Over the last six months, Insteel’s shares have sunk to $28.17, producing a disappointing 10.4% loss – a stark contrast to the S&P 500’s 10.9% gain. This was partly driven by its softer quarterly results and might have investors contemplating their next move.
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Why Is Insteel Not Exciting?
Even with the cheaper entry price, we’re cautious about Insteel. Here are three reasons you should be careful with IIIN, plus one stock we’d rather own.
1. Long-Term Revenue Growth Disappoints
A company’s long-term sales performance can indicate its overall quality. Any business can put up a good quarter or two, but many enduring ones grow for years. Unfortunately, Insteel’s 5.9% annualized revenue growth over the last five years was tepid. This was below our standard for the industrials sector.
2. Free Cash Flow Margin Dropping
Free cash flow isn’t a prominently featured metric in company financials and earnings releases, but we think it’s telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
As you can see below, Insteel’s margin dropped by 5 percentage points over the last five years. This along with its unexciting margin puts the company in a tough spot, and shareholders are likely hoping it can reverse course. If the trend continues, it could signal it’s in the middle of a big investment cycle. Insteel’s free cash flow margin for the trailing 12 months was breakeven.
3. New Investments Fail to Bear Fruit as ROIC Declines
ROIC, or return on invested capital, is a metric showing how much operating profit a company generates relative to the money it has raised (debt and equity).
We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Over the last few years, Insteel’s ROIC has unfortunately decreased significantly. We like what management has done in the past, but its declining returns are perhaps a symptom of fewer profitable growth opportunities.
Final Judgment
Insteel isn’t a terrible business, but it doesn’t pass our bar. Following the recent decline, the stock trades at 15.8× forward P/E (or $28.17 per share). While this valuation is reasonable, we don’t really see a big opportunity at the moment. We’re fairly confident there are better investments elsewhere. We’d suggest looking at the Amazon and PayPal of Latin America.
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