Superior TeleCom's Inferior Earnings

By Brian Graney (TMF Panic)
September 9, 1999

Providing the wiring that makes our electrically connected world go 'round might not sound like the sexiest business to be in, but somebody has to do it. The demand to "plug in" has been generally pretty good to wire and cable supplier Superior TeleCom (NYSE: SUT), whose shares nearly tripled from when the company first went public in late 1996 up to this time last year.

Since then, though, shareholders have watched the firm's growth story unravel as pricing pressures and reduced demand in key product areas have dropped the stock 30% over the last year. More bad news came last night, when the New York City-based company warned that Q3 and fiscal 1999 earnings will fall short of estimates.

Two of Superior's three main businesses are currently tied up in knots. Lower than anticipated shipments to telephone company clients will hamper sales of communications cable, which represented 38% of total revenues last quarter. Meanwhile, the company's electrical wire business (29% of revenues) will see its operating profits sliced after margins for copper building wire fell apart in July. As a result, Q3 EPS is seen coming in $0.30 to $0.36 short of the First Call mean estimate of $0.88. Full year EPS will miss the $3.03 estimate by $0.52 to $0.68.

Superior expects the picture to clear up rather quickly in the future, writing off the communications cable slowdown to customers adjusting their inventory levels. Building wire margins have improved "significantly" in the past six weeks, which will allow for "substantial" operating margins and profit contributions later this year and into next year. The company's third business segment -- selling magnet and automotive wire products -- is humming along quite nicely, although it is too small to bail out the recent poor showings of the other two units by itself.

Despite the setbacks, Chairman and CEO Steven Elbaum is convinced that the business will "deliver 20% annual growth in earnings and long-term growth in shareholder value." That may seem attainable at first blush, considering the ongoing boom throughout the telecommunications infrastructure business. However, Superior doesn't fit the typical model of a go-go telecom growth company. Elbaum must be playing his cards close to his vest, because it's not immediately clear where 20% annual earnings growth is going to come from.

Despite all of the talk of margin improvement in the future, margins in the wire and cable business are just not that great. Last quarter, the company's gross margins rolled in at just under 20% with operating margins (excluding charges and goodwill amortization) at roughly 12.5%. Tweaking those numbers will help matters, but investors shouldn't expect a margin-induced value explosion anytime soon, especially considering the firm's lack of pricing power as more or less a commodity supplier.

The company's return on equity is running at a 50% annual rate, but that impressive figure is due mostly to the leverage provided by a hefty $1.2 billion in long-term debt sitting on the balance sheet. With annualized return on investment capital in the 12% range in Q2, the company is likely beating its cost of capital, but not by a whole lot. Asset management will not be a major value creator either, with the company currently turning its inventories once every 10 weeks or so. That's not god-awful, but it's not exactly Wal-Mart.

With these far from "Superior" business traits in mind, the company's best bet for adding shareholder value is cutting costs to the bone and buying back oodles of its own shares. That may boost earnings in the short run, but growing earnings at a 20% annual clip for an extended period of time will require more of an effort. For investors looking to reap the benefits from the ongoing telecommunications buildout, parking long-term money in a commodity cable and wire supplier like Superior with no pricing power and few business value drivers is probably not the best route.

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