Insteel Seeing Strong Drivers, But The Market Seems Concerned That Leading Indicators May Have Peaked

 

It’s been an interesting six months for Insteel (IIIN) since my last update on this under-followed manufacturer of steel reinforcing products. While pricing and volume have been strong, as has manufacturing leverage, and Insteel saw a favorable ruling in anti-dumping cases against imported reinforcing products, the shares have corrected on what I believe are growing concerns of an approaching peak.

In my last article, I said that I saw upside into the $40s on the passage of an infrastructure bill, and that happened in March, May, and early August, but the shares have pulled back almost 20% since then. I think there’s a “this is as good as it gets” concern in play with Insteel, and I understand that to a point, though I do think the infrastructure bill will be a positive for underlying demand. I could see another move into the $40s and upside to FY’22 expectations, but I would be careful about pushing my luck with what can be a painfully cyclical stock when the cycle rolls over.

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Insteel Seeing Strong Drivers, But The Market Seems Concerned That Leading Indicators May Have Peaked

Insteel Should See Better Pricing, But End-User Demand Is A Real Question

I liked Insteel (IIIN) back in August of 2020, when the company was still under pressure from cheap imports and seeing double-digit price declines despite healthy demand across its markets. Since then, not only has construction activity remained surprisingly strong, but the company also won an anti-dumping case in PC strand and is likely to see further positive actions on the regulatory front. Strong demand and good operating leverage have helped fuel profits and cash flow, sending the shares up about 80% from the time of that last article.

With all the moving parts that feed into Insteel’s business, there’s never really a time when things seem crystal clear, so uncertainty is just par for the course. To that end, while I expect improved pricing realizations and stronger gross margins this year, I’m concerned about a more significant shortfall in demand as non-residential building slows and municipalities have smaller budgets for roads and other infrastructure projects. I do expect federal stimulus to help, but likely not in 2021.

Depending on what happens with a federal infrastructure bill and price realizations now that anti-dumping duties are in place, I believe these shares have more room to run and will likely retest, if not exceed, prior highs around $40. I would caution investors, though, that these are shares that should be bought to be sold; the business is well-run but deeply cyclical, and I think investors would do well to consider an exit strategy when things are looking their best.

 

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Insteel Should See Better Pricing, But End-User Demand Is A Real Question

Strong Volumes Help Insteel Start The Year Right

I cautioned in my recent piece on Insteel (IIIN) that volatility in end-market demand and import pricing made this a more volatile story and a harder company to model, and that worked out in a positive way in the fiscal first quarter, with Insteel reporting better results on stronger volumes. Management also noted that its transportation end-markets looked healthy and that the pricing cycle may be past the worst.

I thought Insteel was undervalued back in late December, but that the volatility and risk made it a difficult stock to recommend for other investors. I feel better about the volume and margin situations, but I think that view still basically holds - the shares do still offer some upside on an EV/EBITDA basis, and the company could well outperform my expectations, but this remains a tricky stock to model, and a lot of the key factors that will influence revenue and margins are beyond management's control.

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Strong Volumes Help Insteel Start The Year Right

Insteel Struggling Under An Unbalanced Tariff Policy

I wasn't all that interested in Insteel (IIIN) back in January of this year, as I was worried that this manufacturer of steel reinforcing products would struggle due to an unbalanced tariff policy that basically forces the company to buy overpriced inputs (wire rod) but compete with cheaper downstream imports sold by companies that can avail themselves of cheaper wire rod in international markets. Much of that has come to pass, with the shares basically flat for the year and sandwiched between the performance of other steel companies like Commercial Metals (CMC), Nucor (NUE), and Steel Dynamics (STLD).

In that last article, I said that Insteel would be more interesting below $20/share, and investors got that chance a few times this past year, with those who bought below $20 at least showing a profit for their efforts. Although I think pricing pressure should ease up some on Insteel in fiscal 2020, gross profit margins are going to remain under pressure and I expect this to be another challenging year.

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Insteel Struggling Under An Unbalanced Tariff Policy

Weaker Shipments Sap Insteel's First Quarter, And Margin Threats Remain

It didn’t take long at all for Insteel (IIIN) to show some divergence from my expectations for fiscal 2019, as the company’s first quarter came in meaningfully lower than I expected on weather-related shipment weakness in the quarter. Even so, the conditions in the market remain quite challenging, and it sounds as though the company will be sacrificing margins to maintain volume with customers in 2019 and hoping for some tariff relief.

I’m still comparatively less bullish on non-residential construction in 2019 than many, and I think that presents some risks to volumes and overall earning expectations for Insteel. While I believe this company is fundamentally well-run, the reality of competing against cheaper imported product is a difficult one, and the possibility of weaker-than-expected demand doesn’t help. I saw the possibility of 25% or more downside in my last update, and the shares are down about 15% from there. I do believe that has de-risked the investment case somewhat, but my confidence in the acumen of Insteel’s management is tempered by the ongoing risks presented by macro factors outside of their control.

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Weaker Shipments Sap Insteel's First Quarter, And Margin Threats Remain

Insteel Navigating A Host Of Uncertainties, With Metal Spreads High On The List

It’s a challenging environment right now for Insteel (IIIN). Although this leading manufacturer of steel wire reinforcing products has an uncommonly good long-term track record for margins and returns on assets, equity, and capital given the cyclical nature of its business, pricing leverage has gotten tricky and non-residential construction spending finally seems to be slowing.

Down about a quarter from when I last wrote about the company, Insteel really hasn’t done any worse than large steel companies like Nucor (NUE) and Steel Dynamics (STLD) or other building material companies like Vulcan (VMC) and Martin Marietta Materials (MLM). Although the share price looks undemanding even if revenue and EBITDA do see some contraction from here, a retesting of past low multiples would represent about 25% to 33% downside risk.

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Insteel Navigating A Host Of Uncertainties, With Metal Spreads High On The List

Insteel Seems To Be Shrugging Off Serious Margin Pressures

There are a lot of things about Insteel's (IIIN) business model that make it a challenging company to model. Although the company has had success in coaxing construction companies to use its welded wire reinforcement products instead of rebar, demand is driven by non-residential construction (and public construction, to a lesser degree) and there's not much Insteel can do to drive that. What's more, the company competes with rebar manufacturers like Nucor (NUE) and Commercial Metals (CMC), but also turns to companies like Nucor to buy the wire rod it needs, putting it in a sometimes-challenging spot between competing with rebar on price and trying to maintain a healthy spread between its rod costs and end-user pricing.

Margin pressures have hit Insteel hard recently on higher wire rod pricing, and the tariff actions taken by the U.S. government aren't going to help Insteel's supply situation (though they should help somewhat on protecting it from imported competing products). Insteel has managed volatile pricing before, and while there will be lags and turbulence, I believe the company's own pricing actions will help restore margins later this year. A bigger question remains the ongoing health of the non-residential construction market and whether these high input prices finally bring an end to a long recovery and expansion. Although I feel far less confident in my Insteel model than I'd like, I'm not sure I see a lot of upside from here.

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Insteel Seems To Be Shrugging Off Serious Margin Pressures