APEMY - Aperam Stainless Steel

[Sportgamma]

Thesis http://sportgamma.net/2011/08/03/profile-aperam/

 

Special situation: Spin-off

 

Timeframe: 12-18 months

 

Expected return: 50% total (33% assuming 18 month duration)

 

The company

 

APERAM came into existence when ArcelorMittal spun-off their stainless steel operations. Aperam is the 6th biggest stainless steel producer in the world, the 2nd largest in Europe and the largest stainless and specialty steel producer in South America. The company had annual production capacity of 2.5 million tonnes in 2009 in stainless and specialty steel.

 

The Company is also a leading producer of high value-added specialty steels products, including grain oriented (“GO”) and non-grain oriented (“NGO”) electrical steels and nickel alloys. Its production capacity is concentrated in six production facilities located in Brazil, Belgium and France. Its distribution network is comprised of 19 steel service centers (“SSCs”), 10 transformation facilities and 30 sales offices. The Company sells its products to customers on three continents in over 30 countries, including customers in the aerospace, automotive, catering, construction, household appliances and electrical engineering, industrial processes, medical and oil & gas industries.

 

The reasoning behind the Spin-off

 

According to Chairman Mittal in the spin-off prospectus: “Stainless steel is a capital intensive business that has been competing within ArcelorMittal for capital allocation against the core strategic areas of focus for the ArcelorMittal group, which are mining division expansion and carbon steel growth projects in the emerging markets. Furthermore, the stainless division does not receive the attention it merits from the financial markets as it is part of the wider ArcelorMittal group and represents only 5% of group EBITDA. Pure-play stainless steel companies have generally traded at a premium in the market compared to carbon steel and diversified steel companies.

 

I therefore believe that an independent stainless company would be in a better position to attract and allocate capital, access third party funding and create value for our shareholders through higher earnings multiples. Ultimately, I believe it will result in a more equitable valuation for the stainless business.”

 

The Mittal family is not dumping the operations as they will keep a 40% ownership after the spin-off and Mr. Mittal will serve on the board of directors. Also, the balance sheet look relatively clean as no debt was dumped on the spinco as often happens.

 

I suspect that one of the main reasons for the spin-off is to make it easier for Aperam to finance mergers and acquisitions. The European stainless industry has been suffering from a chronic overcapacity and attempts to consolidate the European stainless industry have been unsuccessful in the past.  According to CEO Fontana: “We are open to change. There are things we can do by ourselves and they deserve to be done, and if an opportunity comes, then we are open. There were many talks in the past to build a stronger player with better utilization in Europe but they were not successful. The spin off may make it easier, in case it may happen, because people get a better understanding of the operations.“

 

Industry drivers

 

Structural overcapacity: Steel production has deep political implications as local communities often depend on employment from these operations. Therefore unprofitable operations are kept alive for political reasons, subsequently hurting the overall industry profitability and efficiency. Additionally, as it is a capital intensive industry, winding up unprofitable operations can be very costly.

 

Pricing forces: European stainless mills calculate prices for their products by adding a monthly alloy surcharge to recoup the cost of the raw materials they buy. The nickel price is the largest component of that surcharge. Therefore, nickel prices play a key part in determining the prices for stainless steel. When nickel prices go down, stainless distributors become hesitant in their purchasing (link). The reasoning is that if they buy at current prices but nickel continues to drop, they will have a cost-disadvantage to distributors who delay buying. About 60% of nickel consumption comes from the making of nickel steels, so I suspect some sort of reflexivity effect.

 

Outlook

 

-         According to statements from the Aperam leadership European stainless steel producers used about 70% of their capacity in 2010 but it forecasts a growth in demand of about 6% a year in the medium term, with emerging markets averaging 7% to 8% and Europe about 3% to 4%. The potential for demand growth is greater in stainless than carbon steel national demand for stainless (as opposed to carbon steel) increases as countries become more developed. Stainless steel represents only 2% of total world steel market in volume but consumption is likely to return to levels seen before the global economic slump by 2013 or 2014.

 

-         A lower alloy surcharge marks down the value of producers’ inventories, so analysts expect steelmakers to post inventory-related losses in the second quarter.

 

-         ThyssenKrupp, Germany’s biggest steelmaker, is also made public its intentions to spin-off its stainless steel arm (link).

 

Valuation

 

Book value per share is roughly $51.2 with inventories representing about $13 per share. The shares are trading at around €17 in Amsterdam (APAM.AS) and $24 OTC (APEMY.PK) currently. Interest bearing liabilities are about $1.1 billion ($14.5 per share) or 28.3% of book value of equity. They had $268 million of cash in the 3Q of 2011 ($3.4 per share) and no goodwill is recorded on the balance sheet.

 

See earnings and FCF 2007-2010http://sportgamma.files.wordpress.com/2011/08/earnings-and-cash-flow.jpg

 

Their earnings and free cash flow have been weak in the last 3 years after breaking all records in 2007 ($14 per share in FCF). Assuming Aperam is worth their book value to a private buyer, the potential upside would be about 50%. Assuming duration of 18 months, the annualized potential return comes in at 33%.

[oddballstocks]

Thanks for posting this, Amperam has been on my radar since the spinoff.  At the time it seemed overpriced considering the overcapacity and structural cost issues, I didn't realized it had fallen almost 50%.

 

I guess two questions:

1) How solid is book value, you note there is no goodwill but are the facilities fairly valued or out of date?

2) How attractive do you think they are as a take over target?  I know when I first read about them most commentary mentioned that consolidation was necessary in the industry, do you think they are the acquirer or acquiree?

 

Nate

[Sportgamma]

Hi Oddball,

 

1. I must admit that the steel industry valuation is a bit out of my league. However I added comparison of multiples to the thesis, which you can access here:

 

http://sportgamma.files.wordpress.com/2011/08/multiples1.jpg

 

It is my impression that the book value of Aperam seems to be pretty solid when compared to its peers as (1) amortization and depreciation rates are similar to peers,  (2) sales-to-total assets and sales-to-PPE are similar to its main competitors Acerinox and Outokumpo and ebitda-return on invested captial (equity plus interest bearing debt) is similar to industry average.

 

2. In their public statements, management has talked more as a acquirer than the other way around. One of the reasons for the spin-off was to make it easier for the stainless business of AM to issue bonds and they are less leverage than Acerinox and Outokumpo. A possible scenario that I see is a merger between Aperam and the to-be spun-off stainless business of ThyssenKrupp.

 

However, I must add that they main reasoning behind the thesis is that the market price is low because shares are being dumped as a result of the spin-off.

[eclecticvalue]

This one has fallen 70% since the spinoff. I have been watching this at $18 and now has fallen under $12. I thought it would be worthwhile to start a position. Aperam is on course of completing their leadership journey initiative. The leverage has been reduced considerably since last year. I am thinking the recent volatility has been due to the European crisis. There have been no writedowns on book value as of yet.

[oddballstocks]

This one has fallen 70% since the spinoff. I have been watching this at $18 and now has fallen under $12. I thought it would be worthwhile to start a position. Aperam is on course of completing their leadership journey initiative. The leverage has been reduced considerably since last year. I am thinking the recent volatility has been due to the European crisis. There have been no writedowns on book value as of yet.

 

Thanks for bringing this thread back to life, I just took a quick look and EV/EBITDA of 4x and P/B of .25, so we've entered value territory for sure.  I need to look into them again.  Any thoughts after your look?