Asset Class: International Stock (Sector: Materials / Industry: Metals & Mining)
Original Investment Thesis (8/2018): Cyclical investing! There were tons of steel companies in my various screening tools. When I was deciding I wanted to buy a steel company (due to attractive valuations) my only thoughts on this were ‘what if we are near the top of the cycle’? My writeup and thoughts on it when I bought it were all about the nightmare that can be cyclical investing. Some of those have played out (and may continue to play out). I get it…the E (earnings) can go away in a recession/downturn and all of the sudden a ‘cheap’ stock on a PE basis is no longer cheap. A lot of bad operators, in debt companies, or excess capacity might not make it through the downturn at all. My logic on any cyclical I own is they are 1) a high-quality company in the industry, and 2) at a multiple that is a big discount to the industry. If owning these companies is bad then I think there are many options in the industry that will fair much worse than the ones I own. When I chose TX it was an international company (which I was not crazy about either) but it had a higher quality balance sheet than the US-based steel companies I was looking at. Like any cyclical I own I am looking for a high-quality company that has a balance sheet to come out the other side of a cycle. If they get hit hard enough in a downturn, I will add to them significantly. A high-quality cyclical can be a great investment if you are prepared to take what comes (and react appropriately).
Updated Thoughts (9/28/2019): Medium-term holding (will sell once the cycle/valuations transition). I still believe this company is a great operator and nothing much has changed in my mind except the share price has been whacked pretty good. One thing that didn’t help was in mid-August the Argentina stock market dropped 48% in a single day. One day! 48%! The entire stock market for an entire country! This is what you call political risk! Ha. I think I read that it was the second-largest one day decline in any market on earth…ever?!?! Anyway, TX has assets in the country so their stock was drawn down that day. They also had assets in Venezuela a while back (before I owned the company) that were nationalized by that country. This is a risk when dealing with some of these countries in South America. I figured after the Venezuela incident the company would be more cautious on this front. I obviously didn’t foresee this being an issue but should have been more honed in on it. I’m holding onto the company because I think it is still a good value (compared to others in the industry) and is a high-quality company that can weather whatever lies ahead. Oh…by the way…we are not going to stop using steel anytime soon…so there is that!
TX (Ternium SA) – Annual Reassessment
I’ve owned this stock for over a year (on an off…kinda) and just completed my annual reassessment on it. I’ve attached a PDF that has my analysis in case anyone else might find it useful:
I purchased this stock back in August 2018 at $28.69. I originally purchased it in November 2017 at $26.69 and sold 5 days later for $27.67 when I had a change of heart on owning international equities in my portfolio. I had another change of heart in August 2018 and basically readded the position at about the same price.
These are my thoughts after reviewing this when I completed my initial purchase in 2017:
- PRO #1 – Wrestled between this one and TECK. TECK was a bit more diversified across different materials and larger. This one is more straight-up steel and steel milling. It is a little higher quality and much better valuation wise. So I chose to go with this one.
- PRO #2 – They are large in South America and are currently experiencing near-record growth in revenue and profits.
- PRO #3 – Top 10% in valuation and top 30% in quality (with low debt) and always had positive cash flow except one year in past 10 years.
- CON #1 – Was at 8% Debt to Equity but went to 38% Debt to Equity this quarter (according to Morningstar). They acquired CSA in September.
- CON #2 – Complicated ownership structure. In 2008 the Venezuela government nationalized a property (and since run it into the ground…after paying them $1.9b and leaving them with a 10% stake).
- CON #3 – I don’t know a ton about mining in general (I know they are generally whipsawed by the commodity prices) but this one is a high-quality low debt one.
- CON #4 – Lots of uncertainty with NAFTA
- CON #5 – International stock – I normally don’t want to own an individual international stock due to currency risks.
I don’t like that they increased their debt recently. That said they did it to complete an acquisition and have since decreased the debt level from 38% down to 30%. I’d like it to be down further at this point where we ‘might’ be in an economic cycle (as I don’t want a company like this to hold a good deal of debt into a downturn). To be fair even at the current levels they are 1) lower than previous peak levels (during the last financial crisis) and 2) are much lower than the overall industry.
People (smart people) say don’t buy cyclical companies at low PEs because the profits will fall and the stock will get cut in half (making them no longer low PE stocks). I get that but if an event happens that causes profits for TX to drop (recession, crisis, etc.) won’t the profits for all/most of the companies in the industry also be impacted. The rest of (the majority of) these stocks in the industry are selling at much higher multiples. I’ll take my chances with this one and a very decent margin of safety.
So looking at the price history for this stock there is some pretty scary stuff. Seeing the stock drop into single-digit prices and trading at 1x PE and .1x-.3x Price to Sales at times over the past 10 years is pretty scary. This is cyclical investing in a nutshell. Holding this stock during some kind of downturn like that will be scary. That said I would be backing the truck up at that point and adding to the position because those values were ridiculous…and I would have subsequently turned that into a very nice gain since then. Seeing a huge price drop that is explained by an overall cycle shift doesn’t really cause me huge concern. Frankly, I expect that to be the case at this point and have analyzed this stock based on that as best as I can. If the cycle doesn’t shift I should be surprised nicely.
That said this stock is trading at a decent valuation even using the most conservative current estimates available (which might not be saying much). The biggest risk for this is that we are at the top of the cycle and earnings get whacked in a cycle. The price will get destroyed (potentially) as cyclical companies tend to do. But at that point I’ll be adding aggressively (because it will rebound as cyclical companies tend to do). I don’t think this company goes away in a cycle like that as they are very conservatively financed compared to their industry. I think that should benefit them in that type of environment. Weather the storm, survive the storm, come out stronger than others ready for next cycle. The ultimate question I ask is, do I want to be in the steel producer for a while and will this company be a good way to do that. Yes is the answer to both as I think neither the industry or the company go away…ever.
The final thing I looked at was are there similar US-based steel companies that I would want to own (many of those have been dinged recently with the trade war shenanigans). Valuation wise the two I’d want to look at are US Steel and AK Steel. Both these are lower quality and not really worth switching up for at this time.
I’m sharing my analysis here. If you have thoughts on it I’d love to hear them hit me up on Twitter @joeydean72