Investment Jungle

After having done my preliminary analysis of Encore Wire Company (WIRE), I decided that this company definitely deserves further study to determine if it is a Rule #1 wonderful business.

Company Profile:

The company profile was highlighted during my preliminary analysis. Encore Wire Company is a low cost manufacturer of copper electrical building wire and cable.

The Big Five:

Rule #1 Big Five were calculated during the preliminary analysis and there was a gap of 4 years where the numbers were not Rule #1 investor friendly. These gave me pause for concern and I hope to find the cause of those poor performing years.

Debt:

Looking at their 10K Annual Filing, there is long term debt of $98,974,000. This debt is comprised of a $45,000,000 of 5.27% Senior Notes and $55,000,000 of floating rate Senior notes. Both are due in 2011. The company does have a $200,000,000 line of credit that could be used to cover those debts if required in 2011.

For a Rule #1 investor, the right amount of debt is zero. But as long as the company can pay off its long term debt quickly (within 3 years), then it is acceptable. To determine whether or not the debt could be paid off in 3 years, we divide the total long-term debt by current free cash flow.

Well, current free cash flow at the end of 2006 was negative $8,200,000. With a free cash flow in the negatives, you will never get this debt paid off. And this is not the first year that Encore has shown a negative free cash flow. In fact, 4 of the last 5 years has shown a negative free cash flow.

So debt is definitely an issue for a Rule #1 investor looking at WIRE.

Competitors:

Management states that

The electrical wire and cable industry is highly competitive. The Company competes with several manufacturers of wire and cable products beyond the building wire segment in which the Company competes. The Company’s primary competitors include Southwire Company, Cerro Wire and Cable Co., Inc., United Copper Industries and AFC Cable Systems, Inc.

Management believes that it is competitive across the principal elements of competition which include pricing, order fill rate and breadth of product line.

WIRE has not experienced any significant competition from imports of building wire.

Risks:

Management has identified a number of risks:

1. Product Pricing and Volatility of Copper Market

• Copper is the principl raw material used by Encore. It accounted for 82.3% of its cost of goods sold during 2006. Obviously an increase in the price of copper will squeeze their margins.

2. Reliance on Senior Management

• The company feels that keeping both the President and CEO and the company’s vice president are an important part of the company’s success. And neither of these men are bound by an employment contract.

3. Industry Conditions and Cyclicality

• The sale of copper wire is highly correlated with the general level of construction including remodeling. A downturn in the housing market would have an adverse affect on the company.

Insiders:

Encore Wire Company (WIRE) Insiders

Name	Age	Officer Since	Position
Rego, Vincent A.	82	1989	Chairman Emiritus
Jones, Daniel L.	43	1992	President, CEO, Director
Bilban, Frank J.	49	2000	Vice President - Finance
Weaver, Scott D.	48	1993	Director
Courtney, Donald E.	76	1998	Director
Brito, Joseph M.	84	1997	Director
Wilson, John H.	64	1994	Director
Cunningham, Thomas L.	63	2003	Director

There has not been any insider trading in 2007 worth mentioning. The last big flurry of insider activity occurred in February 2006 and there were many sell orders.

Analysts:

There are 2 recommendations this month by analysts. One has a strong buy, the other has a hold.

The problem with these small cap stocks is that they don’t tend to have a lot of analysts following them. So in this case, we have two analysts who are on different sides of the fence.

The Tools:

Let’s look at the 3 tools (Moving Average, Stochastics, MACD).

MACD Analysis:

“Beginning of a mountain, time to buy. Beginning of a valley, time to sell.”

That is a quote from Phil Town. Currently, this stock is sitting in the middle of a deep valley but the trend seems to be turning around. The first trigger point will come when the zero line is crossed and a mountain starts to form.

Stochastics Analysis:

“Buy line crosses up, buy. Buy line crosses down, sell.”

Another Phil Town quote. Currently, the sell line is above the buy line. But the buy line looks to be turning the corner and may soon cross up.

Moving Average Analysis:

“When the price line crosses above the moving average line, buy. When the price line crosses below the moving average line, sell.”

Yes. Yes. Another Phil Town quote from his book. It looks as though the price line is just about to break over the 10 day moving average.

It looks as though all 3 tools are set to indicate a BUY in the near future.

Conclusion:

Having done a deeper analysis of Encore Wire Company, I have some concerns.

First of all, the debt is a big issue. And possibly more importantly, the negative current free cash flow seems to be a trend in this company. It has been negative 4 of the last 5 years.

Secondly, the housing boom in the US has helped fuel this company to fantastic Big Five numbers in the last 4 years. But now that the ride is over, how will this affect WIRE? Will they go back to their old ways where the Big Five were all single digits?

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