ALLOY STEEL INTL INC AYSI
January 08, 2020 - 3:36am EST by
bowd57
2020 2021
Price: 1.45 EPS .28 0
Shares Out. (in M): 16 P/E 5.1 0
Market Cap (in $M): 23 P/FCF 0 0
Net Debt (in $M): -12 EBIT 6 0
TEV ($): 11 TEV/EBIT 1.9 0

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Description

Hi, guys --

There are many hurdles to investment in catalyst-free, PA-only, Pink Sheets perma-cheapie Alloy Steel International. I decided to write it up because recent thinking about the business has nudged me toward believing that there might actually be some hope here, that there might be some reason to own it other than my unhealthy fetish for the world's cheapest stocks. As usual, this is going to be a brief write-up, so I'll do the club the favor of applying the "Nth-grade book report" tags myself.

What do they do?

AYSI uses its patented process to manufacture Arcoplate from its remote eyrie in the burning sands of Western Australia. Arcoplate is a "solution that saves time and money by reducing [...] wear and material hang-up issues." It's also jam packed full of carbides! Arcoplate is a thin(nish) sheet of metal that can be welded to other pieces of metal that you want to protect and keep smooth. There are a variety of uses, but the canonical application is Australian mining equipment. This corny video from the company is only 2.5 minutes long and explains things better than I could:

https://www.youtube.com/watch?v=TOg4DDU-kRg

What's The Appeal?

The company is really, really,really cheap, despite having what seems like a moaty niche. 5x PE; 50% of the market cap in cash; 90% of book; at the current price, it's a net-net by a whisker. I'll expand on the "moaty niche" bit later, but they actually have an actual business, actually, as is evidenced by their financial history:

  2015 2016 2017 2018 2019
Sales 24.1 17.1 21.7 26.2 29
EPS 0.31 -0.02 0.21 0.26 0.28
Book 23.3 25.1 23.2 25.6 26.7
Cash 12 14.3 12.9 11.3 12.4
Shares 17.3 17 17 17 15.9

Admittedly, those #s aren't all that impressive, but (A) there are a whole bunch of adjustments to make, which I'll go through if there's interest, and (B) although US traded, this is an Australian company, and AUD is down 25% over the period. On a constant currency basis this looks a whole lot better; if you gross the 2019 #s up by 33% there's a definite upward trend, made even more pronounced by my unspecified adjustments.

Why So Cheap?

First, a bit of history before I get to the bad stuff -- this is one of those stories where you have to know about the founder, even though he's dead. The company was founded by Gene Kostecki, whose family moved from Ukraine to Australia in 1949. He was a boilermaker in Perth who, as far as anyone can tell, wandered off into the desert, told Satan to get behind him and returned bearing burning tablets inscribed with the secrets of Arcoplate. AYSI went public in the US in 2001 with with one of the most terrifying prosepctuses I've read:

https://www.sec.gov/Archives/edgar/data/1127454/000089843201500218/prospectus.txt

-- all proceeds to Kostecki & his CFO, insane amounts of self-dealing, already a licensing dispute with Arcoplate  Holdings  (UK) PLC, which was somehow also an affilate of Kostecki, only $8000 in cash, and on and on. I have no idea how they were able to get this to fly, I guess they really know how sell stock in those days.

The company staggered around the OTCBB for a few years as something that looked like a terminal short until 2007, when revenues jumped from $3MM to $8MM and the company became solidly profitable. In 2010, revenues took another step up to $24MM, coinciding with the introduction of Super Arcoplate (a thicker version of the original) and the signing of a 5 year contract with BHP Billiton. There were huge plans! They were going to build a $20MM plant in Indonesia, and grow revenues to $300MM by 2015!

Kostecki delisted the company right around then. Right around then they went through a couple of CFOs and some other senior staff. Gene resigned as CEO. Then he came back. Then he resigned again in July of 2013 and died 10 months later due to a severe bout on pneumonia. So the company, and perhaps the founder, went through a period of instability between 2010 and 2014. The company is now run by Gene's son, Steve, and controlled by his widow, Maria, who holds 65% of the shares.

Here's a little rememberance of Eugene:

https://catholicukes.org.au/alloy-steel-international-company-humble-roots/

Now on to the bad stuff!

1: The company is family controlled and there are material related party dealings and conflicts of interest.

-- It's controlled by the widow and run by the son. There was another son who was in charge of the USA business, which seems to have been nil, but he moved on/was let go earlier this year.

-- The family derives significant income from the company. Off the top of my head,

A: 6% royalty on Arcoplate sales, or $1.645MM in 2019.

B: $700k in rent for the company headquarters which also serves as one of their plants.

C: Steve's salary. I don't know much he makes, his dad was paid $150K.

D: $235k to Kostecki Brothers Racing to promote the brands.

So that's $2.7MM annually -->that I know of

-- Additionally, in 2016 AYSI paid ~$5MM to acquire Matrix Metals from the family trust. MM supplied "various materials and production inputs to ASAI, under long standing supply arrangements", but there was no visible increase in gross margins. It was stated that, "AYSI management regards this transaction as a key step toward consolidating the Company's distinct valuable assets, which process commenced with the passing of AYSI's founder, Gene Kostecki, in 2014.", but no further consolidation has been reported.

I could try mitigate any of these if anyone's interested, but this would still a problem post-mitigation.

2: Low float, low price, low volume, low interest, no exchange == highly illiquid.

3: Foreign company conducting business in AUD introduces extra levels of risk.

4: Non-filer, although they do report through OTC markets,

https://www.otcmarkets.com/stock/AYSI/disclosure

, albeit often with a lag. I'd also note that their quarterlies are not to be relied on; I'd assume the cash balance and revenue numbers are correct, but anything else is very unaudited. The reports are #s and footnotes only, no commentary.

There's an active and long-suffering community on investorshub.com that maintains historical income statement data:

https://investorshub.advfn.com/Alloy-Steel-Inc-AYSI-9225/

5: The whole thing sounds like a fraud. It doesn't seem to be, but if it actually is, that would be embarrassing.

Ugh. That Is Bad. So Why Now?

Really nothing very concrete. I've owned this since 2014 and haven't written it up lower prices, although (too lazy to look) I don't think the valuation metrics have been much lower for extended periods of time. I'll leave the semi-potential-soft-catalyst for the end, the rest of if it just how I'm thinking about the business.

1: I think the stock, albeit with huge variance, will perform in line with the business for some time. All that means is, if they make $0.30/share in 2020 and nothing else changes, the central tendency of stock will be to go up by $0.30. Given how cheap this is, that's a lot! This is unlike some other perma-cheapies, like, say, NWLI, where I think if they make $50 in 2020, the stock will go up by $30. I think these guys will have to sit on the cash hoard for a few more years before the market starts discounting it further, is another way to put it. Of course I acknowledge that this could open at $0.40 tomorrow and stay there for months except when I buy some at $0.50.

2: It occurred to me that currency is some kind of potential catalyst. At these levels, all one can hope for is a potential catalyst, and that's one. I have no views on AUD/USD, but if it ever becomes a tailwind instead of a headwind, it could make a real difference to reported results and trends.

3: The 6% royalty really sucks, but then I realized that a different way of looking at it is that product is even that much more awesome! If we use gross margins & ex-excess cash ROIC as proxies for business quality, well, they've already been high for an extended period, but if you bump them up 6% they go through the roof. They've had years with 50% adjusted gross margin, what's large pharma gross margin again?

4: Really short term, I think the next couple of quarters are going to be good, due to elevated inventory levels and a massive uptick in sales to a single customer that I think will take some more time to work through.

5: They're not just sitting their duffs in Malaga. They're introducing new products, like cutting services and and ceramic wear tiles. Most interestingly, they seem to have incubated this entirely new welding supply business:

https://arcoweld.com.au/

I suggest tooling around that website for a bit. In addition to consumables, they seem to be white labeling (or whatever the converse of white labelling is) a whole range of welding equipment. They claim to have warehouses in Fiji and New Zealand in addition to Australia. They've got distribution through a large chain. They have a sales staff with an org chart. I have no idea if they'll ever make any money off this, but am impressed by the entreprenurial spirit, and that they seem to have built this whole thing with no visible impact on 2019 financials -- in other words, the FY was even better than I thought it was. So another potential catalyst is that this or something else they try actually works; given the balance sheet and the valuation, they can have multiple failures as far as I'm concerned.

Maybe they'll roll up the welding supply distribution business in Australia, in which case they'd be worth at least 40-80x EBITDA!

Valuation

I'm going to wimp out and just say, "Higher", assuming you think is investable all, of course. The problem is that upside is enormous, like, this might actually be a worth a lot to a strategic, but information is scarce and I'm not in a position to try to pop the hood myself. It's so obviously cheap on the numbers that the real question is investability  -- ex liquidity, which we'll take as a given -- which would be more easily addressed via dialogue in the comments section.

 

Yours,

Bowd

 

 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

None.

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