y/Y.
The company is doing a good job in terms of pricing (ex steel) and was able to post good growth in Infrastructure margin despite flattish sales. While the Agriculture margin was down, the total adjusted margins for the company were up Y/Y despite the sales decline. As the sales start recovering towards the back half of FY24, margins should further benefit from volume leverage.
The company has also initiated an organization realignment program to drive cost optimization, simplify its operating structure, and strengthen its shared service model. The company plans to spend ~$33 million to $36 million on this program in 2023 and expects to fully recover this spending through lower operating costs within the next 12 months. So, FY24 margins should benefit from the lower cost as a result of savings from this plan.
Valuation and Conclusion
VMI is currently trading at a 15.11x FY24 consensus EPS estimate of $15.25 and a 13.55x FY 25 consensus EPS estimate of $17, which is at a discount compared to the Company's 5-year average forward P/E of 19.23x.
I am optimistic about the company's sales and margin growth prospects. These prospects are supported by secular demand trends in the Infrastructure segment, federal stimulus funds, the upcoming reversal in the interest rate cycle in FY24, volume leverage from sales recovery, and cost-saving benefits from the company's organization realignment program. While there is some pressure on the agriculture side, this segment should also recover especially in the latter half of FY24 with the help of easier Y/Y comps. The strength in the international agriculture markets and entry into adjacent products and services should also help. Given the good growth prospects and a lower-than-historical valuation, I have a buy rating on the VMI's stock.
Risks
- Valmont has some large projects going on in Egypt and tension in the Middle East adds to geopolitical risks.
- If my expectation of the Agriculture end market being close to the bottom proved optimistic and this market continues to worsen, it may negatively impact the company's business.
For further details see:
Valmont Industries: A Good Buy At Current Levels