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AZZ: A Well-Managed Company With Strong Demand in Industrial End Markets

·4 min read

As a relatively unknown small-cap industrial company, AZZ Inc. (NYSE:AZZ) has a promising future ahead of it. The company is a global provider of metal coatings services, welding solutions, specialty electrical equipment and highly engineered services.

The end markets it serves are power generation, electricity transmission and distribution and broad-based industrial markets where they protect metal and electrical systems used in a variety of infrastructure platforms. More specifically, the metal coating division provides hot dip galvanizing and other metal coating applications to the steel fabrication industry.


What is galvanizing?

Galvanizing is one of the most widely-used methods for protecting metal from corrosion. It is done by applying a thin coating of zinc to a thicker base metal, helping to shield it from the surrounding environment. Street signs, lamp posts and metal utility poles almost all use this process. The silver color on these items are actually the coating of zinc.

Without the protective zinc coating, the metal would remain exposed to the elements and potentially oxidize and corrode much faster. Galvanized steel is a cost-effective alternative to using materials such as stainless steel or aluminum to prevent corrosion.

Infrastructure bill

One of the Biden administration's major spending plans is the $1.2 trillion bipartisan infrastructure bill, known formally as the Infrastructure Investment and Jobs Act.

This 2,700-page bill would allocate $110 billion of new funds for roads, bridges and other related projects. The bill also includes a total of $40 billion of new funding for bridge repair, replacement and rehabilitation. In theory, this will be a great benefit to AZZ as steel products such as plates, pipes, tubes, rails and girders will be necessary to complete these massive infrastructure projects. The bill also allocates $65 billion for upgrading the electricity grid, which would benefit the companys Electrical Solutions segment.

Financial review

The companys latest financial release was on Jan. 10, 2022 for the third fiscal quarter of 2021 ending Nov. 30, 2021. Revenues increased 2.3% for the quarter, but there was a divergence in the two key segments. In the Metal Coatings division, revenues increased 15.4%, while in the Infrastructure Solutions segment, revenues decreased 11.4%.

The impressive sales in the Metal Coating division were driven by strong demand for hot-dip galvanizing within the renewables, utility, OEM and construction end markets. In the Infrastructure Solutions segment, some of the business units were affected by material delivery delays, including customer supplied components, as well as labor shortages.

Operating income increased 8% but was negatively affected by the slower growth in the Infrastructure Solutions segment. Net income for the nine months ending Nov. 30 was $62.4 million, an increase of 43% from the prior year period (excluding restructuring charges).

Balance sheet

The company maintains a relatively safe balance sheet with cash and equivalents of $20.4 million and long-term debt of $191.5 million. The current ratio (current assets divided by current liabilities) was strong at almost 3.

The company typically generates strong free cash flow, and over the past three fiscal years, free cash was $54.9 million, $109.7 million and $85.9 million. For the nine months ending Nov. 30, free cash flow was $30.5 million.

Valuation

AZZ is trading roughly in the middle of its 52-week price range. Analyst estimates for the fiscal year ending in February 2022 are $3.18, and for the following year, estimates are $3.46. The resulting forward price-earnings ratios of 15.5 and 14 seem reasonable, particularly considering the Infrastructure Solutions segment is somewhat under pressure. During periods of strong growth when all business units are clicking, the price-earnings ratio should be higher.

Strategic options

In the past, the company has commented on its emphasis for the Metal Coating business to be a key driver of corporate performance. In the most recent earnings release, management reiterated this goal by stating:


We continue to actively pursue initiatives to drive growth and enhance shareholder value. Previously, we have disclosed a desire for AZZ to become a predominately metal coatings company and over the past two quarters have meaningfully advanced our work on specific strategic options designed to achieve this commitment.


Conclusion

I believe AZZ is undervalued at this time and has the potential to generate strong gains going forward based on growth in end markets as well as internal execution on margin growth and strategic alternatives.

This article first appeared on GuruFocus.