With earnings closely linked to capital and infrastructure spending in the economy, Houston Wire is a stock meant only for the long term players.
The Houston Wire and Cable Company (HWCC) has been in business for over 40 years, with a history marked with successful IPO’s, and a number of mergers and acquisitions. Operating in an industry heavily linked to capital investment in the economy, HWCC and its peers have recently seen a drop in demand, and resultantly, a decline in sales and earnings. The company, in proportion to its size, seems to be suffering significantly more than its peers.
Houston Wire: Business Overview
HWCC is one of the largest providers of electric and mechanical wire and cable, hardware, and related services, in the USA. The company provides a single source solution to its customers, with an unparalleled variety of products available in stock. While most of its competitors operate within a limited geography or product category, HWCC provides an unmatched depth and breadth of product, with nationwide delivery within 24 hours. This business model, while may provide a USP to the company, can become a burden when times are tough. High levels of inventory, large warehouses, and a widespread distribution network can hurt the balance sheet when sales aren’t going as planned – exactly what is happening with HWCC.
HWCC serves utilities, industrial and infrastructure markets. One-third of the company’s revenues are dependent on activity in the oil and gas sector, where investment has been on a continuous decline for two years now. Similarly, the Capital Projects and Infrastructure (CP&I) spending in the USA has been on a decline since its peak in 2014, and according to PWC, is expected to fall further in 2017 before finally rising again.
In this scenario, it is not surprising that sales for HWCC have been on a downward trend since FY’15, with annual sales dropping 21% versus the previous year, and sales for 3QFY’16 dropping 17% versus 3QFY’15. HWCC is hurt by the downturn in the economy, more than its peers, with the industry average decline in sales standing at 4% for 3QFY’16. Gross margins for HWCC stand at 18% for the most recent quarter, compared to the industry gross margin of approximately 30%. This difference in cost structure, while may not affect the company’s financials in economic booms, explains why the company is unable to cover its fixed costs when sales are on a decline. While total operating expenses for 3QFY’16 have decreased versus the same period last year, this decrease is not proportionate to the decrease in sales, resulting in a net operating loss of $1.8 million (-3% of sales). As operating expenses consist largely of salaries and other fixed costs, this result is not surprising. Earnings for 3QFY’16 show a loss of $0.09 per share, compared to earnings of $0.04 during the same period last year.
The company’s liquidity position has consistently remained strong, with the current ratio in 3QFY’16 standing at 5.3, more than double the industry average, and in FY’15 at 6.5. The strong current ratio, as well as its decline, can be attributed to inventory levels which are generally high. There has been a 16% drop in inventory during the first nine months of the year, which combined with the reduction in accounts receivable and trade payables (due to reduced sales), has led to the size of the balance sheet reducing by 12% versus FY’15.
HWCC has more long term debt than its peers, but stands stronger where total debt to equity is concerned. The long term debt to asset ratio stands at 20%, in 3QFY’16, down from 25% in FY’15, and is at its lowest levels since 2010. While the company may have more debt than peers, it is in a strong position to meet its financial obligations, with the TIE ratio equal to 14 times (almost three times the industry average). The company’s cash position, while deteriorating versus previous periods, is strong, with a healthy cash flow from operations despite operating losses.
The market, however, doesn’t appear to have positive expectations from HWCC. The company’s stock price has been on a steady decline since the beginning of FY’15, losing more than half its value since then. There is little liquidity in the market with respect to trading volumes, with an average 3-month volume at 41.5 thousand shares. The one-year target price is in the range of $5-6, a drop versus the current price of $7.
If we look at the BV per share, we see this at $5.6 per share, with a P/B ratio of 1.1 (3QFY’16). With the industry trading at a P/B value of 1.8, we see that the market is undervaluing HWCC. The company seems to agree that the stock is undervalued, and has repurchased 91.5 thousand shares between July and September 2016.
The stocks beta against the NASDAQ is 0.15, indicating its strength as a tool for diversification. With returns that have little to no correlation to the market, it provides a buffer when the market behaves against expectations.
While HWCC has made little capital investment in recent periods, and growth opportunities seem limited, the company recently announced the acquisition of Vertex, a leading master distributor of industrial fasteners, for $32 million. This acquisition ties in with HWCC’s business model and strength in master distribution and indicates management’s positive outlook for the future.
With CP&I spending expected to increase beginning from 2018, it is obvious that the HWCC stock is not about to provide you with immediate returns. If you are looking to make a quick buck within the next few months, or even a year, this is not the stock for you. However, if you play it out for the long term, sit through the economic downturn, and wait it out 3-5 years, you may just have a winner on your hands.
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