Powell Industries: At Forefront Of 4th Industrial Revolution (NASDAQ:POWL)

When I first learned about the Fourth Industrial Revolution (sometimes referred to as “Industry 4.0”) which was originally discussed in 2016 by Klaus Schwab of the World Economic Forum, it was after this review of it came out in 2020 on Seeking Alpha suggesting that the Fourth Industrial Revolution is just beginning that I became interested in the investing aspect of this latest trend.

We believe we are living through the Fourth Industrial Revolution today, and that it is driving the current pace of innovation in the marketplace. Building on the Third, a digital revolution occurring since the mid-20th century, the Fourth reflects many technologies – blurring the lines between physical, digital and biological spheres.

Technological and industrial advancements increase economic productivity, which is foundational to wealth creation. Paul Krugman, Nobel Prize winner in economics, noted: “Productivity isn’t everything, but in the long run it is almost everything, as a country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.” Today, the average American only needs to work 11 hours per week to match the productivity of a 40-hour work week in the 1950s.

Now, four years later I believe that we are starting to see the impacts of increasing productivity from AI, the electrification of everything, digital automation of just about everything we use in our daily lives, and process optimization in manufacturing as a few examples. The chart below from the US Bureau of Labor clearly illustrates the dramatic rise in productivity over the past 50 years.

The SA article went on to predict:

This trend toward increasing productivity, a result of the Fourth Industrial Revolution, is only beginning, in our view. Over the next decade, we believe we will see major technology-driven efficiencies or product improvements in many areas. These will include insurance, medical diagnosis, automotive distribution, industrial design, the pricing and exchange of capital, and the analysis of data.

In the category of “industrial design”, I identified Powell Industries (NASDAQ:POWL) as one company that would likely stand to benefit from its increasingly important role in the fourth industrial revolution in this article that I wrote back in March 2023: Powell Industries: A Growth Stock For The Fourth Industrial Revolution. This was what I wrote about POWL at the time:

Powell Industries, Inc. is diversifying away from oil, gas, and petrochemical industries to expand product and services offerings to benefit from Industry 4.0 trends. Major advancements in manufacturing are one beneficiary of this latest industrial revolution. Connected physical and digital systems and assets, advanced automation, digital intelligence, and other key factors are delivering the benefits to various industrial processes and sectors.

When I composed that first article, I mistakenly rated the stock a Hold because I thought it was overvalued at $44. Today the stock trades for about $168 and has delivered a total return of 285% since the article was published.

I am upgrading POWL to a Buy for long-term growth investors but with the caveat that from a technical perspective, I believe that the stock is likely to trade below $150 before it rises higher than $170. If you study the chart, which I have included from Yahoo Finance to more clearly show the technical trading pattern over the past few months, you will see a series of peaks and valleys. I am no expert in technical analysis, but it does appear to me that we are descending from the latest peak.

Furthermore, there was recent news that impacted SuperMicro (SMCI) stock which reverberated to other stocks in the electrical industry.

SMCI’s fall led to declines for other companies in the electrical equipment industry such as Powell Industries, a maker of power-distribution equipment for electrical utilities that are seeing rising demand from energy-hungry AI.

Any hint of a downturn in electrical demand could easily cause market sentiment to change, which could potentially lead to a selloff of POWL stock. In addition, there was some recent insider selling at $185 per share, which could have marked the recent top for the stock.

On the other hand, Zacks investments rates the stock a Strong Buy after the company reported an earnings beat in late July.

In late July, Powell posted a strong quarter, beating estimates by 79%. EPS came in at $3.79, which was up from $1.52 last year. Revenues came in at $255.1M v the $171.4M last year.

Net new orders were $235M, which was higher by 19%. The company had a backlog of $1.3B in the prior quarter and was able to keep that number at $1.3B after expanding its capacity. Management commented that excellent project execution improved gross margins by 510 basis points.

The SA Quant system also rates POWL a Strong Buy with very good factor grades in all categories.

What is Powell Industries’ Market Advantage?

Powell are experts in electrical distribution for multiple industries and applications. From the company’s 3Q 2024 Investor Deck:

From the fiscal Q3 earnings call, Chairman and CEO Brett Cope provided this summary review of quarterly results:

Revenues in the quarter were 50% higher than the prior year as we saw strength across nearly all of the market sectors we serve. The revenue growth was driven by our core industrial end markets as oil and gas and petrochemical revenues grew 56% and 158%, respectively. Our utility sector also delivered a strong performance. We booked $356 million of new orders in the quarter, the highest quarterly total of fiscal 2024 and orders were spread broadly across our key end markets. We saw a significant increase driven by our electric utility sector, further underscoring the strength we are seeing in that market.

As evidence mounts that efficiencies in productivity are contributing to financial performance as additional proof of the impacts of Industry 4.0, he further commented on margin improvements within all aspects of the company’s operations:

Another encouraging dynamic we are observing is the improvement in gross margins across the whole of our business, including many of our nonindustrial markets. Historically, projects in these markets tend to carry a slightly lower average gross margin than highly complex electrical solutions. However, we are now seeing that gap narrow as the economics of these nonindustrial markets are improving and Powell becomes more effective in our manufacturing and delivery process.

On the bottom-line, we recorded net income of $46.2 million or $3.79 per diluted share, which was more than double the $18.5 million or $1.52 per share in the prior period.

According to the POWL EPS Quarterly Estimates and Surprises, the company has beaten estimates by nearly 50% for the past two quarters and are expected to increase by 80% on a year over year basis in FQ4 2024.

Expansion Plans

And even if the change in earnings growth declines next year as indicated by the orange line, there is still plenty of room for additional growth in the next few years due to company expansion and acquisition plans that are likely not reflected in those future estimates. Some of those new capacity initiatives were also discussed by CEO Cope on the Q3 earnings call:

Last year, we completed the expansion of our Houston facility on the Gulf Coast, which is providing us with incremental fabrication and integration support for large power control rooms especially for projects that support delivery and transport by water access.

The previously announced expansion of our electrical products factory in Houston is also progressing as planned. This $11 million factory addition is expected to be completed in the middle of fiscal 2025 and coincides with our initiative to release new products in support of our future growth across the customers and markets we serve.

Most recently, in early July, we acquired nine acres of property neighboring our Houston headquarters location for a total consideration of $5.5 million. We are currently undertaking some minor remediation work to get the space prepared for productive use and we expect this additional property to contribute incremental revenue in fiscal 2025.

End markets that the company serves are growing too, including electric utilities in part to meet the growing demand for electric power for AI-driven data centers and other industrial markets that need reliable, secure power.

In fact, one analyst on the Q3 earnings call asked about the growing demand from the electric utilities that POWL serves.

Q. Brett, it sounds like you’re more constructive on the utility market than you were, say, six months ago. Can you talk a little bit about what’s going on there? And what’s the opportunity profile as you see it?

A. The utility market, as you know, over the last — over the long haul, we’ve intentionally built a strategy, especially on the distribution side with the infrastructure spend and the hardening, if you will, and the resilience that the utilities are building in U.S., Canada, U.K. specific where we’re really focused. There’s some international there, but that’s the bulk of our core market.

More recently, we are seeing some new generation of market. I won’t say it sort of went away, but it’s coming back a little stronger and then our participation rate is stronger.

Yet another indication that the Industry 4.0 trends being embraced by Powell are helping to grow the business, improve financial performance, and help streamline operations was this summary of the current state of the backlog, which was essentially inline with the previous quarter but with higher convertibility, as explained by CFO Mike Metcalf and illustrated on the slide from the Investor Deck.

Last quarter, if you looked at the $1.3 billion of backlog, the convertibility over the next 12 months was in the mid-50% range. this quarter, as you’ll see in the Q, when we publish it right after this call, that’s up in the 60-percentage range. So, we’re getting a little bit more out the door from our backlog, and that’s helping elevate the revenue level as well.

New Technologies = New Opportunities

New technologies are driving new opportunities for Powell as well. For example, automation of manufacturing processes via remote diagnostics and predictive analytics help to lower the overall cost of ownership for capital equipment on a global basis. Increasing demand for renewable energy including biofuels/biodiesel continues to provide new opportunities as does the evolving battery storage technology and grid resilience measures that global utilities are increasingly adopting. According to CEO Brett Cope, R&D spending increased by 49% on a YTD basis (through June 2024).

Although the oil & gas sector still provides about 40% of the revenue mix, there are longer term opportunities in carbon sequestration and carbon capture as well as hydrogen fuel technology that may provide additional revenue sources beyond the current and traditional technologies like LNG, petrochemical, and refining as explained by CEO Cope on the Q3 earnings call.

The fundamentals for our oil and gas and petrochemical markets continue to support our expectation for continued strength for these sectors. This sector includes energy transition projects, such as biofuels, carbon capture, and hydrogen, areas where Powell has not historically participated, but where we are seeing a substantially higher volume of project activity.

Risks and Threats to Continued Growth

With its relatively small market cap of about $2B and a high amount of short interest (currently about 14% according to SA), there is some potential for continued price volatility as I suggested in the introduction. The stock price responded positively to the latest quarterly earnings report, jumping by as much as 40% immediately after the report on July 31. However, since that time and similar to the price action after the Q2 report, the share price has now retreated from its recent high of about $190 back to the mid-$160 range. There is not much coverage by Wall Street analysts with only 2 analysts providing forward estimates, and any negative news can cause short-term traders and speculators to sell, driving the price down just as quickly as it went up.

Additionally, any downturn in the petrochemical and refining industries due to slowing global demand for oil and gas products will likely have a significant negative impact on future earnings. The US economy is responsible for the vast majority of revenues (over 80% of total) and while the economy has remained strong in 2024, that could change after the election in November or due to unforeseen events across the globe including increasing geopolitical conflicts, slowing growth in China impacting global demand for oil, or some black swan event that could cause the overall market to crash.

What is the Price Target for POWL?

Currently, the company has a strong backlog, holds $374 million in cash (as of the end of June) with no debt, and is raising earnings estimates for fiscal Q4. The stock has momentum, trades at a very reasonable forward P/E of 13.88, and is showing signs of consolidating in a technical price range between about $130 and $185. The TTM GAAP P/E of about 15 is on the low end of the one-year range suggesting that growth is expected to slow.

It can be difficult to predict price action on a small cap growth stock, especially when there is very little coverage from Wall Street analysts and relatively high short interest. In my experience with growth stocks, when there is strong momentum and increasing EPS estimates (even if only by 2 analysts as in the case with POWL) along with a strong balance sheet, the odds are in favor of a rising price until there are clear signs of a slowdown. The latest EPS revisions have been up as shown on the EPS Revisions page.

At the current P/E of about 15 times earnings, the price target for FY 2025 (starting in October) would come in at about $187. However, future EPS estimates are likely to continue to increase as we get further along in 2024 and a more reasonable P/E for POWL given its one-year average of around 20 gives us a target price closer to $250. Therefore, unless we see a substantial market correction in the next several months, I view POWL as a Buy at the current price of about $168 and a Strong Buy if the price should drop below $150 due to a market correction or changing sentiment (and not because of a change in the business).