A Beleaguered Sector
A sector that has been much maligned over the past five years has been the steel industry. Steel production is capital intensive, the equipment is expensive and the business is extremely competitive. Examination of the big names in American steel production including Nucor (NUE) and United States Steel (X) since the 2008 financial crisis - and the corresponding slowdown in construction and steel consumption - reveal that fact. Despite the fact that some names in the steel sector including Schnitzer Steel (SCHN) and Nucor offer dividends over 2% annually and are trading at attractive prices relative to book value, the large amount of debt carried by large steel production companies raises significant concerns in my mind. Despite these warnings, there are bright spots to be found in the dark corners of the sector...
I believe that Ampco-Pittsburgh is one such stock that provides an attractive area for investment and merits closer inspection in the steel sector. The company is a venerable one and was forged in a crucible - founded in Pennsylvania, in 1929, its corporate history has witnessed the Great Depression, the corrosion of the American steel industry and a myriad of financial crises during its lifetime. Despite all the adversity, the company has remained in business and has paid and increased dividends for over a decade.
Currently the company operates in several areas, including Pennsylvania, Virginia, New York, and the United Kingdom. The steel segment of the company primarily produces forged and cast rolls while the Buffalo Air Pump and Aerofin divisions produce HVAC products, liquid and air transfer pumps and heat transfer coils.
Currently priced at $18.99, against $7.63 of cash per share and $18.57 of book value per share the company has around six times more cash on hand than the debt that it carries - in marked contrast to its larger peers. AP also offers a dividend yield currently of 3.79%, and has insider ownership of 14.8% - with recent insider purchases coming in May of 2012 when the price of the stock briefly fell below $16 per share. The company is small, with a market cap slightly below $200 Million.
I believe that the company's large cash position could be for several things: investment into capital intensive infrastructure utilized in steel production, share-repurchases, surplus for a special dividend or a reserve for potential acquisitions. The large portion of cash relative to the debt carried by the company and its diversified lines of business are one of the reasons I have been attracted to the stock - in contrast with many of the larger steelmakers that carry a very large amount of debt relative to cash on hand - something I believe makes them extremely vulnerable to cyclical downturns.
Forged and Cast Rolls
The first segment of Ampco-Pittsburgh, the production of forged and cast rolls is conducted by the Union Electric Steel Corporation, which has divisions in the United States and the United Kingdom. The Rolled and Forged portion of Ampco-Pittsburgh's business is one that I believe to be most vulnerable to the vicissitudes of the global economy and the one which is the most capital intensive by virtue of the high amount of capital investment required for costly equipment (forges, presses, etc...) and the enormous amount of power consumed by the processes (which requires very high temperatures). Due to the location of a portion of this business segment in the United Kingdom, there is also the presence of currency risk.
Air and Liquid Processing
The other branch of Ampco's business I believe is the segment offers inherently more attractive prospects. Per the company's 10-K, found here, Aerofin produces heat exchange coils for power generation (nuclear and conventional), automotive and HVAC. Buffalo Air Handling produces HVAC products for the industrial, commercial and institutional building markets and Buffalo Pumps produces products that are used in the defense, refrigeration and power generation industries.
Litigation and Environmental Concerns
Due to the company's extensive history as a corporate entity in the industrial sphere, there are several areas of liability that need to be explored before considering investment: one significant and one less significant.
1. Less Significant: Remediation of Land
Per legislation in the United States, companies engaged in heavy industry over a long period of time are often on the hook for environmental cleanup of previously or currently owned sites. Ampco-Pittsburg is no exception, and has remediation that needs to be conducted. Despite this fact, the costs of remediation are relatively minor when compared to...
2. More Significant: Asbestos Litigation
The company and one of its subsidiaries are involved in asbestos-related litigation and the settlement of such cases. The company currently carries Asbestos insurance which currently bears a large portion of the costs regarding claims to be paid out in the future. In addition to carrying insurance for these claims, the corporation has also established reserves to absorb the costs of additional claims made until 2022 and, per its 10-K receives a tax benefit for these claims.
Spin-off or Acquisition Target?
Because of its large cash position, relatively low debt load and diversified businesses, I believe that Ampco-Pittsburgh could represent an attractive candidate for acquisition from a larger steel producer, as the industry has been undergoing a phase of consolidation, which provides larger entities with considerable benefits - including superior pricing power. I also believe that the presence of a considerable discount to total assets (A discount slightly under 30% when comparing current prices to assets plus cash) could further increase this possibility.
The possibility of a spin-off or acquisition of one line of the company's businesses (either Forged and Rolled or Air and Liquid) is also possible, because of the decentralized nature of the corporate entity and its geographic diversity - which could result in a shareholder receiving a special dividend for their shares in the form of cash or stock in the new entity.
I believe that Ampco-Pittsburgh is an attractive company because of its robust dividend yield, strong cash and minimal debt position, numerous lines of business and potential as a takeover target. However, despite this fact I would caution against the risk of overpaying for the company as the steel industry as a whole has faced considerable headwinds since the economic crisis. Nevertheless, if the company's dividend yield rises over 4% - I will be a buyer.