The boom goes on in steel prices.
Mexico’s Ternium (NYSE:TX) is not going to see quite the same price leverage as U.S. steelmakers like Nucor (NUE) or Steel Dynamics (STLD), but global prices have also been quite a bit stronger in 2021 so far than initially expected. That’s going to drive robust revenue for most of the year, as well as even better operating leverage and cash flow generation than previously expected.
The biggest risk I see with Ternium today is that high steel prices start destroying demand, just as industrial markets in Mexico, Argentina, and other South American markets start to recover. There is also some uncertainty on capex/capital allocation beyond this year, with management clearly interested in growing the business to capture expanded opportunities. Even with that factored in, though, the shares continue to look undervalued.
With lead-times for hot-rolled steel in the U.S. approaching 10 weeks, prices continue to stay at or near record levels at close to $1,300/ton. On top of that, while some producers are trying to restart idled capacity, U.S. Steel (X) recently announced a one-month outage for one of its blast furnaces, while there are rumors of an outage at ArcelorMittal’s (MT) Calvert mill.
While futures prices are not guarantees and a lot can change over the next few months, current futures have HRC steel prices staying at $1,000/ton or above through November, an extended boom time that will do great things for margins and cash flows at producers like Nucor and Steel Dynamics.
At this point, most markets are contributing to the growth, with aerospace and oil/gas really among the only major markets not meaningfully participating. Even there, though, aerospace destocking should end in the first half of 2021 (more of a driver for specialty stainless steel), while stronger oil prices should drive a faster recovery in the oil/gas sector.
Industrial companies were pretty confident that they could pass on higher material prices when they reported earnings in January/February and gave initial guidance for 2021. At that time, steel prices were around $1,100/ton, but futures were suggesting a meaningful drop-off in the second half of the year. Just how far companies can push pricing remains to be seen, but I do think steel prices at close to $1,300 risk some demand destruction.
Looking at Ternium and its markets in Mexico, Argentina, Brazil, and other Latin American countries, the same general dynamics are in place, though not with the same momentum in pricing. Management has seen improving demand from industrial markets in both Mexico and Argentina and improving construction demand in Argentina as well, but there will be a point where higher steel prices start pressuring volumes given the still-tenuous recoveries in many countries.
Ternium’s fourth quarter results saw a 25% EBITDA margin and steel EBITDA of $210/ton, and that was a relatively modest 13% sequential improvement in realized pricing. With the bigger increases in the steel prices since then and the fact that a lot of Ternium’s realizations come on a one-quarter lag, there should be even greater margin leverage in store, though higher input costs will have a moderating effect.
The company is also scheduled to complete its last growth capex project, the Pesqueria rolling mill, in the next few months. With that project complete and EBITDA margins in the 20%’s (if not higher for at least a couple of quarters), Ternium is set to generate significant free cash flow (possibly around $1.4B) in 2021, and the combination of low capex and ongoing economic recoveries in Latin American economies should set the stage for another strong year in 2022, even if not quite as strong as 20201.
Management has already reinstated the dividend, and at $2.10/ADR, there may be some “compensation” already in place for the missed dividend in 2020. Even with that dividend hike, Ternium will have significant surplus cash at the end of 2022, and how management plans to use it is a major unknown.
Ternium management has spoken of the growth opportunities they see/expect from the USMCA, and a lot of that is likely to take the form of “near-shoring” – relocating manufacturing and essential supply chain components from countries like China to countries like Mexico. That, in turn, should drive more steel demand.
Ternium has been gaining share within Mexico’s steel market, but it’s a market that still relies heavily on imported steel (in the mid-to-high 30%s), and Ternium has the opportunity to not only install more capacity but more value-added capacity, as the share of imports is even higher in areas like auto steel. Accordingly, I do expect Ternium to look to invest further in capacity expansions, and perhaps with an increased focus on higher-value steel types.
Steel prices won’t hold these levels for the long term, but they still could offer some upside surprises by staying stronger for longer. At some point, though, these prices will incentivize more capacity to come into the market (and/or destroy demand for customers that can’t pass on the higher prices). For the time being, it’s an opportunity for Ternium to produce some excellent margins and cash flows.
Since my last update on Ternium, my estimate for 2021 revenue is now more than 30% higher than before (around $11.5B), and my EBITDA estimate has almost doubled to $2.7B. As I don’t expect any sort of “new normal” in the steel market, though, my out-year estimates don’t change quite as much, and I do expect a falloff in 2022 and 2023. With management sounding more as though they intend to pursue growth opportunities, I have assumed more capacity additions in my model, boosting my long-term revenue growth rate to around 3%.
Ternium is already quite profitable compared to many of its peers, and across the ups and downs of the cycle, I do expect good FCF generation (in the mid-single-digits), with some margin leverage possible if the company prioritizes higher-value steel products with its future capacity additions.
Discounted cash flow is often a tricky tool to use with commodity stock investing, though the shares do still look modestly undervalued by this approach – a rarity in the sector. EBITDA and ROE-based methodologies do also suggest the shares are undervalued on a more near-term basis, with both approaches giving me a fair value of around $45.
Up over 135% since my last article (outperforming Gerdau (GGB), Nucor, POSCO (PKX), and Steel Dynamics; underperforming Cleveland Cliffs (CLF) and U.S. Steel, and matching ArcelorMittal), it’s tempting to take the profits and run. I do think the music is going to stop at some point for the steel sector, and these are not shares I want to own as long-term holdings from today’s level.
Still, the “stronger for longer” thesis can’t be ruled out, particularly with Ternium enjoying end-market recoveries and share gains in markets that still leave room for profitable capacity growth. With near-term upside to the mid-$40s, it may not be time to cash out, but I would caution against expecting anything like another 100% run from here.
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Disclosure: I am/we are long TX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.