AZZ Inc.

Moat: 2.5/5

Understandability: 3/5

Balance Sheet Health: 3/5

Azz Inc. is a provider of galvanizing and metal coating solutions in North America, primarily serving the construction and industrial sectors, and more recently has expanded into producing specialized products for transportation and power generation.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

AZZ operates in two main segments: Metal Coatings and Infrastructure Solutions.

Metal Coatings: This segment, which has been the company’s core business for many years, provides hot-dip galvanizing, powder coating, and other metal finishing services to protect steel and other materials from corrosion. The coatings are applied primarily to steel used in construction, industrial projects, and transportation infrastructure.
Infrastructure Solutions: This segment focuses on providing products and services related to energy transmission, distribution, and infrastructure. It has a more specialized and custom approach, providing solutions in grid reliability, substation control, switch gear, and lighting. These products are often sold to utilities and transportation companies for power transmission and other critical infrastructure applications.

In terms of revenue distribution, Metal Coatings has comprised a majority of revenue in the past years, but the Infrastructure Solutions segment has been growing at a faster pace.

Both the Metal Coatings and Infrastructure Solutions sectors, have a high degree of cyclicality, depending a lot on the global economy and industrial spending, and specifically the Infrastructure segment is highly reliant on the demand of the grid.

Industry Trends and Competitive Landscape

The industries in which AZZ operates are capital-intensive, requiring significant investments in equipment and facilities. For galvanizing specifically, the local nature of the business tends to produce highly fragmented markets where the companies often don’t have very high market share.

Here is some detail on what the competitive landscape of the industries looks like,

Metal Coatings: The market for metal coatings is characterized by fragmentation, with many local and regional players. Some large companies also operate in this sector, however, there’s no single dominant firm in the market. The industry is also subject to pricing pressures from customers who often seek to obtain services at the lowest price. A key aspect to winning in this business is low cost production since products are similar for all companies, and geographic positioning to lower transportation costs. A company’s ability to create a strong, reliable relationship with customers is important, since that is what will increase their WTP.
Infrastructure Solutions: This market is more concentrated, with larger companies focused on specific applications or technologies. These include established players with proprietary or technologically advanced products and systems. A key aspect to win here is the presence of a strong and reliable product that has good relationships with the clients and great switching costs.

Moat Assessment (2.5/5)

While AZZ is a leading provider of galvanizing and coating solutions, its moat is relatively narrow, and here’s why:

Switching Costs (Moderate): Switching costs in galvanizing and coating are moderately high. Clients often seek reliable suppliers due to the risk of the underlying products failing with time. A large project could have hundreds of millions of $ in damages due to poor coating, therefore creating switching costs that are related to performance and reliability more than price.
Network Effects (Low): There are minimal network effects for AZZ’s products and services.
Intangible Assets (Moderate): While the company does have a well-established reputation for reliability and quality, especially in the metal coating segment, the brand advantage is not that strong. There are no brand moats, or any patents or regulatory licenses that protect their business. There are some regulations on the production of some products, but these aren’t enough to really have a strong competitive advantage.
Cost Advantages (Moderate): In its metal coating business, AZZ benefits from economies of scale and good geographic positioning to achieve better profitability but its process advantages are not that unique or too difficult to replicate. In Infrastructure Solutions, they have some cost advantages since they produce products in areas where they have more expertise, and have existing agreements with their clients that limit potential new competition.
Size Advantages (Low): While AZZ is a larger player than many of its rivals in the metal coatings space, the company doesn’t have significant scale-based cost advantages due to the local nature of the business. It’s also not big enough in its infrastructure solutions segment to have a material advantage. It’s a somewhat relevant factor, however.

AZZ’s moat is in the intersection between the reliability that customers give the company, and their ability to have cost advantages through their local positioning. This, however, isn’t as big as it could, since it’s often possible for competition to replicate their advantages, even if it takes a bit longer.

Risks to the Moat

Economic Cycles: Both of AZZ’s segments are cyclical. Therefore, reduced construction activity and decreased capital spending in industrial projects and power generation could significantly reduce demand and reduce their profitability.
Commodity Prices: Fluctuating prices of raw materials, like steel and chemicals, can impact AZZ’s profitability. While they do have some power to raise prices to consumers, passing down prices to the customers is harder when the price has been going up.

A major risk to the business is any reduction in industrial investment, where they’ve historically focused all their efforts.

Intensified Competition: Increased competition from new entrants or established players could decrease pricing power in the metal coating business and increase volatility in the infrastructure sector.
Technological Disruption: New coating technologies or manufacturing processes may reduce the competitive advantage of its current offerings. The rise of a more distributed energy system would have a severe impact in its revenue and their ability to serve utilities.

Business Resilience

Diversified Customer Base: AZZ serves a diverse set of customers across multiple industries, which somewhat reduces its reliance on a single industry or client.
Established Reputation: The company’s long-standing presence in the metal coatings industry and some of the clients that they have in the Infrastructure space, means that they have some relationships in place which could help to maintain their revenue.
Potential for Long-Term Contracts: Contracts in infrastructure solutions can span for several years, and many of their clients have long-term, trusting relationships with the company.

That said, AZZ may have challenges in recovering and performing once their customers’ spend decreases. So, it is important to keep track of the industry and look for strong signs that the company can keep its client base and has significant switching costs.

Financial Analysis

Revenues: Looking at their last financial report (10-Q), revenues increased to 139.6M compared to 122.4M the year before. Their revenue is mostly made up of domestic sales, with sales in Canada having an immaterial percentage. The growth of revenue has been strong in past years, as seen by their 10K, due to large acquisitions and a growing business environment. The management noted in their earnings calls that the revenue was driven by strong demand.
Profitability: Gross profit increased to 44.1 million (from 37.9 million) while net income increased to 8.9 million (from 2.5 million) compared to the last year period. Their profitability is being affected by high costs of raw materials and some cost to support sales in new segments. It’s important to note that while net income has grown in the last 10-Q, it is still 69% lower than their net income 10-Q 1 year before, which is a big decrease and should be kept in mind.
Balance Sheet: The latest balance sheet (10-Q) shows total current assets of 528M, and total current liabilities of 400M, with a net debt of around 1.2B, and a low equity. Thus, the company is reliant on debt to fuel their acquisitions and growth. It’s important to note that their inventory is less than 3% of their total assets, which is a good sign that most of their assets are well liquid.
Capital Allocation: They use a combination of cash and debt to make their acquisitions and fund their capex.
Other Notable Metrics:
- Return on equity (ROE): 9.41% vs 1.13% YoY (This is highly dependent on when the data was taken, they can have different results in the upcoming years.)
- Operating Cashflow : Positive $72.9M vs negative $119M in the same period of the past year. (Again, a very volatile measure that changes a lot.)

Overall, the company has had positive performance, and is now showing good recovery, and good management capabilities after their recent acquisitions. However, they also have high levels of debt, and their margins can be easily squeezed if they don’t focus on having good relations with their clients and having cost advantages.

Understandability (3/5)

AZZ’s business is relatively straightforward to understand—they apply coatings and provide support for infrastructure systems—but a deep understanding of their financials is somewhat more difficult. Since the different segments work differently, the understanding of the drivers and what impacts profitability requires more information and a bit more skill.

Balance Sheet Health (3/5)

The company’s balance sheet exhibits a mixed picture:

High Debt: The company has significant levels of debt, potentially increasing risk and limiting financial flexibility. But they do manage the debt well and don’t show any signs of default.
Decent Liquidity: Their liquidity is good, with lots of cash and assets in the metal coating business. However, they are quite reliant on the economic cycle, and a severe drop in revenue could make it difficult to cover some of their liabilities.
Profitability: While their profitability has come down in the last few months, they’re on a good trend, and have good margins relative to their industry.

Overall, while they’re not in a terrible situation, their debt is something that investors should look out for, and needs to be closely tracked in the upcoming years.

Recent Concerns and Management Response

AZZ has been trying to integrate a major acquisition in the last years. In 2023, they also did a secondary offering to raise capital in order to pay for their debt. The management has also admitted that they have seen some volatility in the margins and a bit of a reduction in some of their market share.

Here’s some key points from management on these issues:

Integration Challenges: They acknowledge that integrating their new acquisition is taking some time, but they are seeing some positive signs from it, they are also working on optimizing their business to extract the most value from it, this is still a major concern and a headwind on the financials.
Market Volatility: They’re actively seeking more predictable revenue streams to withstand the highly cyclical nature of the business, and are focusing on creating long-term value for its clients.
Debt Management: They recognize that leverage is high, but state that it’s in line with long-term targets. In the latest earnings call they mentioned they are planning on reducing debt by using their free cash flow in coming quarters.

While it’s good that the management recognized these problems, it’s something that investors need to keep in mind in their analysis and track in upcoming financial reports and earnings calls.