This Electrical Equipment Stock May Still Have Room To Run
After a tremendous two years, this infrastructure company still looks cheap
Overview
2023 has given the shareholders of Powell Industries POWL 0.00%↑ a lot of reason to celebrate. Based in Houston, Texas, the company manufactures power control room substations and other critical electrical gear to a range of industries and has seen its stock deliver a whopping 155% total return to investors in 2023.
The logic behind this isn’t difficult to understand: infrastructure spending in the company’s end markets has prompted a flood of orders, driving Powell’s backlog up by $700 million to $1.3 billion to end FY 2023 (which ends September 30th for the company).
Today, this $1 billion market cap company sits with no debt on its balance sheet and more than a quarter of its market capitalization in cash ($274 million). With this in mind, I think there’s a lot to like about the company even after its rapid run-up.
Let’s dive in.
A Cycle Question
I often think of a bit from Peter Lynch where he discussed how management teams had certain demeanors according to their industry. Tech executives were always upbeat, and everything was great. Textile executives always seemed down in the dumps, even when things were humming along.
Now, I’m not saying that Powell’s management team strikes that tone with me (the opposite, actually), but the infrastructure segment reminds me a bit of Lynch’s archetype of textiles—it’s a space that, for many years, has always seemed to be just on the precipice of huge orders, only to experience letdowns when the business failed to materialize.
2022 was a down year for ordering in Powell’s end markets and with good reason. Uncertainty around inflation and rapidly rising interest rates aren’t exactly a recipe for growth.
In some ways Powell was the poster child for this condition—from January 2020 to January 2023 the stock largely failed to recover from its Covid-crash lows, returning a negative 19% for the period and, at times, dipping to almost 60% off its highs.
At the end of FY 2022, however, management began beating the drum that the winds were changing. The key driver for Powell in my estimation is the robustness of the backlog. From the earnings call recapping the full FY22:
[W]e ended the year with a total backlog of $592 million. This is the highest backlog in Powell's history and represents sequential growth of 18% and is 43% higher than the end of fiscal 2021. Our project backlog is well balanced across the markets we serve with the utility, commercial and other industrial sectors comprising a growing share of the backlog.
FY 2023 saw things accelerate at a rapid pace. From the FY 2023 10K:
Our backlog at September 30, 2023 totaled $1.3 billion compared to $592.2 million at September 30, 2022. The increase in our backlog is across all of our end markets, and particularly driven by our core oil, gas and petrochemical markets. We anticipate that approximately $648 million of Fiscal 2023 ending backlog will be fulfilled during our fiscal year ending September 30, 2024. Backlog may not be indicative of future operating results as orders may be canceled or modified by our customers and may not be indicative of continuing revenue performance over future fiscal quarters.
A big backlog is great and all, and the fact that the company estimates it will bring in $648 million in FY 2024 from the backlog without accounting for new business (when the firm brought in a total of $699 million in FY 2023), but the last sentence, of course, puts a bit of a dampener on things and reminds us that (sigh) infrastructure is a cyclical industry with ups and down.
The critical questions, then, are:
what can we infer about the future state of the backlog beyond 2024, and
what are the risks that could cause customers to cancel large projects?
Bookings & Growth
The first question came up in Powell’s latest earnings call. Here’s a segment from the Q&A portion where management responded to questions regarding the robustness of booking going forward:
John Franzreb [Analyst]
Thanks for taking my questions. Congratulations on a great quarter. I'd like to start with the booking profile. The incoming order book of $171 million, if I compare it to the 10 years prior to fiscal 2023, you're roughly doing about $150 million of incoming order book. But we just came off two consecutive quarters of over $500 million of bookings. Can you kind of put into context what the opportunity profile looks like, what you would expect the booking profile look like in the coming year?
Brett Cope [CEO]
John, thanks for the comments and the question. It's Brett. Yes. I appreciate the leading on the question on the two previous quarters. A little bit of timing, of course, in that Q3, what was going to book, and as we went into Q4, we were very pleased with the $171 million net for the quarter. When I look at what made up in the sectors in the quarter, it was kind of on average with the core oil and gas, good strong utility content in the fourth quarter, along with a good contribution to the new sector that we're reporting out in the commercial and industrial market.
As I look forward, I think that the cadence continues. There weren't any mega projects in the Q4 given the run we had in the previous three quarters to Q4. But that said, in my prepared comments, activity is still robust. There's -- in fact, you asked a question, which I was thinking about as we prepared for today, you asked me a question a call or two about are we at halftime or where are we at relative to that.
I'm going to hold my answer on that last call. There's still a lot out there. We're very engaged. Timing is a little bit more uncertain given the run we just went through over the last 12 months to 18 months, but there's still a lot in front of us.
Oil and gas is far and away Powell’s largest end customer segment:
So, what are the outlooks for these segments? On the oil and gas front (particularly LNG, which is a key customer for Powell) things appear to be solid going forward. Here’s a bit from S&P Global from last year on the long-term forecast of US LNG exports:
S&P Global Commodity Insights analysts recently predicted that U.S. LNG export capacity will reach 21.7 Bcf/d by the end of 2027, an 84% increase from existing levels. How quickly new projects can come online will be a key issue for a global gas market facing a supply shortfall headed into the mid-2020s.
Perhaps most importantly, S&P estimates that the bulk of this expansion is yet to come:
Powell's management echoed the sentiment repeatedly in the latest earnings call that demand was robust across its major end markets. Of course, part of this is being driven by the massive $1.2 trillion from the 2021 infrastructure bill. While it is difficult to nail down exactly how much has been spent and how much remains to be spent (there’s an interesting piece here on the subject from the Project On Government Oversight), I don’t think it’s unreasonable to speculate that the 2023 tailwind for Powell is not a one-off and that the record investment in U.S. industrial capacity will continue.
Valuation
Most value or value-skewed investors I know have a serious aversion to charts that look like Powell’s, and this makes sense. Value-oriented folks aren’t eager to jump into a stock after it’s had a massive rally and would prefer to wait for a pullback. However, Powell's stock is relatively cheap on a historical basis.
Today Powell trades at 18x forward earnings estimates, a level not seen for the company since the COVID-19 flash crash in 2020. EV/EBITDA forward estimates are also at an attractive level, I think, from an RR perspective.
Metrics are easy to state—understanding what they mean is another matter. What I can glean from the company’s current valuation (which has had a historic 5-year 12x forward EV/EBITDA and ~38x forward earnings valuation average) is that the market is wildly discounting the idea that earnings could continue on the same trajectory going forward. In other words, the market seems to believe that 2023 will not repeat itself. For the reasons stated above, I think that this is likely not the case.
Further, on a forward earnings basis, the fact that Powell currently trades so low against historic averages is quite attractive. Early in 2023, for example, the stock traded for around 25x forward earnings.
Therefore, I set my base case to be a re-rating to 25x of an FY2025 EPS estimate of $5.25, a potential 2-year IRR of almost 20%.
Note: I do not currently hold a long position in any stock mentioned in this article, but may initiate one within the next 72 hours.
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Thanks for bringing this company to my attention, you have done a phenomenal job at analyzing the fundamentals and valuation wise, there could be real opportunity moving forward.