Alloy Steel International: Explosive Growth at a Reasonable Price 13 comments
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Alloy Steel (AYSI.OB) is an Australian maker of alloy wear plates primarily serving the Australian mining market. Wear plates are used to prevent or slow abrasion in many areas, including bins and chutes used in the mining process. The company offers a compelling investor proposition on several fronts
1. Enormous growth
2. Prudent management
3. Competitive advantage
Growth
AYSI has been on an organic growth tear for the last year, growing revenue from 3.4 million for all of fiscal 2006 to 8.7 million for fiscal 2007 an increase of 155% year over year. During that period, net income increased from a loss of $270,000 to annual net income of 1.3 million for 2007. The impressive growth rate for the company continued into fiscal 2008 where revenues for Q1 were 3.1 million for an annual run rate of over 12 million dollars again all organic. Q1 is in fact typically somewhat slower as end of year holidays and vacations come into play. The implied run rate could be quite a bit more. Earnings per share for 2008 came in at .08. The first quarter of 2008 came in with earnings of .03/share. There are few places you can buy sales growth of 100% for a forward PE around 12.
So what is leading that growth number and why will it continue? Three words: mining mining mining!
Much has been written about the boom in mining going on in Western Australia with BHP Billiton (BHP) and Rio Tinto (RTP), among others. These are the customers that AYSI serves. The mining boom is being fueled by demand in China and other emerging economies that are demanding more and more production and where possible are investing directly to get iron ore and other minerals out of the ground. The trend shows no sign of abating and is actually accelerating.
The chart below from the Australian Bureau of Statistics lays the case out quite nicely:
Mining exploration activity in Western Australia is currently growing at a near double digit rates sequentially, which translates to annual growth of almost 40% in exploration. It can take years to go from exploration to actually bringing a mine on-line so the macro-picture is already baking in growth levels even greater than what we are currently seeing as these exploration dollars come online and as mining operations near term and years down the road begin production. The company invested $500,000 in new plant and equipment in 2007 with over $300,000 of that coming in Q4 alone. By contrast, there was less than $100,000 in capital expenditures for all of 2006. The company indeed seems to be tipping their hand that there is growth ahead.
Prudent Management
AYSI struggled for years to get their product accepted in the industry. Wear plates are crucial components in mining. If the plates don't perform and have to be replaced, a mining operation can face significant and costly downtime. Building the needed level of trust took time. Their tight cash levels had prevented much spending on marketing and advertising while they worked on market acceptance. For 2007, the company spent a mere $11,000 on advertising for the entire year. The company had relied in large part on word of mouth to build product awareness during the lean years. This not only speaks to careful money management, but is indicative of the competitive advantages of the product itself. AYSI generated almost 9 million in sales in 2007 on a mere 11 thousand in advertising. Their ability to pull that off implies that either the product is very special, the management is very special or both. You can bet that now that the company is flush with cash they will be looking to ramp up sales in both Australia and in a largely untapped international market.
Despite these difficulties, the company has managed to move along without dilutive financing or burdensome long term debt. In fact, the share count at the end of 2007 was identical to the share count when they first went public back in 2001. No dilution at all, even with the large ramp in organic growth recently. This prudent fiscal management is further illustrated by their control of SGA expenses. Despite their 155% sales increase, SGA expenses grew at less than 25% for 2007. This is a company that clearly cares about both the top and the bottom line and treats its shareholders well. That should become obvious as sales continue to grow, more potential customers worldwide become aware of the benefits of the product line, and their organic sales growth and high margins continue translating into increasing bottom line profits.
Competitive Advantage
One real advantage for AYSI is that they have a patented process for applying layers of alloy to their mild steel backed plates. They can do this in a single pass, which gives them an advantage over competitors who require multiple passes to achieve the same thickness. The advantage of this single pass technology is that extra layers often create uneven thickness as well as planar weakpoints that a single pass does not.
In addition, the company is maintaining its technical advantage. They recently announced a new wear plate product called super-arcoplate that can apply a 3/4 inch thick alloy on a 1/2 inch mild steel backing in a single pass. To my knowledge, no other competitor has managed to accomplish close to this thickness on a single pass operation. The result should be a considerably better plate with more even wear, less planar weakness and an even distribution of alloy material. This, in turn, should provide not only greater sales, but stronger pricing power, as well. Customers will benefit from this upstream service by having less downtime.
Summary
AYSI is a rare company in today's microcap market. They are growing their sales organically at a triple digit clip annually. They are doing this growth with ZERO shareholder dilution. They have a macro-picture that supports further large-scale growth in their business for some time. They have a competitive advantage in their industry, with the thickest one pass plate soon to be in production, and they have a management team heavily invested in common shares that puts shareholder value first. I believe the stock is a compelling buy in the 1.30s and I believe there is room for continued significant sales growth and price appreciation going forward.
Disclosure: Author has a long position in AYSI.OB
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This article has 13 comments:
Just called Australia and talked with CFO 13-Feb-08 08:01 pm
Allen Winduss. This is a copy of my post on Value Microcaps where my screenname is Wadegarret.
He was very knowledgable, and I have good news! I will go over one by one the questions I asked him. He was in a hurry to get to a meeting, so I had to go kind of quick.
The men work 6-6.5 days/week. In the Dec qtr, there were around 14 days of downtime, however in the Mar qtr there is expected to be only 4 days. He couldn't remember the number of days down in the Sept qtr, but there were little. I then asked about the second shift. The second shift worked 95% in the Sept qtr, but only 60-70% in the Dec qtr, and are expected to work 100% in the Mar qtr.
Next topic was margins- They were bad in the Dec qtr for a couple reasons. First there was a sudden chrome and steel cost increase in the Dec qtr which was temperary, and has already come back down to about Sept qtr levels for the Mar qtr. Second, they had a couple of large contracts they had to get out which brought lower margins than normal.
Next I asked about seasonality- there isn't much, except that the Dec qtr is usually their weakest because of so much downtime. I asked when the second Mill was going in production. Alan told me by July. I then asked him what tax rate going forward- he said 30%.
22 February, 2008
The company through its manufacturing subsidiary Alloy Steel Australia (Int) Pty Ltd, has successfully concluded preliminary proving trials on developing new technology that will allow the company to produce a much thicker alloy deposit (“SUPER ARCOPLATE”) in a single pass using the company’s unique patented manufacturing method. To the best of the company’s knowledge no other manufacturer of clad wear plate can offer the market anything thicker in an alloy clad overlay than 5/16th or 7.5mm in a single pass as we can do with the new “SUPER ARCOPLATE”
The new plate has a 16mm (3/4”) alloy overlay bonded to an 11mm (1/2”) mild steel backing plate using a single manufacturing pass.
Conventional weld overlay plates from other manufacturers which do not compare with the new single pass 16mm (3/4) alloy may need up to 5 overlay passes to achieve the same thickness during its manufacture. Multiple passes caused by the bulk welding method create both structural and metallurgical weaknesses and in the wearplate and in many cases the material is subject to premature failure when in service.
The company believes that with the single pass technology the new “SUPER ARCOPLATE” will outlast the plate presently being used by consumers by up to 10 times even though it is less than half the thickness of the current plate used.
The new plate has a total thickness of 1¼” or 28mm and will replace quenched and tempered (QT) carbon steel plate of up to 4”or 100mm thick in surge bins, feed hoppers and shutes in most mineral mining operations.
Users of this type of plate are mining giants such as BHP Billiton, CVRD, Rio Tinto, Xstrata and Codelco.
The company estimates that the market worldwide for (QT) and foundry cast white iron castings wearplate used in these applications to be in excess of 3 billion dollars.
The new thicker “SUPER ARCOPLATE” has the potential to capture a significant portion of that market where down time is a critical factor in the mining or mineral processing operation.
The company anticipates releasing the “SUPER ARCOPLATE” commercially on to the market in the second half of this year.
The Directors of Alloy Steel International, Inc. have been advised by the Company's Engineering Department that the new Arcoplate Production Mill is expected to be ready for trialing in June 2008.
This is a realistic target date which will only not be met if there is a delay in the supply of machine components from local and international suppliers. At this point in time, we are not aware of any possible delays.
Testing and real time proving production runs are expected to take approximately six weeks, and on this basis, the machine should be producing commercial product prior to the end of August 2008.
As the new production mill has a significant amount of new innovations, including mechanical, electronic and parameter control software, we have allowed additional time of six weeks for proving and tuning.
The Company is at present looking at patent protection for the new innovations.
First I attribute the drop in share price after last Q to disappointed speculators who jumped in after a blockbuster Q4 where everything from sales to margins clicked perfectly. The stock had a near 100% runup into that report so it wasn't a suprise to see it lose some.
One thing to keep in mind is especially in terms of gross margin there can be some significant variations from quarter to quarter for AYSI.
As a previous poster noted since this article was written the company announced the expansion of their facility to include a second mill. This was news I had been expecting and it validates the growth thesis. I think this likely more than doubles their capacity. I think it will be awhile before 2 mills are running at full bore but assuming they get to that point there should be enormously higher earnings flowing to the bottom line.
As far as how I found out about the company its just a matter of bleary eyed reading of quarterly reports until something interesting pops up.
The quenched & tempered (QT) carbon steel plate that Alloy Steel Int'l will be replacing (as soon as they patent the process and commercialize it around mid August 2008), is estimated to have a current $3 billion+ market worldwide. Potential customers such as BHP, CVRD, Rio Tinto, Xstrata and Codelco are nothing to sneeze at!
Now that they have proven their superior technology with customers such as BHP, Rio Tinto and Fortesque mining who recently equiped their entire new mine with Arcoplate imagine if a company such as CVRD from Brazil who are also potential candidates for a produvt like Arcoplate
AYSI will need to raise some capotal to capitalize on market oppertunities presented to AYSI in South East Asia, Australia, Chile ,Brazil, Russia,China and Canada.
The company and the stock would then be unstopable.Congratulat... to the Directors of AYSI for a great job.