Encore Wire (WIRE) Q3'23 Earnings Update

We’re back into earnings season and that means I’ll be posting some quarterly updates to companies I’ve written deep dives on. For subscribers, if you want to only get the long-form deep dives and not get quarterly updates emailed, you can adjust your settings in the subscription link. Of the companies previously written about in this newsletter, the first to report earnings this season is Encore Wire WIRE 0.00%↑. Encore Wire manufactures electric wires for electricity transmission, generally made out of copper - link to deep dive. Products have a meaningful tailwind as economies recalibrate and electrify everything.

Encore Wire reported Q3’23 results after the bell on October 24 and held its earnings call on October 25. Revenue for Q3’23 was $637.0M, down -16.4% from the prior year. That’s slightly better than the analyst consensus estimate of $634.2M. EPS of $4.82 also beat the consensus estimate of $4.66. Company-specific KPIs to track are volume of wire sold, average selling price and average selling price. Average volume of copper sold increased 6.4% YoY, which was a solid bump after two quarters of immaterial increases. The average closing price of copper on the Comex exchange increased 8.0% during Q3’23 from a year earlier, and as a result, Encore Wire’s average purchase price increased 4.0% from the prior year. However, average selling price dropped -16.8% YoY and therefore margins compressed. Company-wide gross margin was 23.3%, which is a sequential decline of 281 basis points. The normalization of margins from unusually elevated levels began with abatement in Q4’22. QoQ declines ranged from ~3.75% to nearly 5.0% so the declining in margins in Q3’23 actually slowed slower than it had been.

The market expects gross margins to return to the historical average of ~15%. The speed for which margins abate, and an ability for Encore Wire to sustain any “above average” profit margin is imperative for the valuation. Here’s a look at revenue and margins on a quarterly basis.

A couple noteworthy quotes from the October 25 earnings. The first from CFO Brett Eckert discussing profits margins.

If you go back, late in 2019 but mainly throughout 2020, we made some financial and operational changes that improved realized gross margin and moved it from 13% in 2019 to, I think, 15.2% in 2020. I will say this: I don't believe the annual impact of the changes implemented in 2020 were fully reflected in the 15.2% margin for that year. And then, with margins jumping to 33.5% in '21, 36.9% in '22 and 26.9% year-to-date in '23, it's kind of masked the annualized impact of some of those changes we made in 2020. I think (15% is) a great baseline to start with. I just wanted to put a little clarity around it. I will tell you that we continue to take things 1 order at a time, 1 day at a time, 1 week at a time, immediate order, immediate ship, always managing this business like our back is against the wall. I'd also tell you this remains a pennies business, even when you're picking up pennies in handfuls. We're going to continue to put margin over volume and make sure that we're serving our customers at the highest level.

One of the achievements in Q3’23 was the completion of a facility to create cross-link polyethylene, also known as XLPE. It’s the insulation for some types of copper wire and Encore Wire will now be making it themselves instead of buying it in a move that deepens vertical integration. The XLPE facility will allow Encore Wire to ship more product and also save incrementally on costs, which can translate into sustained higher profit margins.

The other notable quote was from CEO Daniel Jones in discussing underlying copper prices that are too low. The average copper price in Q3’23 was $3.78 and it has trended lower over the past month to a current price of $3.57.

$3.60, $3.55 copper is just not representative of the supply today. Interest rate increases, a stronger dollar and some uncertainty around global sentiment is obviously playing a role in all of that. But that price has to move up. It's just way too low. We like an environment where copper prices are moving up steadily. That's the easiest way to manage an order. And so, yes, it's artificially low.

The other thing you're now hearing miners say, and you heard it recently, even this week, that price of copper is not enough to incent them to cover the cost of capital it takes to invest. And so, they'll start focusing on some brownfield projects, but they're slowing greenfield projects. You're slowing that investment in the face of an already significant supply deficit. And so, something has to give with regard to that. And I think you're going to eventually get some strength in the metal as things start to maybe level out a little bit in China, we get our handle on interest rates here, and then demand for all the electrification and grid hardening that's out there really starts to take effect. A lot of these federal programs are still just trickling in. When the wave of that really hits, I have to believe the basic fundamentals of supply and demand take over, and you start to see it in the price.

Lastly, Jones closed his prepared remarks by saying “We continue to believe that our stock is undervalued at current market prices and what we believe are historically low forward valuation multiples”. Encore Wire shares currently trade at 5.5X EV/EBITDA (next twelve months) and forward P/E ratio of 9.1X. Those multiples are both in the 15th percentile compared to the last 10-years, confirming Jones’ statement.

Overall this earnings report showed good financial strength and shares reacted by trading higher by 4.0% today. I liked seeing the strong volume in particular. I’m curious just how much management favors margins over volume and we’ll likely find out in 2024 as the gross profit margin dips below 20%.

Disclaimer: This is not advice to buy, sell or hold any stock referenced. Do your own due diligence. I have no position in any stock mentioned in this report. Like any financial analyst, doesn’t mean I’m not biased.