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Summary

  • Friedman Industries is a micro-cap steel processor which is highly leveraged to the economy. It has a strong and unleveraged balance sheet.
  • Friedman Industries is selling at below tangible book value.
  • Analysis of historical price to book value ratio indicates that the time to buy FRD is now with a view to selling it when P/B ratio exceeds 1.5.

Friedman Industries Incorporated (NYSEMKT:FRD) has been covered by various authors in Seeking Alpha who have pointed out that the company is cheap and may have considerable upside to the improving economy of the US. Friedman Industry is engaged in steel processing, pipe manufacturing and pipe distribution. It is particularly leveraged to the oil industry and the construction industry. Of course, steel is a highly commoditized business and FRD is essentially a price taker.

The steel industry on the whole is very cyclical and in 2013-14 FRD has experienced high volatility in the market. FRD is currently constructing a new pipe construction plant to supply the oil industry in Lone Star, Texas.

FRD has no debt and is cash flow positive. As shown in the chart below, remarkably for a cyclical company, FRD has always shown positive earnings since 1995. FRD's cash return has fluctuated widely over the period and is currently in a down cycle.

FRD is NOT a buy and hold stock. The time to pick up FRD is in a down cycle in the steel market and sell in the up cycle. Book value is good valuation metric for a company like FRD. Looking over its history FRD has traded between P/B ratio of 0.5 to P/B of 3.4. Currently FRD is trading at a P/B of 0.94 indicating that it's a decent time to buy FRD with a view to sell it when P/B approaches 2 which should happen in the next 2 to 5 years. Meanwhile FRD has a history of returning excess cash to investors through special dividends.

The following chart show FRD's valuation bands based on book value.

Conclusion

This is the time to buy FRD with as its selling below book value with a view to selling it when exceeds book value of 1.5. Risk of permanent loss of capital is low as the company has no debt. The company is highly leveraged to the improving economy. The company is about to complete a new facility for its tubular products which should come on line next year. This may provide a catalyst to the stock in 2015 - 2017 when P/B ratios expand.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

Source: Friedman Industries: Cyclical Stock With A Pristine Balance Sheet In The Buy Zone