From Macro Trends to Micro Bets: A Market Outlook and Deep Dive into Atkore

In my early September post, I anticipated that the market sell-off was over and that, given the oversold conditions, equity markets were poised for a rebound. Indeed, they bounced back, gaining over 4% the previous week and adding another 1.3% this week. he major news this week was the Federal Reserve's unexpected 50 basis point rate cut—I had anticipated a 25-point reduction. However, the decision and the accompanying dot plot offered clarity on their future approach. The FOMC statement clearly signaled a shift from prioritizing inflation to a more balanced focus that now includes employment and economic growth. The dot plot suggests they expect to cut another 50 basis points this year and 100 basis points next year. That said, I would caution against relying too heavily on the dot plot for long-term forecasts; the Fed doesn't have a crystal ball and will adjust its expectations as new inflation and economic data emerge. If future data shows more significant weakness, the Fed has indicated it's prepared to react. Powell reiterated that the Fed is committed to staying ahead of the curve. However, current data, particularly on consumer spending and income, show the economy remains solid. Consumer spending grew at about 3% in Q3, which doesn't suggest an economy on the brink of recession. Despite strong consumer data, the deceleration in the labor market is undeniable. Payroll growth has slowed to an average of 116,000 over the past three months, down from 267,000 in Q1. Moreover, the quality of jobs is skewing toward the lower-income tier, and it's evident that tech and financial sectors are shedding jobs. These positions support middle and higher-income lifestyles, where consumers tend to spend more on discretionary items—unlike lower-income consumers who spend the bulk of their income on necessities. I believe we'll continue to see weakness in knowledge worker jobs, which will reverberate throughout the economy in 2025, considering that 70% of GDP is driven by personal consumption.

In the equity market, I began initiating shorts on indexes and individual names towards the end of the week, primarily through butterflies and put spreads. I'm not a doomsayer predicting an economic cliff, but the economy doesn't need to crash for indexes to experience a sell-off. We're now trading at the upper end of historical multiples, with the S&P 500's EPS expected to grow in double digits over the next two years—a high bar, in my opinion. If economic data does come in weak, it will likely be perceived as bad news again, especially since the start of the rate-cutting cycle is now behind us. Continued weakness in middle and upper-class jobs, leading to a further economic slowdown and downward EPS revisions for 2025, is the biggest risk I see in the markets currently (geopolitical events are unpredictable and could also be black swans). I think the market is pricing in a soft landing, but I'm personally not convinced that will be the case. With the S&P 500 trading at 22 times EPS—a multiple that's priced for perfection—I'm leaning towards expecting a 5–10% pullback as we head towards the end of the year and into 2025. The recent price action wasn't encouraging if you're long the market. After the Fed announcement, equity markets initially bounced but then sold off into the close on Wednesday. In overnight markets, they surged and opened up over 1.5% on Thursday, but those gains were again sold off intraday, and the market closed lower than where it opened. The entire move for the week happened during the overnight session on Thursday (in fact most of the gains for the year occurred overnight), and beneath the surface, the price action was not healthy. The combination of high embedded expectations along with price action indicating distribution suggests the risk/reward is to the downside at these levels. These are my beliefs, held loosely, and I'm always open to changing my positioning if the facts change.

In the bond market, the 10-year Treasury actually sold off after the 50 basis point cut, finishing the week higher by over 10 basis points. Some may have been surprised by this move, but I think it makes logical sense. Earlier this year, I mentioned that I would go long duration when the 10-year yield was over 4.5% and short duration when it was around 3.5%, with my fair value estimate in the high 3% to low 4% range. The start of the rate-cutting cycle had already been priced in by the markets, as the 10-year yield had dropped from nearly 4.5% to 3.6%. Some market participants may have even anticipated a more aggressive dot plot and interpreted Powell's comments as signaling a less aggressive path for future rate cuts. Improved economic data may have shifted investor sentiment toward the belief that the economy is on firmer footing, decreasing demand for safe-haven assets like long-term Treasuries. Lastly, and perhaps most significantly, investors may perceive that inflation risks are not receding as quickly—or could even pick up due to sustained consumer spending and a return to easier monetary policy with asset prices near all-time highs. They may demand higher yields to compensate for expected inflation eroding real returns. So, the rise in long-term rates was driven by the interplay of market expectations, economic data, and investor sentiment. While the Fed's actions influence short-term rates, long-term yields are more sensitive to expectations about future economic growth, inflation, and monetary policy trajectories.

MS Software Earnings Review

MS had an interesting note reviewing software earnings, reaching the same conclusion I did after going through all the earnings reports and calls. In Q2 2024, 91% of software companies beat revenue estimates, consistent with last quarter and outperforming the trailing four-quarter average. However, while the number of beats was high, the magnitude of those beats shrank. In other words, companies are getting by with smaller wins. EPS and free cash flow results were stable on the surface—92% of companies beat expectations—but, similar to revenue, the magnitude of those beats was decreasing. For the third straight quarter, fewer companies managed to beat margin estimates, and those that did posted smaller wins. Why is this happening? Many companies are ramping up investments, preparing for what they hope will be a more stable economy in 2025. The macro environment continued to be challenging, especially in small and medium-sized businesses, and forward guidance drove stock performance. Companies that increased full-year guidance were bought up, but those that cut or did not raise were met with violent sell-offs. Applications and vertical software were the worst performers, as companies like SNOW and TEAM showed lower margin beats due to increased investments in growth. Meanwhile, the beaten-down EdTech sector was the best performer, posting an average 2% revenue beat and a margin beat of 230 basis points. Given the low expectations coming into the quarter, stocks like COUR saw significant appreciation.

Industrial Sector Upgrade

Speaking of MS, they also issued an upgrade on the industrial sector, viewing it as set to benefit from three major themes: U.S. reshoring, the era of efficiency, and the electrification of everything. They believe these three tailwinds will combine to drive top-line growth at 300 basis points above GDP growth for the industrial sector. They highlighted two industrial picks they like—TT and ETN.

TT 0.00%↑ is a supplier of energy-efficient HVAC systems, with 50% of revenue coming from commercial, 30% from residential, and 20% from transport. The thesis is that U.S. reshoring spending on manufacturing and physical infrastructure will benefit energy-efficient solutions (70% of revenue is from the Americas). Another bullish point is that 30% of total revenue comes from recurring maintenance contracts. MS anticipates high single-digit organic top-line growth coupled with a few hundred basis points of margin expansion and assigns a premium multiple given the exposure to a theme that looks sustainable for the foreseeable future. ETN 0.00%↑ was another pick, and the thesis here revolves around power management. They sell products like power distribution, circuit protection, and UPS systems. Their clients include utilities, manufacturing plants, data centers, and military entities. ETN is clearly a great way to bet on EV infrastructure build-out, data center needs for AI workloads, and manufacturing facilities. MS looks for top-line growth to be mid-single digits with 100 basis points of margin expansion.

While the tailwinds for the industrial sector are clear, I think it's tough to own these names at current valuations, which are at or near all-time highs. Despite all the tailwinds, the companies are projected to grow the top line slightly above GDP with minimal margin expansion on the horizon, for which you're paying a hefty multiple. A lot of good news and future growth is priced in, and while there is certainly a path for them to achieve high single-digit CAGR in top-line growth while the multiple remains near today's levels, any sentiment deterioration about the durability of growth in the megatrends and how much TT and ETN will benefit could cause multiple contraction and some pain. The risk/reward here isn't great at these levels, in my opinion, and requires patience.

ATKR 0.00%↑

Speaking of industrials, I started buying ATKR a few weeks back and have accumulated almost 70% of my potential maximum position. ATKR provides components such as PVC pipes, conduits, and electrical raceway systems that are critical for facilitating the safe routing of wiring in buildings and industrial projects. Their PVC and galvanized pipes are extensively used in residential, commercial, and industrial construction to house and protect electrical wires. These conduits are essential in solar installations, data centers, and commercial buildings, providing a protective pathway for electrical wiring. They also sell racks and mounts for data centers and solar panels, which are crucial in the booming data center industry and the expanding renewable energy market. ATKR manufactures racks that support the massive wiring infrastructure required for modern data centers and mounting equipment for solar panels. They offer an extensive array of products, and you can find the full list on their website.

To understand how ATKR arrived at its current position and some of the recent issues, it's important to look back at how things unfolded during COVID. The pandemic threw a wrench into global supply chains and economies, but Atkore not only weathered the storm—it found ways to thrive. When COVID hit, it was a seismic shock: supply chains snapped, factories went silent, and uncertainty became the only constant. For Atkore, whose products are integral to construction and infrastructure projects, the pandemic brought significant pricing volatility. Lockdowns and restrictions led to the closure of mills and factories, choking the supply of essential raw materials like steel and PVC. At the same time, an unexpected surge in residential construction occurred as people stuck at home sought to improve their living spaces. This mismatch between dwindling supply and rising demand sent prices for Atkore's products soaring to unprecedented heights. The company's metal electrical conduits, plastic pipes, and conduits—critical components in construction—became harder to source and more expensive. Distributors and contractors found themselves scrambling, and Atkore had to navigate this chaotic landscape carefully. They faced the challenge of meeting customer needs while managing their own supply constraints and cost increases. However, they were able to capitalize on these challenges by passing on price increases due to heightened demand and material shortages, particularly in PVC. This allowed the company to drive gross margins and revenue higher during the pandemic boom years. As supply chains normalize post-COVID, pricing pressures have eased, especially in commodities like PVC. Atkore has seen declining revenue in recent quarters as prices for these materials have fallen. However, the company has managed to maintain gross and profit margins that continue to be higher compared to pre-COVID levels, indicating a level of pricing power and demand stability in their core products.

After experiencing a significant boost to top-line growth driven by price increases during COVID, ATKR is now undergoing a reverse dynamic where prices are coming down as supply chains normalize. Predicting the exact timing of price normalization is challenging, but several indicators suggest that prices may begin to stabilize or gradually increase over the next 6 to 12 months. Many of the tailwinds outlined by MS in their upgrade of the industrial sector apply to ATKR. Government initiatives, such as the U.S. Infrastructure Investment and Jobs Act, allocate substantial funding for infrastructure projects, including electrical and utility upgrades. This increased spending is likely to drive demand and support price stabilization. Key markets such as data centers, renewable energy projects, and infrastructure upgrades are experiencing robust growth. These sectors are significant consumers of Atkore's products.

Does ATKR have a durable competitive advantage? On the surface, it seems like ATKR sells commodity parts, but in the construction and infrastructure sectors, the cost of materials like electrical conduits and fittings represents a small fraction of total project expenses. However, their availability can make or break project timelines. A missing conduit or fitting can halt progress, leading to costly delays. Atkore understands this critical dynamic. Their ability to provide timely deliveries ensures that projects proceed without interruption. They've built an extensive distribution network, strategically locating facilities to reduce shipping times. Advanced inventory management systems keep product availability high, and responsive customer service teams are ready to handle inquiries and expedite orders. Their comprehensive range of high-quality products makes Atkore a one-stop solution for customers. From metal and PVC conduits to cable management systems, they cover a wide spectrum of needs. Rigorous testing and compliance with industry standards build customer trust, and continuous product development addresses emerging needs, such as solutions for renewable energy installations. ATKR materials make up a small portion of the cost related to a construction project, so end customers are less sensitive to price and more sensitive to being able to obtain parts in a timely manner.

When dealing in a commoditized sector, it's critical to have faith in management's ability to execute and allocate capital efficiently. In terms of execution, management has built a fantastic track record and utilizes an internal system called the Atkore Business System (ABS), which is the cornerstone of their operational excellence. Built upon core values of accountability, teamwork, integrity, respect, and excellence, ABS guides all business practices and emphasizes a strategic focus on people and processes, ensuring alignment across the organization. Their approach bears similarities to the renowned Danaher Business System. Like Danaher, Atkore focuses on continuous improvement, strategic acquisitions, and talent development. Both companies understand that operational excellence and a strong culture are sustainable competitive advantages. When it comes to capital allocation, Atkore is disciplined and strategic. They prioritize internal investments in projects with high returns on invested capital. Using the proceeds from the boom COVID years, ATKR reduced shares outstanding from 48 million in 2020 to under 37 million as of 2024. They have also been serial acquirers, using acquisitions to enter new markets and broaden their product offerings. By acquiring companies with complementary products or technologies, the company accelerates growth and diversifies revenue streams. For example, the acquisition of Heritage Plastics in 2019 expanded Atkore's PVC conduit and fitting offerings, strengthening its position in the electrical raceway segment. To be bullish on ATKR, one has to believe that their capital allocation strategy will be key to success by enabling the company to grow organically and through acquisitions, improve operational efficiency, and enhance shareholder value through timely buybacks.

The electrical infrastructure industry has seen significant consolidation in recent years. Larger players like Atkore have been actively acquiring smaller, often family-owned businesses. This strategy not only expands their capabilities and market reach but also increases their bargaining power with suppliers and customers. Atkore has positioned itself as a market leader, holding substantial shares in several product categories. Their economies of scale result in cost advantages and improved margins. Competition is fierce, and challenges abound. Price competition from smaller players can erode margins, and rapid technological advancements require continuous investment in research and development. Yet, Atkore's diverse product portfolio reduces dependence on any single market segment. Their strong distribution network enhances market penetration and customer service, and their focus on innovation keeps them ahead of industry trends and customer needs.

So why buy a "boring" business that is a provider of commodity parts with a hard-to-distinguish competitive moat and no top-line growth over the next two years? For me, it's about their exposure to megatrends such as infrastructure spending, renewable energy, and the electrification of industries. The management team is very solid, and I believe their ability to make strategic acquisitions, grow their product portfolio, and maintain pricing power sets them up for sustained profitability. Many of Atkore's markets are fragmented, with numerous small competitors. This fragmentation provides opportunities for Atkore to increase its market share through both acquisitions and competitive differentiation. Utilizing ongoing FCF to repurchase shares at today's levels will pay dividends to shareholders in future years. ATKR should be able to generate at least $200–300 million in FCF per year, and with their pristine balance sheet, they can utilize that FCF to retire almost 7–10% of shares outstanding per year at today's levels. Valuation is another reason I decided to take a shot on ATKR. I think top-line declines driven by the normalization of pricing (unit volumes continue to be healthy) will come to an end sometime in 2025, and growth will resume in 2026. In my downside scenario, I've assumed top-line growth will resume at 2–3%, equivalent to GDP growth, and EBIT margins will decline to 17% by 2028. Shares outstanding will decline by 4% per year, and the stock will trade at a multiple of 7x 2028 EBIT of $540 million. Discounting the stock back at 10% gives me a current value of around $83 per share, or a 5% discount to where the shares trade today. In my more baseline scenario, I think top-line will grow at 100–200 basis points above GDP, with EBIT margins sustaining at ~20%, shares outstanding declining at 6% annually, and the stock trading at 8x EV/EBIT. Using the same 10% discount rate, that puts the stock at around $130 per share, or a 50% premium to today's price. This is the type of setup I like where a lot of the bad news is priced into the stock, and even if things don't go as well as I assume, the downside is limited.

Of course, there are risks: they are heavily reliant on the construction industry, which is cyclical. A downturn in residential or commercial construction could negatively impact demand for their products. A significant portion of Atkore's products is made from materials like PVC and steel, which are subject to price volatility. While the company has managed these swings well so far, future commodity price shocks could impact margins. Atkore operates in a highly competitive market with a number of alternative suppliers. The commoditized nature of some of their products could lead to margin pressure if competitors undercut on price. They have limited visibility into future earnings as their backlogs are very short-term in nature, and they don't have the ability to foresee downturns in future horizons.

Bottom line, I think management will navigate future pitfalls effectively and will be able to sustain higher margins compared to pre-COVID levels. They have done a commendable job expanding their product offering while positioning themselves as a key supplier in all of their product categories. Even if I'm wrong, I don't think my downside is significant, and if they manage to hit my base case, this investment can generate mid to high double-digit IRR over the next five years.