Investment Thesis
I last discussed Gibraltar Industries, Inc. (NASDAQ:ROCK) in September and the stock has traded fairly flat since then. Since that time, the company has reported better-than-expected third-quarter EPS and inline revenues. Its backlog has increased 5% year-over-year (Y/Y) at the end of Q3, indicating positive growth prospects ahead. The module supply and regulatory challenges in renewables continue to ease, and a large project in the Agtech segment that was delayed by a few months has started in September and is progressing as expected, which should benefit revenues in the coming quarters. The infrastructure business is expected to benefit from Infrastructure Investments and Jobs Act (IIJA) funding. While the Residential segment’s organic revenue is getting impacted by product line rationalization as the company exits less profitable product lines, this headwind is transient in nature, and the long-term story is attractive. Further, the company has a strong balance sheet and is well-positioned to do bolt-on M&As. I believe the company should return to growth in FY24, and the resulting operating leverage should also benefit margins. The stock is trading at lower than historical valuations, and I believe that as the company returns to growth, investor sentiment should improve, and the stock should re-rate. Hence, I continue to maintain a buy rating on the stock.
Revenue Analysis and Outlook
Gibraltar Industries’ organic sales have been declining since 4Q22 as it faces delays due to regulatory issues in the renewables segment and the Agtech business has also seen some delay in the start of a large project. The residential segment was also impacted by inventory destocking at customers and from product line rationalization. While the organic revenue decline continued in 3Q23, the pace of this decline is moderating and the company’s total organic sales were down 5% Y/Y in 3Q23 versus a 7% Y/Y decline in 2Q23 and a 12.4% decline in 1Q23. The company’s total sales were however flattish in 3Q23 with a 4.8 percentage point contribution from acquisitions.
Looking forward, I am optimistic about the company’s revenue growth prospects. The company reported a 5% Y/Y increase in its backlog last quarter. A company’s backlog is a leading indicator of its revenue and provides good visibility of the company’s growth. So, Gibraltar’s sales should benefit as this increased backlog starts converting into revenues in the coming quarters. Segment-wise, the company’s renewables segment has seen several headwinds on the regulatory side in the recent quarter which impacted its growth. There were module supply issues due to the Uyghur Forced Labor Prevention Act (UFLPA) and the Department of Commerce anti-dumping investigation. There were also permitting delays due to capacity constraints at local governments. Further, there were delays in project bookings as customers awaited final Department of Treasury guidance on tax incentives related to the Inflation Reduction Act (IRA) tax credits. While these factors continued to be a headwind, things are improving sequentially, and the third quarter’s renewable segment sales were down 4.2% Y/Y vs 23.7% Y/Y decline in the second quarter. Things are expected to improve further in the coming quarters as module suppliers continue to move up the UFLPA process learning curve and the local government increases capacity to support demand levels. Further, clarity around IRA tax incentives in the coming months should also help sales. The backlog in this segment is up 13.3% Y/Y and I am expecting sales growth to turn positive in the next couple of quarters. In the residential segment, the company is doing a good job in terms of increasing its penetration with existing customers, entering new regions, and gaining new customers. However, its organic sales were negatively impacted last quarter as it made price adjustments in response to decreasing commodity prices and phased out less attractive product lines under its 80/20 initiatives. I am not too worried about it as these factors are transient in nature and should end once commodity prices stabilize and the company is done rationalizing its product lines. Further, phasing out less attractive product lines isn’t necessarily bad for the business and the company’s operating margins improved around 200 basis points last quarter as a result. On the recent earnings call, management shared positive commentary on residential market growth prospects and noted that participation gains with new and existing customers and entry into new regions should carry the company with a decent momentum in residential business in FY24. In the medium to long run, once the interest rate cycle starts reversing and macroeconomic conditions improve, I believe these participation gains should place the company well to outperform end-market growth. In the Agtech business, the company is seeing new orders accelerate and its backlog was up 9.4% sequentially last quarter. This indicates prospects of recovery in the coming quarters. Further, one of the large projects that the company was supposed to start in the second quarter got delayed and was started in September. This project is now running as expected and should help sales growth in Q4 and beyond. So, I am expecting a recovery in this market as well in the coming quarters. The infrastructure segment is seeing good momentum thanks to the Federal funding from the Infrastructure Investment and Jobs Act (IIJA) and given the end-market strength and long-term nature of infrastructure projects, I am expecting this momentum to continue in the coming years. Overall, while the last few quarters have been tough for Gibraltar Industries from an organic growth perspective, I see light at the end of the tunnel and believe the company can return to organic growth in FY24. Further, the company has a strong balance sheet with cash and equivalents of $85.5 million and no long-term debt as of last quarter. So, it is well placed to do bolt-on acquisitions which should further add to organic growth. Hence, I am optimistic about the company’s growth prospects.
Margin Analysis and Outlook
The company is doing a good job in terms of execution and was able to improve its operating margins by 240 basis points Y/Y in 3Q23 despite slightly down revenues. Segment-wise, margins improved in the renewables, residential, and infrastructure segments. While Agtech’s margin was down Y/Y, it was mainly due to the delayed start of a large project which, as I have noted in the revenue section, started in September. As this project ramps up, the segment should see improvement in margins. The company’s cost-saving and productivity initiatives as well as rationalizing its product lines to focus on higher-margin categories should continue to benefit the margins in the coming quarters. In addition, as the company returns to growth in FY24, it should also benefit from operating leverage from higher sales. Further, synergies from the integration of recent acquisitions like Quality Aluminum Products are also expected to help margins.
Valuation and Conclusion
ROCK is trading at 14.54x FY24 consensus EPS estimates of $4.71 and 12.86x FY25 consensus EPS estimates of $5.32. This is a discount compared to the company’s 5-year average forward P/E of 18.32x. According to consensus EPS estimates, the company is expected to post double-digit EPS growth for the next couple of years. I believe as the company’s revenue returns to growth next year and it continues to execute well on the margin front, the investor sentiments should improve and the stock’s valuation multiple can see an upward re-rating. Hence, I continue to maintain a buy rating on the stock.
