Description
I offer the following caveats before I waste anyone’s time…
Schuff Steel (“SHFK”) is a nanocap with resultant pitiful liquidity that as of early 2005 no longer trades on the Amex but rather on the pink sheets. The Chairman/Ceo (who happen to be father/son) own 69% of the shares and tried to buy the company from investors at $2.17/share in cash and then $2.30/share. When they could not get the requisite vote they elected to delist the company under the auspices of Sarbanes Oxley costs. In the recent past (2002-3) the business has appeared to be highly cyclical. Lastly, on the surface, you may dismiss this business as riding the steel cycle but in reality they are hurt by higher steel prices as customers start to prefer alternative building materials versus steel.
What it does offer is a decent business at really really cheap price. The stock trades at 2x earnings and has a 48% FCF to equity yield. I believe SHFK will return 130%+ (from a price 10% higher than the last trade assuming that you would have to force the price up to buy meaningful shares (meaningful is relative but the stock does trade 20K+shares a day a couple times a month)) by merely putting a 6x multiple on a conservative normalized EBITDA-capex and a reasonable chance for a 200-400% gain with a slightly better multiple b/c of the realization that today’s construction environment is closer to normal than an economic boom. I don’t honestly think there will be any realization b/c I am not insane enough to think anyone actually follows this stock. However, b/c of the equity stub nature of the capital structure, the cash flows should allow the return to be realized even if no one ever bothers to use a HP calculator to figure out valuation. It trades 4.1x trailing FCF and 3.1x forward FCF. Worth noting that the stock also trades 175% cheap to the only public comp (Canam Manac on Canadian exchange ticker=CAM/SV/A) You also have a catalyst in that the natural buyers of the company have shown a desire to purchase the public float albeit at a lower price than today’s levels. However, we know the insiders were willing to pay 2.30/share in May 2004 for all or part of the shares (they partially waived the minimum number of shares needed to execute the tender.) Since that point, $14mm or almost $2/share in real cash has been generated (about $8mm in cash and $6mm in debt paydown.) In addition, the business has improved dramatically. But just on cash you can assume that the insiders would now pay $4.30/share for the business.
Quick numbers:
Shares outstanding: 7.06mm @ $3.50 (last trade of $3.15) = $23mm
Debt: $81mm (all 10.50% high yield note which the company has slowly bought back)
Cash: $16.3mm (note that on the most recent quarterly report $8.4mm are listed as restricted funds to backstop Letters of Credit but subsequent to quarter end that money as been released as per a note in the quarterly report)
EV: $87.7mm
1q EBITDA-capex (“FCF”) = $7.4mm
EV/Annualized FCF = 3.0x
Trailing 12 month FCF = $21.7mm
EV/Trailing FCF = 4.1x
1q EPS of 42 cents and trailing 12 month EPS of $1.04
P/E= 2x annualized EPS and 3.3x LTM EPS
Forward PE = 2x
I know EPS accentuates the effect of leverage but the leverage is a high yield note that is not due until June 2008 so the interest rate is fixed and there are no positive covenants to break. Free cash flow to equity is marginally better than the EPS b/c of the slightly lower capex than depreciation.
Background:
SHFK was a participant in the roll-up boom of the late 90’s. The company acquired regional steel fabricators and was poised to take over the mighty world of steel fabrication. Steel fabrication is the preparation of steel for use at a construction (all nonresidential) project. Schuff also has a joist (support structures for the roof on the top of a warehouse or Wal Mart Supercenter) and girder manufacturing business. SHFK operates in Pacific, Southwest and Southeast US. The biggest drivers for fabrication are the construction cycle and capacity within the industry. Margins creep up during boom times due to more business along with better pricing. Fortunately, the business has a significant nonunion (66% of employees) presence so during tough stretches the business can prevent losses.
Just to be clear, this is not a steel manufacturer. It is a building materials company that purchases steel to use as its main input. The higher steel prices arguably have hurt the company as builders could choose alternate materials.
Historical Annual FCF, FCF margin and Op Margin:
2005e: $30mm, 9%, 8.5%, D+A of prob just over $3.0mm and capex of $2-2.5mm
2004: $18.6, 7.0%, 4%, D+A begins falling but significant underspend
2003: $1.3, 0.7%, -0.7%
2002: $12.3, 5.3%, 3.8%, D+A of $4mm and cx of $1mm (capex underspend by $1-1.5mm)
2001: $16.1, 6.8%, 6.8%
2000: $21.63 , 7.7%, 9.9% significant delta b/c of construction of joist facility
1999: $16.8 , 7.1%, 8.9% delta b/c of expansion capex for joist facility.
1998: $14.0, 7.4% – major acquisitions made halfway through year
1997: $9.7, 7.1% – major acquisitions made during the year
1996: $9.0, 8.7%
Long term avg margin: 6.7%
Avg FCF of 1999-2005E: $16.7mm
Value of nonresidential private construction in actual $
1998: $236.7B
1999: $245.8
2000: $268.1
2001: $264.1
2002: $229.8
2003: $213.8
2004: $222.3
Current Census Seasonally Adjusted 2005 estimate: $230.2
My thesis is that normalized FCF on SHFK is over $20mm and if you put a 6x and give them credit for the $1.7/shr in cash they will generate in the next 12 months you have a $9.60 stock (175% upside.) We are arguably midcycle right now in the construction business and SHFK will generate about $30mm of FCF this yr. I am not counting on it, but if this turns out to be a normalized number you would have a $16 stock. I will discuss more about the steel fabrication business below but pricing standards are normal right now and in fact the industry has excess capacity.
Because of the long project cycles of the business, operating results will stay strong several quarters after a downturn and improve several quarters after an upturn. The strength of today’s numbers is a result of a reasonable (clearly not excessive) nonresidential market in late 2003/2004. If you look at analysts who discuss the non-residential building cycle, most will say it is finally turning. So these results you see are the product of a business that according to analysts is just in stage one of turning. I am not relying on their turn but if that was true this would likely be a $35mm plus FCF generator and a 6x on that would imply a $20+ stock.
Some interesting things to note in trying to figure out normalized numbers. Using the company’s FCF numbers w/o any taint of acquisitions and you come up with an average of $16.7mm. However, the company spent $8-10mm on expansion in the late 90’s. Assuming a 20% return on that investment and you can impute an average normalized number is $18mm +. From both a micro and macro view I think that still understates the normalized earnings power. From an industry point of view, due to the severity of the recession, many of the smaller fabricators went out of business. SHFK was able to stay profitable by doing very low margin business which ordinarily would have gone to the very small fabricators. In addition, the industry required tough bonding standards which many smaller players could not meet. This trend has continued and will play into the hands of the larger entities. Note the absolute size of the construction industry in 2004 vs 1998-2002. The size was smaller in 2004 yet SHFK was still able to record a record a margin well above past trends would indicate. The industry is reasonably capital intensive (more so on the w/c side than on physical ppe) and even today’s op profit represents only a 46% ROIC.
Macro
The 1998-2005 window is fairly punitive in several respects. Within that 7 year time frame you have three down construction years. Going back to 1964 about 22% of the years were down construction years vs 42% in this scenario.
Also, much like the US steel producers have benefited from the deprecation of the US currency and the higher shipping rates, fabricators have had a similar benefit. While these factors will end, they are likely to give a nice boost to margins for the next several years.
The Buyout
In April 2004, management attempted to buy out the minority public float. They bumped their purchase price and then gave up when they could not get the requisite shares. After reporting several strong quarters the stock traded as high as $5 at the end of 2004. The company delisted their shares from the AMEX in early 2005. The business has materially improved since they gave up on the tender and I would expect them to try another tender. I think they assumed that delisting the shares would put the holders in a weaker position. My assumption is that since two tenders were voted down any further unreasonable offer also would be voted down.
Capital Structure
The high yield notes are due June 2008. The bonds trade around 100. I imagine the company will continue to repurchase bonds with their excess free cash flow which is about which runs about now runs about $12-14/annum. Since they have three years to refinance debt that on a net basis is 3.25x FCF I am not overly concerned.
Backlog
Backlog currently stands at $138mm and it takes about six months to realize the backlog. For perspective, the low for backlog was $97mm at the end of 2q03. The high for the business was $189mm 2q02.
Financials (if you made it this far and still care)
Financials on the company are available on their website. They are pretty close to SEC style and will remain so b/c the company has public bonds outstanding.
Catalyst
1. New tender offer
2. Public market purchases by management and then a subsequent tender offer