Shares of industrial water and wastewater pipe and equipment maker Core & Main (CNM -0.20%) sank 16.7% on Tuesday, as of 2:12 p.m. EDT.
The company reported earnings this morning, and while revenue came in ahead of expectations, the company's falling margins apparently left a bad taste in investors' mouths. Also, given that the stock was already up 39% on year heading into Tuesday, a mixed result wasn't enough to overcome expectations.
Growth-by-acquisition not enough to overcome pricing normalization
In the quarter, Core & Main saw revenue increase 10.6% to $1.74 billion, ahead of expectations. But the problem was that gross profits only rose 6.6%, and net income actually decreased by 2.4%. Like its peers, Core & Main saw a big increase in pricing for its products following the pandemic, but that pricing is normalizing now. So while the company is still growing, its bottom line has stalled.
Furthermore, Core & Main is highly acquisitive, rolling up a fragmented industry providing water and wastewater pipes, meters, and other equipment. The many acquisitions Core & Main has executed recently have helped growth, but investors may be focusing on the core underlying organic growth of the business, which is only in the low-single digits.
Meanwhile, the growth-by-acquisition strategy has increased the company's debt to $2.45 billion, up from just $1.60 billion one year ago. So, that debt load, now at 2.7 times EBITDA (earnings before interest, taxes, depreciation, and amortization), up from 1.7 last year, may also be making investors nervous.
Industrials: A bargain or trap?
Industrial stocks like Core & Main are in an interesting tug-of-war right now. On the one hand, restrictive high-interest rates are making investors nervous, as these types of companies have revenue tied to construction activity. Meanwhile, yesterday's lower-than-expected Manufacturing PMI number from the Institute for Supply Management (ISM) caused further consternation that interest rates are beginning to slow the economy in a more significant way.
However, money from the Infrastructure Investment and Jobs Act is just now starting to flow into the economy, which could bolster demand, and Core & Main actually noted this in its presentation.
Thus, if the economy can sidestep a recession while getting inflation to normalize, industrial and construction stocks could be a great bet after this dip. However, if a recession hits, industrials could take a hit. With a levered balance sheet, Core & Main could see an outsized move either way even after today's big discount.
