{"id":3896,"date":"2023-10-21T04:14:16","date_gmt":"2023-10-21T04:14:16","guid":{"rendered":"https:\/\/infundpros.com\/news\/preformed-line-products-reasonable-valuation-despite-potential-cyclicality-nasdaqplpc\/"},"modified":"2023-10-21T04:14:17","modified_gmt":"2023-10-21T04:14:17","slug":"preformed-line-products-reasonable-valuation-despite-potential-cyclicality-nasdaqplpc","status":"publish","type":"post","link":"https:\/\/infundpros.com\/?p=3896","title":{"rendered":"Preformed Line Products: Reasonable Valuation Despite Potential Cyclicality (NASDAQ:PLPC)"},"content":{"rendered":"
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Preformed Line Products Company (NASDAQ:PLPC<\/span>) has notable and well-covered tailwinds from U.S. infrastructure spending. For a business like Preformed Line Products (“PLP”) that sells products and parts for energy and communications projects, this will bolster demand and margins over the course of the next decade. On top of this spending, recent high oil and commodity prices have led to higher spending on infrastructure projects internationally. PLP’s operating income has risen over 200% since 2019 as a result of these tailwinds. Its stock has roughly followed and is up around 150% in that time.<\/span><\/p>\n

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Data by YCharts<\/figcaption><\/figure>\n<\/p>\n

These tailwinds in the U.S. are likely to continue for many years as the energy and communications projects that will be financed by the government, as dictated by the 2021 Infrastructure Deal, will fuel sufficient demand. However internationally, demand is a bit more difficult to predict as it is largely dictated by commodities. For example, PLP’s revenue from the EMEA region grew over 40% in 2022 and continues to grow at a rate similar to sales from the USA region because oil producing economies in those regions are growing quite well. This must continue for the company to maintain its elevated margins but it\u2019s difficult to predict due to cyclicality in commodity prices.<\/span><\/p>\n

I do think these tailwinds will continue for the next 12-18 months which, combined with a very reasonable valuation compared to my estimate of 2024 EPS, makes the stock attractive at its current price. Longer term however, operating margins must hold up to give the stock a good margin of safety. This is much more unclear as almost half of the company\u2019s sales are international sales that don\u2019t have long term tailwinds from a large infrastructure bill like the U.S has.<\/p>\n

Despite this uncertainty, I am assigning the stock a buy rating and a $225 price target based. I arrive at this target by taking the middle ground between my EPS estimate and my estimate of the company\u2019s intrinsic value. In this report I will provide a background on the company and its past financials, and I will discuss the thought process behind my price target in more detail.<\/p>\n

Past Financial Results<\/h2>\n

PLP has generally been average to below average over the past decade as judged by its returns on invested capital. This is often the case for relatively capital intensive businesses that provide products to businesses in cyclical industries. The parts that PLP manufactures are often commoditized but individual companies can have competitive advantages that relate to their ability to manufacture high quality products consistently and deliver them in a timely manner. Given the company\u2019s longevity and size, it is safe to assume that they have some of these advantages.<\/p>\n

The company\u2019s average ROIC over the past decade was dragged down by its returns from 2013 to 2017. 2013 through 2017 earnings were negatively affected by reduced demand due to a lack of investment by developed countries to upgrade their electrical grids and communication networks. In the 2017 annual report, the company blamed the lack of investment partially on low oil and commodity prices. Oil prices began to rise again in 2017, but were on a 3 year decline before that.<\/p>\n

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Preformed Line Products ROIC (Created by Author)<\/span><\/p>\n<\/figcaption><\/figure>\n<\/p>\n

The most dramatic rise in the company\u2019s returns on invested capital have come in the most recent years. The chart above shows ROIC through 2022 but I estimate ROIC in 2023 will be around 18%.<\/p>\n

While ROIC is a backwards looking metric, it demonstrates management\u2019s skill in allocating capital and business quality and if it has been consistently high for a long period of time there is a good chance that it will be high going forward. However PLP’s ROIC has not been sustainably elevated. The company\u2019s recently high returns on invested capital are primarily a result of the current demand environment as the business has not changed significantly in that time. Simply, there is higher demand for its products which is pushing volume and prices up for the company\u2019s products which in turn is raising profits. This makes it important to consider whether the current demand environment is sustainable as that will have the greatest impact on the company\u2019s returns on incrementally invested capital.<\/p>\n

It may be tempting to confuse these recent high returns with high business quality but it seems that the board of directors is not even convinced that the business is very high quality. Annual incentive awards for the management team are dictated by whether the company\u2019s return on equity is within in the range of 3-11%. I will discuss management\u2019s incentive pay more below, but I think this threshold says quite a bit about the company\u2019s expected long-term returns.<\/p>\n

Demand Backdrop<\/h2>\n

I think there are signs that are indicating that the demand tailwinds that have bolstered the company\u2019s recent returns will continue at least over the next 12-18 months. The main signs are the infrastructure bill in the U.S. that will keep investment in energy and communications projects high over the course of the next decade, and high oil prices that are boosting oil producing economies internationally.<\/p>\n

In 2016, the annual report specifically pointed out that \u201csales in the energy market continued to decline due to a slowdown in the number and scale of transmission projects in North America\u201d which contributed to the decline in earnings in that year. In 2022, the Biden administration announced that it advanced three large transmission projects to connect more clean energy to the grid. These project are a smaller part of the large push to achieve the goal of a \u201c100% clean energy grid by 2035\u201d. In late 2022, the Biden administration announced billions in expanded funding to modernize and expand the U.S. power grid.<\/p>\n

This are just two examples of the many projects that the U.S. government will fund over the next decade. Other projects are related to U.S. energy infrastructure and projects to help expand internet access. These will all be clear tailwinds for PLP over the next decade.<\/p>\n

Internationally, the long-term demand picture is less clear and will likely be much more cyclical. Non U.S. revenue made up more than 45% of revenue in 2022 so it is a significant portion of the business that will have a large part in determining earnings over the next decade. In fact, the region that has grown the most recently has been the Europe, Middle East and Africa (EMEA) region. On a constant currency basis, this region grew 44% year-over-year in 2022 and 30% year-over-year in the first half of 2023. The most recent 10-Q attributes this growth to volume increases in communications sales in the region.<\/p>\n

Why has volume grown so much in this region? With high oil prices, many economies in Africa and the Middle East are booming. For example, oil accounts for 40% of Nigeria\u2019s GDP, 70 percent of budget revenues, and 95 percent of the country\u2019s foreign exchange earnings and the country has recently announced a plan to being investing more in their infrastructure. PLP has a South Africa subsidiary that serves the \u201celectrical and communications markets in South Africa, as well as in neighboring territories such as Kenya, Namibia, Nigeria, Zimbabwe, Botswana, Mozambique and Swaziland\u201d and it has been successfully in capturing profit from these increased investments.<\/p>\n

The company doesn\u2019t mention specifically which countries in the Middle East it operates in, but its PLP Great Britain subsidiary \u201cserves communications and electrical utilities, contractors, cable manufacturers, and trading houses throughout the United Kingdom, Europe (including Eastern Europe), the Middle East and Africa (excluding South Africa).\u201d With so many oil producing economies in the Middle East, it makes sense that these countries are using this opportunity created by high oil prices to invest in their infrastructure.<\/p>\n

I expect this dynamic to continue for the next 12-18 months however longer term it is difficult to predict where oil prices will be. With no infrastructure bill backdrop in these countries, demand for PLP services will likely be more cyclical and dependent on the global economy.<\/p>\n

Price Target<\/h2>\n

My model for PLP’s intrinsic value takes some of this cyclicality into account as I assume revenue growth falls to the rate of GDP and operating margin compresses closer to its long term average.<\/p>\n

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Preformed Line Products DCF (Created by Author)<\/span><\/p>\n<\/figcaption><\/figure>\n

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Preformed Line Products DCF Continued (Created by Author)<\/span><\/p>\n<\/figcaption><\/figure>\n<\/p>\n

In this model I assume:<\/p>\n