A.M. Castle: Inventing Inventory Part II

| About: A. M. (CAS)

Two days ago, we considered the huge gap in inventory valuations at A.M. Castle (NYSE: CAS). On the one hand, a LIFO valuation tells us the inventory is worth $248 million - but the replacement cost of the exact same inventory is listed at $423 million. Thinking as a value investor, if you were to buy this company (or a piece thereof), which (if either) of these valuations would you rely on? Since the company's market cap is just $470 million, it's an important question!

What we want to know is the market value of that inventory. The key to answering this question lies in determining how much someone (i.e. a customer) is willing to spend on the inventory. Just because the inventory has a high replacement cost ($423 million) does not mean anyone will actually buy these goods for that sum.

On the other hand, the LIFO amount ($248 million) is the one that is stated on the balance sheet. This amount has to be written down to the lower of cost or market (as per Note 8 to the quarterly financial statements), so at least we know the inventory is not worth less than that (according to management). But how much more than that are its customers willing to pay?

Take a look at the company's gross margins. Here we get a hint of how much above the company's cost of the goods customers are willing to pay. Last quarter, sales were approximately 30% higher than COGS.

As an approximation, we may be able to surmise that the inventory carried at $248 million can be sold for about 30% higher than this number, bringing the market value estimate of inventory to about $322 million.

Of course, this method is not perfect. Can you see any potential problems that we can rectify? Would you expect the actual market value of inventory to be higher or lower than the $322 million estimate we just calculated?