Encore Wire: the ace stock of the decade

Indraneel Kasmalkar
Jan 28, 2024
5 min read

Updated: Feb 1, 2024

Disclaimer: This article discusses stocks for informational purposes. Do not make financial decisions without consulting your fiduciary.

Key points

Encore Wire plays into the major themes of AI, EV, IOT.
Its earnings are set to rise with the price of copper over the next decade.
Stock is highly underpriced, of high quality, overly shorted, and is currently undergoing massive share buybacks.

Introduction

Climate change, electric vehicles (EV), artificial intelligence (AI), virtual reality, internet of things - these are the big themes of the upcoming decades. Unfortunately, the stocks associated with these themes already bear expensive price-to-earnings (PE) ratios - think of Nvidia, Tesla, Meta, Microsoft: they all have PE north of 30.

But what if there were a cheap stock you could invest in? Moreover, what if this business was relatively immune to the disruption that these new technologies could bring?

Welcome to Encore Wire, the ace stock of the decade. Encore Wire manufactures copper and aluminium wires and cables.

At first glance, a wire-making company sounds very pedestrian compared to AI and EV. But wires and cables are the building blocks of the AI tech revolution as well as the transition to sustainability. Copper consumption by data centers in North America alone is set to grow substantially for the foreseeable future [1]. Electric vehicles need four times as much copper than regular vehicles [2]. Encore Wire will benefit from the exploding demand created by the grand themes of the upcoming decades. Even if one AI technology is replaced by another, wires and cables will still be in demand. And it is precisely the pedestrian nature of the company that puts it at an attractive PE ratio of 8, as of January, 2024.

The business characteristics

Encore Wire was founded in 1994 in McKinney, Texas, and is a mid-size producer of copper and aluminium wires and cables in North America. Encore wire has shown stable growth of earnings and book value over the past decades, making it a reliable business with a nice 31% return on capital employed for 2023 [3]. It has a flawless balance sheet with zero debt which makes it immune to the high interest rate environment. Management seems extremely down-to-earth and very attuned to investors, given their commitment to stock buybacks.

In terms of the business model, wires and cables have become a market commodity whose prices are completely tied to the price of copper. However, Encore Wire behaves in a topsy turvy way where its profits skyrocket when copper prices are high. Essentially, high copper prices force the larger cable manufacturers to raise prices, while Encore enjoys large profits by keeping its operating costs low. When copper prices spiked in 2021, earnings for Encore Wire spiked seven-fold - a preview of things to come this decade.

The low operating costs of Encore Wire stems from the two competitive advantages. First, a single campus model: By keeping all its manufacturing facilities within the same plot of land in McKinney, Texas, it reduces transportation costs, maximizes scrap recycling, and ensures prompt delivery. Second, vertical integration of the entire copper-to-wire production chain: by reducing reliance on external suppliers as much as possible, Encore wire reduces supply chain disruptions and builds quality and efficiency. These advantages give it a durable economic moat.

Encore Wire does not believe in acquisitions. It prefers organic growth, and has been increasing its capital expenditures to expand its offerings.

Future Prospects

The spike in copper prices during the Covid-era created unprecedented profits for the company. With the recent abatement of the price of copper, Encore Wire's profits have declined as well. However, I believe that the price of copper as well as the profits of Encore Wire have bottomed already. Firstly, management indicates that they made notable operational changes in 2020 that have improved margins, suggesting that Encore Wire will not return to the pre-2020 slim net profit margins of 3-10%. Secondly, and more importantly, multiple sources warn of massive copper deficits in the coming decade as a result of the AI and the zero-carbon transition [4], placing Encore Wire in a prime position to reap benefits.

Encore Wire has also increased its capital expenditures, with over $150 million spent in 2022, $160 million in 2023, and a further $200-300 million to be spent in the 2024-2025 period. All capital expenditure was funded through its free cash flows! The company uses these funds to expand its product lines, such as building a new facility for cross-link polyethylene insulation [5].

The one risk I see for Encore Wire is physical climate risk: a single campus model makes the company highly vulnerable to extreme events such as hurricanes. Luckily, it is my day job as a climate risk scientist to simulate hurricanes and quantify physical climate risk. Stay tuned for some risk analysis in the coming months!

Recent stock price action

The WIRE stock price increased from 60 to 200 over the 2021-2023 period - a result of elevated copper prices. With the recent drop in copper prices there has been relentless shorting of the stock, with over 25% of open short interest. The short sellers clearly believe that Encore Wire got lucky with elevated copper prices during the supply chain disruptions of the COVID-era. Countering the short sellers is the company itself: Encore Wire has bought back over 2.5 million shares (12.5%) over the 2021-2023 period, stating that the stock is grossly underpriced. A further 1.2 million shares remain authorized for repurchase by March 2024. The buybacks were fueled by the huge profits of the COVID-era and highlight the company's commitment to deliver value to the shareholders.

Valuation

Based on the historical financial data for Encore Wire, I conservatively estimate a median earnings growth rate of 20% till 2035, leading to an earnings per share of $130.0 by 2035. Combined with a historical high PE of 20, the price in 2035 may end up at $2600 per share. All that is left is to put a discount rate of your choice!

Final thoughts

I wanted to invest in AI but I was aghast by the high PE ratios of AI companies. So I simply traversed up the supply chain until I could find companies with sufficiently low PE ratios. Encore Wire just seemed fantastic: a fortress balance sheet, no debt, upstream of the AI, EV and sustainability spaces, and a long 5-10 year runway predicated on elevated copper prices. Couldn't ask for better.

REFERENCES

Venditti (2023). Copper: The Critical Mineral Powering Data Centers. Visual Capitalist. Accessed Jan 13, 2024.
Stevens (2022). A coming copper shortage could derail the energy transition, report finds CNBC. Accessed Jan 13, 2024.
SimplyWallSt Editorial Team (2024). Why We Like The Returns At Encore Wire (NASDAQ:WIRE). SimplyWallSt.
Mills (2023). The global copper market is entering an age of extremely large deficits. Mining.com. Accessed Jan 14, 2024.
Encore Wire (2023). Encore Wire Reports Second Quarter 2023 Results. Encore Wire Investor Relations.