Friedman Industries: Strong in a Weak Market

Friedman Industries Inc. (FRD) is engaged in steel processing, pipe manufacturing and processing, as well as steel and pipe distribution. This is a sector that has suffered a double whammy of declining demand and a whipsawing spot market steel prices. Needless to say, the company business and the stock price has suffered too.

This is a small company in the sector and probably has one of the strongest balance sheets. It appears to be well positioned to prosper when the demand for its products improves. The catalyst here being a generally improving economy as well as increased infrastructure spending in the next two years as part of the stimulus.

I am putting this company stock on my watch list, with an intention of committing money to it when my liquidity allows it. Let us take a brief look at its financial condition.

Current Market Capitalization: 41.2 million

Balance Sheet (Q1 2010, most recent quarter):

Current Assets: $43.86 million, $21.87 million in cash

Total Assets: $61.39 million

Liabilities: $5.64 million, 0 long term debt

Equity: $55.75 million

Income Statement:

2009: $13.68 million

Last 4 quarters: ($0.16), ($0.3), $4.56, $5.44 (in millions) = $9.54 million

Growth Rates (5 yr average)

Sales: 12.44%

Net Income: 40.07%

Other Ratios (5 yr average)

Return on Equity: 18.5

Return on Capital: 17.7 (company used to have debt earlier which has now been retired)

Finally, the stock is currently offered at:

Price/Book: 0.74

Price/Earnings: 4.3 (trailing 12 months)

Given that the company has $21.87 million in cash, assuming the company requires 5% of sales as working capital (in truth, the number is more like 2%), at 2009 sales level of $208 million, the company can realistically distribute $21.87 – 208 x 0.05 = $11.5 million back to the shareholders and still continue to operate its business without any problems.

Therefore, in essence a private buyer for the company can acquire the entire company for $41.2 million (current market cap) – $11.5 million (the cash that can be taken out), or $30.7 million. This means that in reality, the company is only selling for an equivalent of 30.7/9.54 = 3.22 P/E ratio.

The company's 10-year average P/E ratio is close to 10.

At these prices, this company is a definite buy. The only risk going forward is whether the business environment will improve materially to make the company profitable again. But given that the company is well managed and its losses in the last 2 quarters have been minimal, I estimate that the company has sufficient liquidity at hand to survive for next four years at the current level of losses.

Comments

[Ron Sommer:]

I agree that FRD is undervalued. It is also on my watch list. I believe the full value of FRD is in the $10-$15 range.

Oct 10 11:37 AM

[CarthageCap...:]

Totally misleading. You somehow forgot to mention that they lost their biggest customer.

To paraphrase the annual statement "United States Steel Corporation is their biggest customer (30%). In February 2009, USS announced that it was temporarily idling its plant at Lone Star, Texas, due to weak market conditions. Since February 2009, the Company has received few orders from USS and a significantly reduced supply of pipe and coils from USS. The Company expects these circumstances will continue until market conditions improve."

I was impressed that the company didn't lose money last quarter, but at this point this this is a sunken ship slowly leaking water. No matter what your prior 5 year growth sales say.

Oct 13 02:35 AM

[Arohan:]

CarthageCapital, you are correct about the temporary loss of USS. However, I am looking at FRD from the perspective of its current balance sheet to see if it has enough juice to last through the weak market conditions, and I think it does. If and when the economy improves and the steel demand comes back, the company is well positioned to start growing. The current forecasts say that the steel demand will be up in 2010.

If the economic conditions worsen rapidly to the extent that the company needs to be liquidated, there is enough tangible value on the BS that I am confident that the shareholder at current prices will be able to recover a good chunk of his investment.

The question is whether the company will muddle through and leak some of the value in the process. Maybe. I would invest if I trust the management to be competent. Otherwise, just give it a pass.

Oct 13 09:14 AM