Greetings

Introduction

Encore Wire Corporation (Encore) is a Delaware corporation, incorporated in 1989, with its principal office and manufacturing plants located in McKinney, Texas.

Encore manufactures a broad range of electrical wire and cables, used to distribute power from the transmission grid to the wall outlet or switch. Encore’s diversified product portfolio and low-cost of production positions it to play a role in the transition to more sustainable energy infrastructure. Figure 1, 2 and 3 show that Encore has done very well. It has outperformed both the industry average and the index over 15 years.

Customers

Encore sells its wire to wholesale electrical distributors throughout the United States. Most distributors supply products to electrical contractors. Encore’s customers are numerous and diversified. Encore has a bit of concentration risk with two customers, each of whom slightly exceeds 10% of the company's total sales.

Encore’s management believe that the speed and completeness with which it fills customers’ orders is crucial to its ability to expand the market share for its products. Management also believes that, for a variety of reasons, many customers strive to maintain lean inventories. Because of this trend, the company seeks to maintain sufficient inventories to satisfy customers’ delivery requirements.

Competition

The electrical wire and cable industry is highly competitive. Encore competes with several companies who manufacture and sell wire and cable products beyond the building wire segment, in which the Encore competes. The company’s primary competitors include:

• Southwire Company LLC;

• Cerrowire (a Marmon/Berkshire Hathaway company);

• General Cable (a company of the Prysmian Group);

• AFC Cable Systems, Inc. (a part of Atkore International).

Industry conditions

The residential, commercial and industrial construction industry, which is the end user of Encore’s products, is cyclical and is affected by a number of factors, including the general condition of the economy, market demand and changes in interest rates. Industry sales of electrical wire and cable products tend to parallel general construction activity, which includes remodeling. Data on remodeling is not readily available. However, remodeling activity historically trends up when new construction slows down.

Residential, commercial and industrial construction could decline if companies and consumers are unable to finance construction projects or if the economy precipitously declines or stalls. This could result in delays or cancellations of capital projects.

Operating performance

The company’s operating results are driven by several key factors, including:

• the volume of product manufactured and shipped,

• the cost of copper and other raw materials,

• the competitive pricing environment in the wire industry, and

• the resulting influence on gross margins and the efficiency with which the company’s plants operate.

Price competition for electrical wire and cable is significant, and the company sells its products in accordance with prevailing market prices. Copper, a commodity product, is the principal raw material used by the company in manufacturing its products. The price of copper fluctuates, depending on general economic conditions and in relation to supply and demand and other factors, which causes monthly variations in the cost of copper purchased. Additionally, the Securities and Exchange Commission (SEC) allows shares of physically backed copper exchange traded funds (ETFs) to be listed and publicly traded. Such funds and other copper ETFs hold copper cathode as collateral against their shares.

The acquisition of copper cathode by Copper ETFs may materially decrease or interrupt the availability of copper for immediate delivery in the United States, which could materially increase the company’s cost of copper. In addition to rising copper prices and potential supply shortages, management believes that ETFs and similar copper-backed derivative products could lead to increased price volatility for copper.

Encore cannot predict copper prices in the future or the effect of fluctuations in the cost of copper on the company’s future operating results. Wire prices can and frequently do change on a daily basis. This competitive pricing market for wire does not always mirror changes in copper prices, making margins highly volatile.

Figure 4 shows the operating performance of Encore. In particular 2021 and 2022 have seen massive increases in the company’s returns. This is driven by increases in gross margin, which are due to favourable market conditions. In short - wire prices are up because demand is good.

Copper supply

Chile is the world’s dominant copper supplier. It accounts for 30% of global production. But it’s overall production is close to 18 year lows. In addition, high-grade copper discoveries have become less frequent and more lower-grade discoveries have been made in the past decade - these discoveries are not viable at current prices. At the moment, many global copper producers are reducing their output, while global demand for copper continues to grow. This points to increased future input costs for Encore.

Key success factors

Encore sells a commodity product in a highly competitive market. Management believes that the historical strength of the company’s growth and earnings is in large part attributable to the following factors:

• industry-leading order fill rates and responsive customer service;

• single-site, vertically integrated business model;

• deep supplier relationships for key raw materials;

• product innovations and product line expansions based on listening to and understanding customer needs and market trends;

• low-cost manufacturing operations, resulting from a state-of-the-art manufacturing complex;

• low distribution and freight costs due in large part to the “one campus” business model;

• a focused management team leading a skilled work force;

• low general and administrative overhead costs; and

• a team of experienced independent manufacturers’ representatives with strong customer relationships across the United States.

Valuation ratios

Figure 5 shows valuation ratios. The reductions in P/E (and other ratios) are driven by increases in earnings. This makes Encore’s stock look cheap, but this is only true if earnings remain at these higher levels. If earnings drop, the valuation ratios will increase.

Conclusion

Encore is a well-run wire manufacturing company that has experienced significant stock price increases in the past two years. However, with interest rates rising, their customers may have challenges financing new projects. This could have a negative effect on construction projects which need wire. To some extent this may be offset by increases in remodeling, which occurs when new construction subsides.

Based on trailing numbers the company’s valuation looks low, but ROE and ROIC could reduce to their long-run averages, meaning the current valuation ratios could be misleading.

In Encore’s case, it is challenging to decide whether their recent stellar performance can continue or not. The outcome is largely based on two factors:

1. the outlook for copper, which is Encore’s main raw material cost, and

2. the average selling price of wire.

These two items determine the gross margin, which drives Encore’s profitability and its valuation.

Investment lesson

As often happens with investing, the future is fuzzy, yet your decision to invest is based on future expectations.

A good lesson to note here is to beware of using the rear view mirror to make investment decisions. The past financial performance looks great, but that does not tell us about the future. There’s tons of historical information available from the financial websites, social media and other places. This is often used to present persuasive investment cases. Do not get taken in.

As an investor, your job is to use current information and make educated conclusions about the investment potential. Even if you apply yourself, there are no guarantees that your thesis will be correct. If your thesis is correct, there are no guarantees that the market will react accordingly.

Welcome to investing :-)