Alloy Steel International Rebounds Thanks to Q4 Numbers

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 |  Includes: AYSI, BHP
by: David Pinsen

Alloy Steel International (OTCPK:AYSI) is a nano cap company headquartered in Australia that uses a high tech, proprietary process to manufacture protective wear plates for mining equipment. Essentially, the company is a picks and shovels play on the mining industry, particularly iron ore and coal mining (AYSI has a long term, strategic supply agreement in place with BHP Billiton (NYSE:BHP)). As the iron ore and coal mining industries continue to benefit from the demand for industrial commodities from China and other emerging economies, AYSI has the potential to indirectly benefit from that demand as well.

On September 3rd of last year, I wrote a post about why I was adding more shares of Alloy Steel at 90 cents per share, despite the stock having dropped more than two thirds since the beginning of the year. In that post, I wrote:

It looks like I overestimated how much the company would earn this year. My mistake. I thought it would earn over 30 cents this fiscal year, but that appears to have been unrealistic given the capacity constraints the company mentioned in our call earlier this week. Nevertheless, the company has already earned 17.2 cents in the first three quarters of this year, better than the 14.9 cents it earned in its previous best year (2008).

I also noted my rationale for adding more shares at that point:

My general idea regarding small growth companies is that if I can buy shares at a single digit multiple to a conservative estimate of what the company will earn next year, that’s probably a good deal.

Imagine that AYSI earns in all of 2011 what it has earned so far in the first three quarters of this fiscal year (17.2 cents). That seems like a conservative estimate to me (absent macro headwinds from China affecting the mining industry, I would expect the company to add to its 2010 earnings next quarter, and grow earnings by a modest amount or more next year). If you estimate that the company will earn ~17 cents next year, at its closing price Thursday (93 cents), the company was trading for about 5.5x that forward earnings estimate. That seems like an attractive valuation to me, even given the current secular bear market.

A few weeks after I wrote that, on September 27th, Alloy Steel announced that it was voluntarily de-listing its shares from the OTC Bulletin Board. AYSI message boards were full of commenters suspecting the worst, some claiming that the company was must be on the verge of bankruptcy. As I noted on my blog at the time, though, Short Screen showed an Altman Z-Score of 5.13 for Alloy Steel. And since scores of 3 and higher indicate a lack of financial stress, bankruptcy didn’t seem to be a likely outcome for AYSI.

The next day, AYSI plummeted by more than half again. Since my investment thesis of September 3rd appeared to still be intact, despite the voluntary de-listing, I added more shares at 44 cents.

Last week, AYSI finally reported its audited Q4 and annual results for its 2010 fiscal year, which ended on 9/30: record earnings of 10.8 cents for the quarter and 28 cents for the year. Those results and the management’s comments suggested that the company had resolved the production problems it had experienced with its second mill. The stock shot up 150% on the news, and an additional 26% Monday, though it gave back about 6% Tuesday.

At Tuesday’s closing price of $1.78, AYSI was trading at about 6.4x trailing earnings. It’s worth noting, too, that the company had previously announced that it was planning to expand its manufacturing capacity via a facility it was building in Indonesia:

The land of an area of approximately 37,500 square meters (403,646 square feet) is located in Cilegon (click here), a port side industrial estate in close proximity to Jakarta, the capital of Indonesia.

The current Arcoplate manufacturing plant in Western Australia with a land area of 4,750 square meters (51,128 square feet) is at full production capacity and has been limited by capacity to service the increasing demand.

The company didn’t offer an update on that expansion program in its most current release, but considering that it was able to generate 10.8 cents in quarterly earnings from its smaller Australian facilities in its fiscal 4Q 2010, there would seem to be significant upside potential if and when it can further expand its production capacity. According to a Q&A with company management at the end of August, its manufacturing capacity was the limiting factor in its sales. They noted at the time ...

There is currently high demand for the product, but we are limited by capacity constraints.

The results the company released last Friday would seem to support that claim.

Additional disclosure: I am long shares of AYSI.PK.