|Shares Out. (in M):||78||P/E||-||16.0x|
|Market Cap (in M):||1,288||P/FCF||-||-|
|Net Debt (in M):||1,038||EBIT||110||210|
Overview: Aperam (APAM), a best-in-breed stainless steel manufacturer in an out-of-favor industry, offers investors over 200% upside with limited downside given its low leverage with no near term maturities, high dividend yield, strong cross-cycle earnings power, credible cost-cutting program, and positioning to benefit from Brazil’s urbanization and very likely European stainless steel consolidation. Everyone is negative on the stainless markets, and seemingly no expectations are baked into APAM's current valuation. Since its spin from ArcelorMittal (MT) at €30/share early this year, APAM has traded below €11, providing a compelling entry point to investors. APAM is undervalued on an absolute and relative basis: it currently trades at ~2x normalized EBITDA and at a 30-50% discount to peers Acerinox SA (ACX) and Outokumpu Oyj (OUT1V), both of which have lower cross-cycle earnings and significantly higher leverage than APAM. When market participants focus on normalized EPS as they did in the beginning of 2009, the stock will have a huge move.
Company Background: APAM has one of the largest stainless and specialty steels distribution networks in the world, with 19 stainless steel service centers, 10 transformation facilities and 30 sales offices located on 3 continents over 30 countries. With a production portfolio of Ferritic, Austenitic, non-grain oriented electrical, grain-oriented electrical, and high nickel alloys, APAM has diverse exposure to the stainless steel space. The company also has high exposure to niche stainless grades whose margins significantly outstrip those of commercial grades on a per-ton basis. Roughly 70% of APAM’s 3,100kt upstream capacity are located in France and sit in the lower half of the European cost curve. APAM’s key asset, its Brazilian mill Timoteo, has upstream capacity of 0.9mt and produces flat stainless steel and electrical steel products. Brazilian stainless steel market is in tight supply, and industry participants consider Brazil’s stainless market one of the most attractive end markets globally. Timoteo is running close to full capacity, with volumes in the most recent quarter growing quarter-over-quarter as a result of strong automotive demand.
APAM’s assets generate margins well in excess of European peers; from 2007 to 2009, EBITDA per ton averaged $314 for APAM (10.4% margin), $165 for Acerinox (5.6% margin), $186 for Outokumpu (4.5% margin), and $93 for ThyssenKrupp (2.5% margin).
Stainless Steel Industry: All stainless players’ earnings and valuation have suffered due to slower than expected economic growth, European end market exposure, nickel price volatility, and slow improvement in production discipline. Industry participants believe they have pricing power when global capacity stainless steel utilization is at or above 80%. Utilization declined from ~85% in 2006 to ~65% in 2009 and has since recovered to ~75%. While many players have taken higher-cost capacity offline, earnings across all peers remain well below cross-cycle earnings potential not only from lower stainless selling prices but also from alloy surcharge volatility.
In the absence of pricing power, volatility in the alloy surcharge has a significant impact on stainless demand and pricing. Costs for alloys used in the production of stainless steel, including nickel, chrome, and molybdenum, comprise the “alloy surcharge” added to the base price of the finished product. Many stainless companies have stated over the past year that nickel pricing volatility has pushed potential buyers to the sidelines in anticipation of lower surcharges and expect demand to return once alloy volatility subsides.
Leadership Journey: In its last two years as an MT subsidiary, APAM achieved $144mm in sustainable cost reductions. At the time of the spin, APAM launched the “Leadership Journey” (LJ), an initiative to target management gains and profit enhancement of $250mm over the next two years ($100mm in variable cost savings, $100mm in fixed cost savings, and $50mm in revenue upside).
The primary goals of the plan are to increase productivity and rationalize downstream operations in order to drive down fixed costs, expand vertical integration, and generate efficiency gains. By Q3 2011, APAM stated LJ had contributed $123mm to EBITDA or a run rate of $200mm of recurring cost savings through 1) switching from LPG to natural gas 2) converting its blast furnace from coke to biomass in Brazil, and 3) suspending higher cost operations of its traditional cold roll mill in Isbergues. In conjunction with its Q3 2011 earnings release, APAM announced that given its faster-than-expected progress, the company is targeting an additional $100mm of cost savings by 2013, leading to a combined target of $350mm. With 78mm shares outstanding, an additional $100mm in annual cost savings “moves the needle” significantly. As part of this increase, APAM will focus on further industrial optimization and rationalization in Europe, systematic benchmarking in Brazil and new sourcing initiatives, in addition to conversion to biomass at Timoteo, investment in a new hot annealing and pickling line at Gueugnon, investment in a new induction furnace at Imphy and service center expansion in Campinas. The company also announced 120 job reductions that have been agreed upon with trade unions, and management also mentioned purchasing synergies for nickel and scrap that could further expand LJ’s value creation potential.
While peers ACX and OUT1V missed 3Q expectations and have guided to sequential decrease in earnings due to lower volumes and lower base prices, APAM guided above analyst estimates due to cost reductions, FX tailwinds, and signs of demand stabilization. While the stainless steel outlook remains uncertain, APAM continues to improve operations and financial positioning and pay shareholders a 4.7% dividend yield until valuation improves.
Valuation: APAM’s strong execution and value creation in a very difficult environment suggest the company should earn a premium multiple. However, based on a conservative multiple on what we see as “normalized earnings” (i.e. historical normalized EBITDA of ~$700mm plus LJ contribution), APAM offers equity investors significant upside as illustrated below.
|Current Share Price (USD)||$16.50|
|EBITDA - Maint. CapEx||$240||$340||$550||$850||$1,150|
|EV / EBITDA||6.0 x||4.7 x||3.3 x||2.3 x||1.8 x|
|EV / EBITDA - Maint. CapEx||9.7 x||6.8 x||4.2 x||2.7 x||2.0 x|
|Fair Multiple Analysis|
|EV / EBITDA||7.0 x||5.5 x||5.5 x||5.5 x|
|Implied Stock Price||$30.65||$36.03||$57.17||$78.31|
|EV / EBITDA - CapEx||10.0 x||7.0 x||7.0 x||7.0 x|
|Implied Stock Price||$30.26||$36.03||$62.94||$89.84|
|(1) D&A is above normalized levels in near term given recent growth capex and capex related to Leadership Journey. Long term, we expect D&A to decrease in line with maintenance capex of $150mm.|
|Entry||11/16/2011 05:10 PM|
I am gonna take the opposite side on this one (being short it since the spin... )
This industry is a dog and MT got rid of it because it wanted nothing to do with it because it is simply a bad business to be in. Thyssenkrupp is dreaming about getting rid of their stainless business as well for the same reasons, they couldn’t find a buyer, which should tell us something, and most recently were talking about an IPO (will make another good short).
The list of catalyst reads more like a wish list to me
#1: why would stainless consolidate? Have there been any announcements of capacity closures? The problem here is that the industry is very extremely fragmented and the only way it can consolidate is through players going bust. However, none did to my knowledge in 2007-2009, so why would this happen now? We have 12mt overcapacity globally and additions on the way. Most bullish analysts model industry cap utilization in low 80% through 2015. Do you have an edge on why this would change?
#5: Nickel is the most wildly traded and probably the most manipulated metal. High volatility in it is pretty much the norm, not a temporary event.
#8: Europe is as good as in recession by now. APAM generates, ~40% of their EBITDA in Europe. Do you think it is reflected in the consensus at this point?
#7: Not having this number off the top of my head, but mostly stainless goes into (high-end) appliances. Sure, some goes into construction, but not enough for it to be a major driver
Finally, on the valuation, and this is a matter of opinion rather than a fact, I think commodity stocks do not trade on normalized earnings, ever, neither do they cost-cut their way to the riches. You could expect decent return in those when the underlying commodity is performing very strongly and/or when they’re growing production at high incremental ROIC. In this case, hard to see growth given global overcapacity and hard to see stainless outperformance given the sad state of the global macro environment.
|Subject||RE: RE: agree|
|Entry||11/17/2011 05:33 PM|
Mittal still owns over 40% of APAM, so I wouldn't say that he "wants nothing to do with it." Despite concerns on the industry and on the MT divestiture, I find it hard to believe APAM valuation reflects its cost savings realization, relative positioning vs peers, any industry improvement, etc. Yes, TK has been working on its stainless divestiture, though its inability to find a direct buyer is a function of its lower-quality operations. APAM has higher quality assets than peers and better growth exposure, yet it trades at a lower relative valuation. I'd argue this makes APAM more attractive to potential buyers, especially given its low leverage.
In response to your numbered points:
1) Why did carbon steel companies consolidate back in 2001-2002? To improve operational efficiency and cash flow and earn higher returns on capital. When carbon steel companies consolidated, the "one face to the customer" strategy improved margins across the board and prevented producers from dumping excess supply in competitors' markets. Stainless industry is in oversupply, a consolidated path to market is a sensible approach. Aperam, among many other stainless producers globally, has announced higher-cost capacity closures this year - it is a part of each of the players' restructuring initiatives.
We also believe a merger could create value for both parties. Take ACX as a potential acquirer; ACX has performed reasonably well this year (relatively speaking...) given temporarily stronger stainless markets in the US, though its earnings going forward are at risk. ThyssenKrupp is building capacity in the US and will surely bring down ACX's returns. Plus, ACX's euro exposure is in Southern Europe, which has been hit particularly hard by the crisis. APAM, with its lower relative valuation, offers exposure to growth markets, higher margin specialty stainless, and more profitable northern European markets. A combined entity would have greater product mix, consolidated market approach, lower distribution costs through a more comprehensive distribution network, increased distribution through group's own network vs. independent distributors, lower fixed costs per ton sold and cost savings through benchmarking and expense sharing, greater industry visibility, and so forth. ACX is trading at a richer valuation based on how it performed in 2011, not how it's going to perform in 2012+. If the company recognizes it is trading at a temporary premium, then it has every reason to purchase an undervalued competitor.
Finally, stainless companies have reasonable pricing power above the 80% utilization threshhold. Capacity additions you mention are not in APAM's core markets and should not impact pricing (whereas TK build-out in US is a negative for ACX).
5) Nickel has been on the decline since January 2011 and has been exceptionally volatile over this period.No one expects stable pricing, but no one expects nickel prices to go to 0. Generally speaking, when nickel appreciates, buyers recognize surcharges will increase and purchase stainless steel. Otherwise, we see classic deflationary behavior and buyers move to the sideline (. It's worth noting that after the Nickel market squeeze in 2007, APAM (among others) switched to a higher proprotion of ferritics, the stainless steel that uses ferrochrome as a subsistute to the majority of nickel content.
8) Valuation will improve without any resolution to the eurozone crisis; if the crisis worsens, current very low valuation should be supported by the offset between decline in european earnings and increase in contribution from Brazil and leadership journey, for which the company gets little credit currently."40% of EBITDA in Europe," which the company guided to at the time of spin, goes down as Brazilian profitability improves and European contribution decreases. Current estimates do not reflect 40% of EBITDA will be generated from Europe in 2012. Brazil is operating at capacity (30% of total capacity is in Brazil), the currency headwind has dissipated, and the country is accelerating urbanization in time for the world cup and olympics. While Europe deals with its issues, you get Brazil growth, dividend yield, debt paydown, and $350mm EBITDA contribution from the leadership journey.
7) A majority of stainless in the US goes into household appliances. The high correlation between urbanization and stainless consumption is not only explained by adoption of household appliances. Stainless consumption grows from housing and office building, auto, stadium, train / rail, bridge, and subway construction. Data shows high correlation over periods of infrastructure build (olympics, for example) even if not coincident with significant growth in household appliances.
I agree on your point you won't make money investing in a coal miner if coal prices are heading down. That said, we are talking about a company that is essentially doubling EBITDA by fundamentally changing its operations. A company with a lower cost profile is worth more than a higher cost profile, all else equal. By taking off capacity that is low to negative EBITDA, the company (and the industry) benefit from higher capacity utilization and no negative EBITDA contribution (addition by subtraction). The company is decreasing input cost volatility and streamlining operations - these and other initiatives will create shareholder value over time.
Thanks for the 'wish list' characterization.
|Subject||RE: RE: RE: agree|
|Entry||05/18/2012 09:40 AM|
This has been hit 40% while peer ACX down 10%. Compelling pair trade here. Any updated thoughts? Qtr wasn't great but stock pricing in worst case here