Monday, November 8, 2010

Spread Too Thin

Integrated Electrical Services (IESC) provides wiring, power connection and related maintenance services to the industrial, commercial and residential markets. The company trades for $52 million, but has net current assets of $74 million.

As one might expect, revenues for this company are highly cyclical, as they are strongly correlated with new construction. Indeed, Integrated Electrical has seen its revenues drop 30% from year-ago levels as the recession has put construction projects on hold.

But considering the types of services the company renders, one would expect the company to be able to cut costs to adapt to a lower revenue environment. Providing electrical services should require a great deal in the way of variable costs such as labour and supplies, but likely doesn't require fixed costs such as factories and specialized equipment. True to form, the company only has $20 million of property and equipment (versus quarterly revenue of $120 million).

Despite this, the company has been unable to reduce costs in line with demand. In its last quarter, the company lost $6 million, following losses of $12 million the quarter before. Part of these losses are due to bad debt and restructuring charges, but the majority of these charges are cash losses. This is despite the fact that the company has cut costs, as administrative expenses are down 20% from the year-ago period.

So what gives? Why can't the company match its variable costs with its revenues to at least break-even, like other companies we have seen with variable cost structures? The answer may be that the company's operations are spread too thin.

The company serves 48 states from 89 locations. Closing locations would reduce revenues further. It would appear that the company has made a choice to keep capacity high, even though demand is presently weak. This is confirmed by the fact that management stated on its last conference call that operating leverage is significant as the market recovers.

While Integrated Electrical looks cheap based on its net current assets, investors have to allow for the fact that further significant losses may occur before the company returns to profitability. As new construction demand remains relatively weak, there is an oversupply of electrical service providers, resulting in competition that is lowering margins. Integrated Electrical's decision to remain in most of its markets and battle it out for business rather than shrink and focus on profitability increases the chances of further losses, which reduces the appeal of the company at its current price.



Investments said...

good stuff.

Paul said...


I wanted to share this with you.

This is a great interview with
Alice Schroeder, author of The Snowball. This is a bit different than the average Buffett story since she does a bit of criticizing, but also gives him his bit of due glory. It looks like she and Buffett had a falling out after the book was published.

Anonymous said...

Hey Saj - great blog.

What do you think of ANCI?

Saj Karsan said...

Thanks, Paul.

Anon, I don't know enough about ANCI's industry to offer any useful comment on it