A View on Friedman Industries

Dec.10.10 | About: Friedman Industries, (FRD)

Friedman Industries (NYSEMKT:FRD) processes, manufactures and distributes coil and tubular (pipe) products made from steel. It has been in operation since 1939 (though in its present form since 1965). Its long history provides the value investor with a great deal of information to consider, with public data stretching back into the 1970s. Although my ultimate conclusion is that there does not currently exist a margin of safety sufficient to warrant an investment, this is a great company to consider in the future when Mr. Market’s mood becomes more bearish toward FRD.

Some of the attractive points:

  1. Extraordinarily stable costs as a % of revenue, indicating a highly variable cost structure.
  2. Zero debt (in fact, it doesn’t even have debt facilities right now because they were unimpressed with their lender’s renewal fees/rates).
  3. Strong dividend track record (18+ years!).
  4. No dilutive securities.
  5. Negligible off-balance sheet liabilities.
  6. LIFO inventory shows off-balance sheet asset (though, currently just ~$100k. Historically it has been higher, showing an LIFO liquidation which may have propped up margins in the last year).

Despite the above, the only major red flag for FRD is its reliance on US Steel as both a supplier and customer. In 2009, 30% of total revenue was derived from US Steel. This number fell to 4% in 2010, mainly because revenues collapsed (US Steel stopped ordering due to the economic climate, shuttering certain plants that ordered from FRD). The remaining revenues are derived from 160 companies, with none more than 10% of revenue.

As a result of its long track record and (#1 above) the stability of its margins, this company was relatively easy to value as a perpetuity. Using a normalized revenue level (assuming, possibly to the investor’s detriment, that US Steel will continue to order – which it has begun to do in 2010) and historical averages for operating expenses, conservative estimates generate an EPV in the low $8.00 – $8.25 range. The company is currently trading in the mid $7.00 range, meaning an adequate margin of safety does not currently exist. Regardless, I’ll be keeping an eye on this company as I wait for a market overreaction (preferably to a completely unrelated event).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.