Armstrong World Industries: Shares Have Appreciated Enough (NYSE:AWI)

Things have been going exceptionally well for a company known as Armstrong World Industries, Inc. (NYSE:AWI). For those not familiar with the company, the firm is focused on the production of ceiling systems and other similar offerings. Back in October of last year, I wrote an article about the firm wherein I upgraded it from a “hold” to a “buy” after seeing shares underperform the broader market for some time. That underperformance, combined with improved revenue and profits, led me to be optimistic about upside potential eventually occurring.

Truth be told, that upside came a lot faster than I anticipated, and it was much more significant than I could have hoped for. Since the upgrade, shares of the business have risen by 58.2%. That is very nearly triple the 22.2% move higher seen by the S&P 500 (SP500) over the same window of time.

In terms of how shares are priced now, there is no denying that the company is not as cheap as it once was. In fact, while I still believe that the firm will do well for itself and its investors eventually, I think now might be a good time to take a step back and downgrade it to something more modest like a “hold.” This does not mean that I think the company will be a bad performer. Rather, it’s just that I think that further upside will more or less match the broader market for the foreseeable future.

Time for a downgrade

Fundamentally speaking, things have been really positive for Armstrong World Industries. As an example, we need only look at data covering the first quarter of the 2024 fiscal year. Revenue for this time came in at $326 million. That represents an increase of 5.2% compared to the $310 million generated the same time one year earlier. According to management, higher prices charged by the business contributed about $20 million to the firm’s upside. Volumes, however, managed to fall, impacting sales to the tune of 4%. Some of this growth was attributable to the company’s acquisition of BOK. However, organic growth, driven mostly by higher pricing, pushed revenue for the Mineral Fiber segment up by $11 million year over year.

On the bottom line, the picture improved as well. Net profits of $59 million came in comfortably above the $47 million reported for the first quarter of 2023. All other profitability metrics improved as well. Operating cash flow remained virtually unchanged at about $26 million. But on an adjusted basis, it rose from about $46 million to nearly $60 million. Meanwhile, EBITDA for the company expanded from $96 million to $111 million.

The first quarter of 2024 was not the only time in which the company has experienced upside. For 2023 in its entirety, revenue came in at just under $1.30 billion. That’s 5% above the $1.23 billion reported one year earlier. With that move higher in sales came higher profits and cash flows without exception. Net income grew from $212 million to $219 million. Operating cash flow expanded from $182 million to $234 million, while the adjusted figure for this grew more modestly from $232 million to $236 million. And lastly, EBITDA expanded from $385 million to $430 million.

The good news for shareholders is that there is no indication that growth for the company will stop anytime soon. Management said that revenue should grow by between 8% and 11% this year, climbing to between $1.395 billion and $1.435 billion. This should be driven by in part Architectural Specialties revenue that should rise by between 21% and 24%. They expect net profits this year to be between $253 million and $259 million. On an adjusted basis, net income should be between $256 million and $264 million. If everything goes as expected, adjusted operating cash flow should be somewhere between $365 million and $390 million, while EBITDA for the business should be between $465 million and $485 million.

This optimism seems to be based on an assessment of the health of the key markets that the company services. By vertical, about 30% of the company’s revenue comes from the education market, while another 30% is attributable to the office space. The first of these is expected to be positive for the business, thanks to what management describes as healthy state government budgets and further investments in research and development at laboratories across the country. The latter, however, is expected to be slightly negative. In the past, I have written about high vacancy rates in offices across the country. Naturally, this would lead to reduced spending in that area. However, I am surprised that management describes this as only slightly negative, when I would have expected it to be quite a bit worse than that.

Outside these categories, healthcare is the largest end use for the company’s products. It accounts for about 20% of overall revenue. Due to continued growth in hospitals and urgent care centers, it’s believed that this would be a slight positive for demand. The remaining 20% of revenue is split between transportation and retail. The former of these is expected to be positive, largely because of $15 billion in funding that has been set aside for airports by the US government that should be spent by the end of 2026. However, retail is expected to be a weak spot because of population shifts.

Taking these estimates, combined with historical results from 2023, I was able to value the company as shown in the chart above. On a forward basis, shares do look significantly cheaper. But even then, I wouldn’t exactly call the firm cheap. The stock is also definitely more expensive than it was when I wrote about the company in October of last year. In addition to this, shares look to be more or less fairly valued relative to similar enterprises. In the table below, you can see precisely what I mean. On a price to earnings basis, three of the five companies ended up being cheaper than Armstrong World Industries. This number increases to four of the five when looking at the price to operating cash flow multiple. And lastly, when using the EV to EBITDA multiple, this number drops to two of the five.

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Takeaway

Eventually, I fully expect that Armstrong World Industries will go on to achieve solid results from a growth perspective. Just in the ceiling and wall solutions category for the building products industry, the company boasts an installed base of roughly 39 billion square feet. This alone opens up the door for repair and remodel demand to push sales higher. The company is successfully acquiring other businesses, which is also helping.

However, Armstrong World Industries, Inc. stock does look to me to be fairly valued. Because of this, I think that downgrading it to a “hold” is only logical.