Description

Intro – Investment Overview

• Atkore stock (ATKR) is up 40% since the start of 2022, and up ~270% from pre-pandemic highs. Although both the business and stock have seen massive outperformance over the last few years, the market is still underestimating its competitive position and management’s capital allocation acumen.

• Fundamentals are strong and have compounded in a big way since 2016. Revenue has grown at a 15% CAGR, with EBIT growing 40% per year (operating margins expanded from 9% in 2016 → 27% LTM). This is partly the COVID windfall, but the business has been steadily improving ever since its IPO. Cash returns on incremental invested capital have been 32% since the time ATKR started trading publicly in 2016.

• The stock currently trades at 6.1x EV/EBIT and 10.8x market cap/FCFE on an LTM basis (assuming $1B in EBIT and $520M FCFE over the period June 2022 → June 2023). The reconciliations for FCFE may lead to varying numbers, considering I accounted for some odd solar tax credit accounting changes. Overall, though, the gist is correct, and the point is just how cheap the company is. Equity holders have earned a cash flow yield north of 10% over the last year while owning a very high-quality company. 

• With a substantial portion of its products being cyclical, investors are justifiably cautious about 2022 possibly being a peak in operations. To an extent this is true, with sales likely to be down somewhere in the 10% range this year and operating (EBIT) margins seemingly on a path to ~26% from a stellar 32% at the end of FY22. 

  • Even with this in mind, it is important to consider the full picture. As pricing stabilizes, it is clear that Atkore participates in markets of macroeconomic importance that will experience secular tailwinds from both public and private interests over the next decade. These include: modernization of the electrical grid, buildout of 5G networks, increasing computing demand, and a shift to clean energy.

• I believe that Atkore represents a one-of-a-kind aggregator of electrical raceway and safety & infrastructure products. It acts as the #1 or #2 player in nearly all applicable segments and provides high quality products for customers (it sells to distributors who sell to manufacturers). On average, between 2-4% of an end user’s project budget is spent on Atkore products, which are all necessary to the functionality and safety of whatever is being built. 

• Consolidated sales volume has grown at a low single digit rate (4%) through Q3 of FY23, which shows that the business is still in a fundamentally strong position and customer demand continues to grow. Pair this with the fact that price increases may prove to be more durable than the market assumes, and this provides room for upside surprise.

• Even if it’s overused, I think it could be beneficial to take a “pick and shovel” view of the investment. From this perspective, Atkore is the one that supplies tools to the manufacturers of the picks and shovels so they can actually produce their picks and shovels to sell to the guys in the gold rush. That seems like a good place to be invested.

*One note: FY is used throughout to denote the fiscal year of the company, which ends in September of each calendar year. FY23 would refer to the time frame that began in September of 2022 up until September of 2023. The company just recently reported Q3 on August 8th and is now in Q4 of its fiscal year. I have been compiling my work over the last couple of weeks and decided to wait to submit until the most recent quarter was reported in order to incorporate updated information. I did not feel comfortable submitting the write-up a couple trading days before earnings, even if I was confident that the report would go well.

History

Atkore is headquartered in Harvey, Illinois and was originally known as Tyco Electrical and Mechanical Products (owned by Tyco International), until a majority stake (51%) in the business was sold to private equity firm Clayton, Dubilier, & Rice in November of 2010. As a result of this event, Atkore International became a newly incorporated individual holding company formed to hold Tyco’s electrical and metal products businesses. In 2014, the rest of the common stock of the business was acquired from an affiliate of Tyco, which made CD&R a complete owner. This part of the business’s past played a pivotal role in embedding new DNA into the company, transforming it into what exists today. Private equity can be cutthroat and sometimes get a bad rap for the way they do business, but one thing you can’t deny is that they are very efficient. Over the 6 years that Atkore was in PE hands, it began scaling its M&A operations, completely replaced the management team, shed all non-core businesses, and established the Atkore Business System (ABS) which is still referenced in nearly every corporate document published to this day. The company went public in March of 2016.

Business Model and General Overview

Atkore is a producer of electrical, safety, and infrastructure products and primarily serves the non-residential construction market (65-75% of sales), with residential construction and OEMs making up the rest. Examples of products are plastic pipe and conduit, metal electrical conduit, metal framing, and electrical cables. Considering this, the business is exposed to some significant mega trends like data center construction, transition to renewable energy, and the shift of powerlines underground. All these facts lead me to believe Atkore is well positioned for future growth beyond what is implied in the price of the stock today. I view the current state of the business as more of a plateau than a peak.

Upper-level management prides themselves on having high ethical standards and treating customers, employers, communities, and shareholders with honor. The Atkore Business System (ABS) is mentioned in all presentations, which is based upon the stated core values of accountability, teamwork, integrity, respect, and excellence. It is the “driving force behind culture and performance.” In addition, the three interlocking focuses are strategy, people, and processes. Within the broader focuses, it is clear that the ABS is what keeps product quality, cost efficiency, commercial excellence, and talent acquisition at the forefront. I don’t want to spend too much time talking about this because it is mostly summarization, but I truly feel like it is important to point out. As opposed to boilerplate language normally used in corporate culture, Atkore is actually guided by these principles, and they have a true positive impact on performance. 

The company splits operations into two separate categories: 1) electrical and 2) safety & infrastructure.

1. Electrical

• Considering the importance of this part of the company to Atkore’s cash flow, it is understandable why investors may be concerned. Volume in the segment is tracking to come in flat for the year, meaning M&A is the only factor that exists to offset any decrease in prices.

• This segment is the cash cow of the business – it represents 3/4 of sales with high cash margins (adjusted EBITDA) of 38% in the first three quarters of FY23, which were closer to an average of 20% in the past. 

  • Margins have stayed stronger than I was originally anticipating earlier this year, mostly as a result of lower costs and increased efficiency in the face of falling prices. Looking into the future, it is hard to tell what a “normalized” margin profile will look like. On the most recent earnings call, an analyst asked a question related to the long-term profitability of this segment, and CEO Bill Waltz stated that “mid-30s is probably too high” as we look forward to next year, but that they “haven’t set guidance yet.” So even though management has proven to be perennially conservative, considering the company’s structural improvements and focus on productivity, a range from 30%-32% seems like a reasonable long-term target. This also assumes that margins will drop another 700 bps from projections for FY23. 

• I’m not the biggest fan of using EBITDA (especially of the ‘adjusted’ variation), but there is a clear reconciliation provided. It’s not exact, but if we assume costs between segments are proportional, then the pre-tax income margin for the electrical segment will come in at 25% for this year. In other words, the Electrical segment will provide about $680 million in pre-tax earnings for the business during FY23, or about 89% of the total. 

  • The stock is trading at 8.2x market cap/Electrical segment pre-tax earnings (5.6B/680M). This means that there are limited upside assumptions baked into the price regarding the other main segment.

• Main products produced and sold to customers of this segment are shown below:

2. Safety & Infrastructure (S&I)

• Here is the classic “smaller, but much faster growing” sibling to the Electrical segment. Volume in the S&I segment has continued to grow strongly at 14% for the past 9 months, even though it dipped down to +7% YoY last quarter. This is significant because it has largely (but not completely) offset price decreases for the segment. It is also important to note that a lot of capital has been allocated to growth expenditures and increasing capacity here over the last couple years. For example, a new solar mill facility ramped up last month, and management expects this to have a meaningful impact on increasing volume in the segment starting in the current quarter.

• Cash earnings margins (adj. EBITDA) have decreased by 900 bps YoY to 10.1% in the most recent quarter. 

  • *As a disclaimer, Atkore was clear to discuss some changes in accounting treatment that had a significant impact on the profitability of the S&I segment during Q3. The business is a beneficiary of solar tax credits and will be unable to recognize them as a reduction in COGS for this fiscal year, and will instead have to implement the benefit in the income tax provision line item. Three quarters worth of credits had to be added back to COGS, which solely impacted Safety & Infrastructure, seeing as this is the segment that produces the solar-related products. Without the increase in expenses, adjusted EBITDA for the segment would have been $42M at a 19% margin for the quarter, which would be a record. Management said they are only making these accounting adjustments for FY23 (due to the fiscal year ending in September) and will go back to recognizing the credits in COGS starting in FY24.

• This segment is still relatively nascent and structurally improving, so I would expect margin expansion to be accompanied with continued volume growth and efficiency gains. The longer-term average EBITDA margin falls in the low teens range. Using the same approach/reconciliation as with the Electrical segment, we can infer that pre-tax earnings margins will come in at 10% for this segment. This means that S&I will contribute $82M, or 11% of the total.

  • *These pre-tax earnings assume consistent accounting and that the solar credit benefit remains in COGS. This is what it would have been without the change.

• As before, the main products for this category are best described in a picture:

Capital Allocation

There are three legs of the stool: internal investment, stock repurchases, and M&A. Management has proven to be very shareholder-friendly, exhibiting a laser focus on making sure that capital is allocated efficiently based on whatever opportunities are available. They have been effective, especially since the beginning of 2021, considering ~25% of the enterprise value has been earned in FCFF before growth capex. (This also depends on when you measure the enterprise value, seeing as it has increased a lot over the last few years. It is 25% as of the most recent EV.)

They have also spoken about a desire to have net income and operating cash flow be equal over a 3-year average time period. As working capital begins to even out over the next 12-18 months, this is achievable. All other differences result from growth vs. maintenance spending, which should prove to be minimal in a steady state. I am in favor of this goal because it will make it easier for the market to see the value within the company.

Share Repurchases

• Since August 2016, Atkore has repurchased 40% of outstanding shares. Share count has dropped from 62.5M to 37.8M as of August 3rd, 2023. Toward the start of FY22 (November 2021), the board of directors approved a share repurchase program up to $400M, amending it to $800M in April of 2022, and then amending it again to $1.3B in November of 2022. Over this time, the company has spent a cumulative total just under $1B in repurchasing common stock. The buyback came as the FCF yield shot up, which shows that the decision was opportunistic. Seeing as there are some corrective forces at work in the form of pricing pressure, this was a savvy decision by management and will offset a large portion of value loss that would have occurred. It is clear that Atkore is not just focused on growth of the company overall, but instead understands the importance of maximizing value per share of the stock, which is what drives shareholder returns.

• As of June 30, 2023, there was $384M left available on the repurchase plan. Also important – Atkore funds buybacks with cash and does not use debt.

Capital Expenditures

Growth Capex

• According to corporate documents, this spend will go toward “expanding and updating production capacity and improving the productivity of manufacturing operations.” This seems fairly self-explanatory.

• Highlighted in the FY22 full year presentation – Atkore had a goal of $200M in total capital expenditures for FY23, which the business it still on track to hit as of the most recent quarter. The CEO said that this capital will go toward “new organic growth activity,” but I believe at least some of the total should be attributed to maintenance. It is reasonable to assume that growth capex will be somewhere in the range of 2% of sales in a steady state. This is derived from long-term guidance of capital spending at 3-4% of sales, less maintenance capex. 

  • These are management assumptions. It is reasonable to assume that total capex could climb into the range of 6-7% of sales considering the number of opportunities that Atkore is exposed to. I would not mind this as long as management was spending on investments with the highest available return on capital. 

Maintenance Capex

• Although it is not discussed in-depth within any documents recently, management has given specific insight to cash maintenance expenditures in the past. Looking through the S-1, it is written that they will be equal to ~2% of sales every year. I assume this has stayed about constant, seeing as the business produces most of the same (or similar) products using similar processes compared to 2016.

M&A

M&A became a part of Atkore’s DNA when it was acquired by CD&R back in 2010. Historical success has been the result of a mix of discipline along with the industry lending itself very well to roll-ups. The markets Atkore operates in tend to be fragmented with a lot of smaller, family-owned type competitors that are open to selling to a larger entity. Most of the companies also tend to have similar product designs, manufacturing processes, and approaches to distribution. This makes it highly likely that acquisitions will lead to significant synergies (1+1=3), which is reassuring when compared to most industries, where management typically has trouble making M&A purchases a worthwhile use of capital.

The most attractive aspect of Atkore’s acquisition strategy is that all purchases are made with cash on hand. This shows confidence in decision making, considering there is complete exposure to both the upside and downside, and no risk is shared with the acquiree. I have not seen management explicitly state they only intend to use cash, but looking through all filings, it is evident cash is their first choice. Typically, management finds a fast-growing market that aligns well with their current product mix, and they start buying other businesses to enter said market. They took this approach earlier in the 2010s with PVC by acquiring four different businesses, which expanded their offerings in the space. This gave them significant share in conduit, fitting, elbow, and sweep products and increased their manufacturing and distribution from one location in Georgia into the Southwest, Northwest, Midwest, and Western US. 

Atkore is now taking this same approach with HDPE products, with five of its last seven acquisitions related to this particular market. Management has noted HDPE as a strategic initiative that represents a $7 billion opportunity. Their stated intention is to be a top 10 player in all product categories in the space, which include conduit, pressure pipes, water pipes, and corrugated offerings. This sector serves end markets like the broadband, telecom, renewable energy, oil & gas, and water infrastructure industries. Growth drivers will be the realization of synergies and expansion of 5G networks, with the broadband and telecom industries likely to be the biggest source of growth.

Atkore M&A Stats:

• Over $200M in acquisitions during 2011 → Sept. 2016 time frame

• As of FY22 end, $649M was spent on 16 acquisitions since FY17

  • Return on capital – all business acquired FY21 and before within this tranche are operating on a Purchase Price/EBITDA of less than 2x as of the most recent full year financials. These are the only return characteristics we are provided, but they give evidence that cash returns on capital deployed in M&A are very high

• $320M deployed in FY22 alone (most purchases in HDPE, as discussed earlier)

• One acquisition made in FY23 so far, fairly large at a purchase price of $90M (HDPE related – Elite Polymer Solutions)

• For anyone interested in each specific acquisition related to the FY17 → FY22 time period, Atkore has provided the following graphic I found very useful:

Market Opportunity and Overview

Atkore operates in a $40B+ TAM as of the end of FY22, which is likely a bit smaller now with prices cooling. Since its IPO, Atkore’s addressable market has grown over 2x, which is a result of organic growth and acquiring businesses in order to expand into new categories. Main product segments of the business include: (1 – 39%) plastic products, (2 – 19%) metal conduit + fittings, (3 – 17%) metal framing + cable management & construction services, (4 – 14%) electrical cable + flexible conduit, and (5 – 12%) mechanical tubing + other. The numbers next to each denote ranking, with 1 being the largest, along with relative percent of sales. To be conservative, Atkore’s main markets should grow at least in line with the broader construction industry. Oxford Economics and Global Construction Perspectives estimate that global construction growth will be 3.9% per annum until 2030, meaning that volume for the entire industry will come in at a whopping $15.5 trillion. Just as an aside – I would expect Atkore’s end-markets to grow at a faster pace for longer due to secular tailwinds but prefer to be conservative. Using a growth rate of 4%, Atkore’s TAM will be $48.7B in 2028.

Atkore has a lot of flexibility, with most products used in a variety of different settings by unique end-users. For example, plastic pipe is used in projects such as data centers, single-family homes, institutional buildings, and utility projects. This fact is very important, seeing as it gives the company downside protection from any one group of customers while also giving them access to upside from a number of possible sources.

With sales likely to come in around $3.6B for FY23, this means that Atkore has a market share of 9.5%, which is significant. As discussed in the M&A portion above, the market has proven to be very fragmented, with a few large competitors, but many smaller players competing in niche categories.

• One main question for forecasting: What market share can be reached by 2028? If we assume 5% growth in sales from M&A (which is similar to past levels) and 5% growth from increases in volume – There is a clear path to 10% sales growth until 2028 once prices stabilize. My forecasts for intrinsic value are below this 10% CAGR mark.

90% of sales are in the United States LTM and this is in line with historical trends. I expect this to stay constant into the future as US sales grow in line with international sales. 

• This can get a little bit foggy. Considering that Atkore sells to distributors who sell to manufacturers, it may have more of a hand in international projects than the geographical breakdown implies. If it sells to a distributor such as Graybar Electric Company, Graybar could technically sell the products to contractors internationally even though it is based in the United States. 

Competitors

• Encore Wire Corporation: commonly referred to as the main competitor. It manufactures electrical building wire and cable. Most similarities are found in customers (electrical distributors) and end-markets. Encore’s stock (WIRE) has had a wild ride over the last few years and the 5yr chart looks eerily similar to ATKR. I believe that this business will also prove to be materially better as we move into the future, but there is a much higher risk profile. The business is nowhere near as diversified as Atkore, meaning there is much higher exposure to single commodity price movements (copper). Although I think the business will continue to execute well, I don’t have an opinion about where the stock will go from here. Based on research I have done, both WIRE and ATKR produce similar products that are high quality and specialized. Sales for Encore have fallen 25% YoY and net income has halved.

• Acuity Brands: industrial tech mostly focused on lighting and spaces. It serves the broader construction market.

• AZZ Inc.: provide metal coating and galvanizing solutions that enhance the longevity of buildings, products, and infrastructure. It serves both the renewables market and broader construction market 

• Belden: most of its products are related to cable, cable management, panel, and patch systems

• Cornerstone Building Brands: “exterior building products,” which includes windows, doors, siding, metal roofing & wall systems. Interestingly enough, the business was recently acquired by CD&R

• Valmont Industries: categories such as – Transmission, Distribution & Substation, Lighting & Transportation, Coatings, Telecommunications, and Renewable Energy. They have a product variety as wide as Atkore, but the mix is different. A lot of the products are “farther down the manufacturing line,” and the business has 13% operating margins as of the most recent quarter compared to Atkore, which is still over double that. Total sales are about 8-10% higher, but FCF is materially lower.

Atkore has far and away the best margin profile and the best capital allocation when compared to all of these businesses. None of them have quite the same product mix as Atkore or are as effectively diversified. Each company exhibits at least some type of overlap, however, whether that be in products, customers, or sometimes both.

Key Customers

Global distributors

• Consolidated Electrical Distributors, Graybar Electric Company, Rexel, Sonepar S.A., Wesco International

Super-regional distributors

• U.S. Electrical Services Inc., Crescent Electric Supply Co., United Electric Supply

Members of buying groups

• Affiliated Distributors, IMARK Group, and STAFDA 

Industrial distributors + big box retailer

• Home Depot

Atkore also directly supplies a limited amount of alternative energy original equipment manufacturers (OEMs)

Electrification trends, government initiatives, etc.

Inflation Reduction Act (IRA) of 2022

• Solar Tax Credits: the following quotes are from a summary of a few select portions of the IRA, including what benefits will be available to applicable businesses over the specified time frames. When I was originally researching Atkore, I thought this would’ve been a relatively insignificant matter, but it turns out to materially affect profitability of the Safety & Infrastructure segment. The accounting change was actually very helpful in the sense that it made the impact clear – about $20M in EBITDA was lost. Atkore qualifies for the credit in both of the following scenarios:

• For 2023 → 2024 – “The IRA retains the Section 48 credit for solar generation projects and reestablishes an opportunity to claim a 30% tax credit. Under the revised statute, the full 30% rate is deemed a “bonus rate” that taxpayers are entitled to only if the project is under 1MW of generation output or if the new prevailing wage and apprenticeship requirements are met.”

• For 2025 → 2033 – “The IRA introduces a technology-neutral tax credit for clean energy generation projects placed in service after Dec. 31, 2024. Distinct from the technology-specific tax credits under the existing ITC regime, under Section 48E, taxpayers will be able to claim a 30% bonus credit based on emission measurements, which requires zero or net-negative carbon emissions. Solar is a non-emitting source of electricity generation and will be eligible for this credit.”

Broadband Equity Access and Deployment Program (BEAD)

• Sets aside $65B to invest into “closing the digital divide,” which means allocating money to 5G networks, cellular connectivity, fiber optic to the home, etc.

• The national government is in control of distributions, which has led to the funds not hitting states’ budget as fast. It was discussed in the recent Q3 call that carriers are building out a bit slower than expected. Overall, though, this is very positive because Atkore has a clear vision regarding the minimum amount that will be spent over the next few years, which has played into longer term guidance of $18+ EPS in 2025.

CHIPS Act

• The act earmarks nearly $53B for spend in the semiconductor industry to bolster competitiveness. Most notably, $39B is set to be allocated to manufacturing incentives, which is dedicated directly to spending on large fabs that use a lot of energy and require Atkore products. All of this does not mean sales are flowing directly to Atkore, but management has repeatedly stated interest from the public sector has been effective at keeping businesses engaged, especially in the non-residential construction sectors. On the most recent earnings call, CEO Bill Waltz said that “there's a lot of things I think we'll talk about more in the future as we work with what we call kind of global mega projects. But just imagine chip manufacturers and things like that across the globe, we have a really good relationship with some of those customers.” He also noted construction in the manufacturing sector is up 12% so far this year.

AI trends, data centers, and compute power

• AI has been the talk of the town over the course of 2023 and played a large part in starting the recent bull run (specifically in tech, but essentially everything else as well). As a marker, the QQQ is up 40% from October 2022 lows and the S&P is up over 20% during the same time frame. I do believe that artificial intelligence will be a massive market of critical importance going forward, I just don’t know what the main products will look like and what niches will generate cash flow. I would say from that perspective, it’s in the “too hard” pile, to quote Buffett. This means I don’t have an interest in picking a specific winner toward the end of the value chain. However, one thing I do know is that there is a 100% (not even 99%) probability that demand for compute power will be exponentially higher a decade from now than it is today. This means that businesses will need to work hard to construct semiconductor fabs and data centers in order to provide supply. By order of derivative, we can also conclude that the demand for electricity and energy will be exponentially higher. By order of second derivative, this means that substantial amounts of Atkore’s products will be needed by the market. (Again, this is them providing picks and shovels for the guys making the picks and shovels reference)

Great picture from FY22 year-end presentation related to megatrends:

Competitive Advantages

For this section, I do not think it is beneficial to give arbitrary labels such as a “wide” or “narrow” moat. This is an inexact science and can be misleading if we look at competitive advantages in this light. The goal is to determine the degree to which returns on capital are both defensible and sustainable. Some of them will be more permanent in nature, but consumers, businesses, and broader economic forces are changing constantly.

All-in-one provider

• This is by far the biggest advantage that the business has. It is unique for a company like Atkore to be able to supply all required products for an entire project from end to end. Considering their product assortment, it makes each customer’s world much easier when they have demand to fill and are able to access a one-stop shop. This provides Atkore with pricing power, seeing as customers’ time is saved and products of best in class quality are provided. Even with slightly higher prices, the value received by each customer is much greater than with any single or small group order that would be made with a competitor.

Culture and focus

• I believe Atkore has intangible qualitative attributes that make it a great business and investment. I have touched on it throughout, but management is very good. They are flexible and willing to do what it takes to make sure that shareholders are best off. It is rare to find managers that think like investors. In my experience, this is the best competitive advantage a business can have, because they will take advantage of opportunities as they arise.

• Even prior to COVID, management worked to increase productivity in the business. They grew operating margins from 2% in FY15 to 12% in FY19, while sales only grew 10% in total. This is a testament to the team at Atkore and their ability to execute. Often overlooked due to its difficulty to measure, I think that a good culture is the main ingredient that leads to a company’s prosperity. 

• There is a clear willingness to analyze the company, see what works, and pivot. Management has shown this again during the most recent quarters, with cost cutting playing a key role in maintaining their best in class margin structure. 

Return on incremental invested capital (ROIIC) analysis

ATKR has been a massive benefactor of inflation over the last few years, so a substantial portion of its incremental cash flows have come without any accompanying investment. This has created a free money printer. Of course, not all price increases are invalid, they are a key attribute of any business, no matter what industry it operates in. The question is – how much of the price increases are sustainable vs. unsustainable? 

*FCFF was used to equate to cash earnings distributable to all capital providers. An estimate for FY23 was used, considering that management has been clear with guidance, and we only have 1 quarter left. This approach will give a more accurate picture as we approach end of the FY.

Years mentioned are fiscal years

Returns have been much higher over the last 3 years than it was pre-COVID, and this has pulled up the average. Using available data from the S-1, return on capital (total, not incremental) grew from 3% in FY14 to 20% in FY19. So irrespective of wild changes in price, the business was improving fundamentally even prior.

Balance Sheet Overview

Atkore is focused on making sure that it has a modest amount of debt relative to earnings and currently have a long-term debt/EBITDA of <1x. As of June 30, 2023 it had $762M of long-term debt, and this rises to $848M if we incorporate lease obligations. Management’s goal is to always have the company at a level of <2x long-term debt/EBITDA, so they have ample room if they find a large and accretive opportunity that requires them to borrow capital.

Debt levels have been constant since the end of FY21, and the debt is made up of two main factors: “Senior Secured Term Loan Facility due May 26, 2028” and “Senior Notes due June 2031.” The term loan facility accounts for $370M outstanding and the terms are SOFR plus 2.00% plus slight spread adjustments to account for LIBOR being higher than SOFR. Regarding the senior notes, they were issued in May of 2021 at a rate of 4.25%.

Valuation

For valuation, I wanted to use the Michael Mauboussin approach of understanding the current expectations implied within the stock price, and then seeing what the fair value is in comparison to that. Although this section is at the end of the report, I did this work first using broad assumptions to see if a deeper dive was warranted. I used a forecast period of 5 years (not including 2023) to the end of FY28 because I found this is how long the market is assuming it will take for Atkore to reach a steady state of operations.

Side Notes

• I was conservative in my assumptions, assuming steady state margins below current levels as well as a 1 percentage point gain in market share through FY28. I believe it is likely that Atkore will outperform, especially on the sales side.

• I did not incorporate share buybacks into my calculation of fair value. It is highly likely these will play a role and materially increase intrinsic value per share, even over the next 12-18 months.

• Management expects adjusted EPS around $18-19 for FY23, which only has one quarter remaining. The original outlook at FY22 end was to reach $18+ in EPS by 2025.

Sales Growth

• Messing around with different assumptions has proven that sales growth is an important contributor to value. Variation in growth figures from zero to mid-single digit changes the fair value by 20%. It is clear that sales will be down ~10% this year. The market is smart enough to figure this out, so the contrarian view comes into play over the 5-7 year time period.

• The market currently assumes sales will grow at a constant 2.5% until FY28 and be at the revenue figure roughly equal to FY22. This is unlikely and too pessimistic. My view is that Atkore will be able to reach 10.5% share of their TAM from a point of 9.5% today, this implies a sales CAGR of 7.5% from the 2023 base.

Margins

• Another main driver of value for Atkore is the margin profile. Holding sales figures constant over the forecast period and changing steady state EBIT margins of 21.5% to 26% in FY28 produces a change in fair value of 20%. This shows that both sales growth and margin assumptions are of equal importance. The market has slowly come to terms with the fact that management has been effective in cutting costs and increasing productivity over the last 12 months, and the stock has responded accordingly (up 60%). I believe assumptions are still too low, with 30% long-term EBITDA margins likely (a blend of low 30s from the electrical segment and low to mid 20s for the S&I segment), which translates to operating income at 26% of sales. 

• Stabilizing prices accompanied by volume growth will help keep margins stable as well. It is promising that sales have begun increasing QoQ as of Q3.

Cost of Equity

• This was something I thought about for a while. I was doing work to try and come up with the best equity risk premium and settled on a value of 3.4%. This may seem low to many, but it incorporates an expected return on the market (S&P, QQQ, or whichever broader index you choose) of just north of 7.5%. I think this is fair and I had a difficult time trying to justify anything north of that based on the current prices. 

• I had to make a few calls about what I believe is truly implied today, both regarding Atkore and the broader market. Getting into the 14 or 15% range is simply too high based on how the rest of the market is valued. Although this wasn’t completely mathematical and quantitative, it is sometimes important to use subjective reasoning.

• You could also take the approach of estimating cash flows and then using a discount rate in line with whatever your desired return is (i.e. 10%, 15%, or some other value).

Market Implied Expectation

For this work, I started with what I knew and played around with numbers until I got to the market price. This also gave me insight as to what drives value vs. what does not.

Intrinsic Value

Fair value is currently $216 per share compared with a market price of $148 as of 8/11/23. The stock is trading at less than 70% of fair value.

If intrinsic value compounds at cost of equity, these are the IRRs based on how long it takes for market price to converge with intrinsic value:

1 year - 63%

2 years - 35% 

3 years - 27%

4 years - 23%

Catalyst

• Efficient capital allocation (share buybacks, M&A, growth capex)

• Continue to prove to the market that the business is structurally better than it was in 2021 and prior

• Continue to be productive in cutting costs