Friedman Industries Looks Cheap Based On Fundamentals

Summary

• The company closed H1 FY22 with a net profit of $24.5 million thanks to high steel prices.
• The last time the company had unusually high earnings, it distributed a special dividend. I expect the same to happen in the near future.
• Steel prices have been declining for a few months now but I expect Friedman Industries to finish FY22 with earnings of at least $30 million.
• Overall, I think Friedman should be trading at over $12 per share, and I view it as a speculative buy due to the low trading volume.

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Introduction

In November 2021, I wrote a bearish article on SA about Chinese steel pipe producer Huadi International Group (NASDAQ:HUDI) and someone in the comments suggested I should take a look at U.S. steel products manufacturer and processor Friedman Industries (NYSE:NYSE:FRD).

I have to say I like what I see – Friedman is benefitting greatly from high steel prices and looks set to book the best financial results in its history. The company looks cheap at the moment as its TTM P/E ratio stands at only 1.75x as of the time of writing. Taking into account Friedman distributed a special dividend of $0.50 the last time it posted strong results, I expect a special dividend of at least $1.00 per share to be announced in the near future. Let’s review.

Overview of the business and financials

Friedman Industries was founded in 1965 and it specializes in cutting to length hot-rolled steel coils as well as manufacturing and processing steel pipes. It was a family-run business until 2010 when the founder retired and now all management and board members are independent.

(Source: Friedman Industries)

Friedman Industries currently has two hot-rolled coil processing facilities in Arkansas and Alabama as well as two electric resistance welded pipe mills in Texas. In May 2021, the company announced it is investing $21 million into the construction of a 70,000-square-foot coil processing facility in Texas. The latter will be located on the campus of the new 3-million-ton flat-rolled mill of Steel Dynamics (NASDAQ:STLD). Friedman’s new facility is expected to start operations in April 2022.

Turning our attention to the financials, we can see that FY22 is shaping as a historical year for the company as net sales more than tripled in the first half of the fiscal year and the net profit came in at $24.5 million.

(Source: Friedman Industries)

Looking at a breakdown by segment, we can see that the majority of revenues come from prime coil sales, although revenues from other products have also grown significantly.

(Source: Friedman Industries)

The company sold 108,500 tons in H1 FY22 compared to 81,500 tons a year earlier as it recovered from the effects of COVID-19, but the main driver for the strong results was high steel prices. Sales prices were 245% higher compared to H1 FY21, although Friedman Industries didn’t manage to capitalize completely on them due to hedges. The company had hot-rolled coil futures contracts in place, which resulted in losses of $8.2 million in H1 FY22.

Looking at the near future, Friedman sees margins and sales volumes declining slightly in Q3 FY22. It also expects to reclassify a loss of around $14.7 million into earnings during the quarter related to derivatives designated for hedge accounting.

Turning our attention to the balance sheet, we can see that Friedman doesn’t have much debt but there was a concerning increase in receivables and inventories in H1 FY22. According to the company, this is due to the significant increase in steel prices and so I think we should view it as temporary.

(Source: Friedman Industries)

Now then, what can we expect from the company when those profits finally make their way into the balance sheet as receivables and inventories decrease? Well, I think we should look at history for this. The last time Friedman booked unusually strong earnings was in FY 2012 and this was followed by a special dividend of $0.50 per share.

(Source: Friedman Industries)

(Source: Seeking Alpha)

Even if steel prices crash over the next few months, I view it as likely that Friedman will finish FY22 with a net income of at least $30 million. In light of this, I think that the distribution of a special dividend of at least $1.00 per share could be on the horizon. Looking at Friedman’s 10-year financial summary, I see a small steel company with typically low margins that usually manages to stay profitable and rewards its shareholders with small dividends. I think it’s a well-run business with a clean balance sheet and I’m surprised it’s trading below its tangible book value during a year with record profits. Considering Q3 FY22 is likely to be strong, I think Friedman should be trading at over $12 per share.

Some of the reasons Friedman could be overlooked by investors at the moment could be its microcap status as well as the low liquidity of its shares. It’s not unusual to see less than 20,000 Friedman shares change hands over the course of a trading day. This is a major issue when steel prices tank as a rush for the exits by investors can result in a significant share price decline. In fact, it's likely that this happened recently. You see, October was a pretty bad month for steel prices and then Friedman’s share price started falling in November. Can you see the correlation over the past year?

(Source: Trading Economics)

(Source: Seeking Alpha)

Investor takeaway

I view Friedman Industries as a small well-run steel company whose valuation has a strong correlation with the price of steel. The latter has been falling over the past few months and I think this creates an opportunity to accumulate shares of the company at low prices.

Friedman Industries is set to finish FY22 with the strongest results in its history, but those earnings were still in the form of high receivables and inventories as of September. I expect the latter to decrease to normal levels as steel prices decline and Friedman Industries seems likely to distribute a large special dividend in the future. My reason for this expectation is that this is exactly what happened after the strong results of FY12.

I think Friedman should be trading at over $12 per share, but I view this one as a speculative buy due to the low trading volume which results in high volatility.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.

I am not a financial adviser. All articles are my opinion - they are not suggestions to buy or sell any securities. Perform your own due diligence and consult a financial professional before trading.

Comments

[Go and do likewise]

So, it looks like FRD is rolling off a bunch of bad hedging and FQ4 will be the last batch. That said, it will be roughly $5.7M less than FQ3. So assuming the rest of the income statement is equal to FQ3, then I am guessing FQ4 would have earnings of maybe .40 to .55/share.

[Go and do likewise]

Looking 10Q filings and earnings PRs.

From the 10Q filings

FQ1 — "The estimated amount of losses recognized in AOCI at June 30, 2021 expected to be reclassified into net earnings (loss) within the succeeding twelve months is $31,544,060."

FQ2 — "The estimated amount of losses recognized in AOCI at September 30, 2021 expected to be reclassified into net earnings (loss) within the succeeding twelve months is $26,353,840."

FQ3 — "The estimated amount of net losses recognized in AOCI at December 31, 2021 expected to be reclassified into net earnings (loss) within the succeeding twelve months is $9,220,880."

From Earnings PRs

FQ2 — The Company also expects to reclassify a loss of approximately $14.7 million into earnings during the third quarter related to derivatives designated for hedge accounting.

FQ3 — The Company expects to reclassify approximately $9 million of these hedging losses into earnings during the fourth quarter.

[Go and do likewise]

Big reported loss but I see stockholder equity in FQ3 $91.1M v $80.3M FQ2

[Gold Panda]

@Go and do likewise yes, due to the cash flow hedges

[dlvvlv]

Panda-"Overall, I think Friedman should be trading at over $12 per share". Errrrr, not likely Panda Bear. Earnings really sucked the wet one. -43 earnings on +81 Y/Y Revs. Going to be a while before SP sees $12 IMO

[Gold Panda]

@dlvvlv

Cash flow hedges, net of tax 13,795,418

Comprehensive income (loss) $ 10,833,585

[Go and do likewise]

@Gold Panda Would it be fair to view these hedging losses as a missed opportunity rather than a loss of equity in the company?

[Gold Panda]

@Go and do likewise it's complicated

"If it is determined that hedged transactions associated with cash flow hedges are no longer probable of occurring, the gain or loss associated with the instrument is recognized immediately into earnings. "

[Go and do likewise]

Wow, nice article and nice timing.

[Steve Fischer]

This is a good company as is Cleave Cliffs and MT. The problem is the spread is huge right now $9.30 bid -$9.69 asked -they nail you on both ends.

[tetech]

Already near your 12 est value. Wait for a pullback? The spac accounting standards are worse than the pink sheets otc. I own X.

[Gold Panda]

@tetech yeah but this is on NYSE

[chaeflin]

Thanks for bringing this to the S.A. audience, nice job of presenting the reasons for owning the stock.

[Gold Panda]

@chaeflin thank you

[trusthouse]

Looks like an interesting way to play volatility in steel with about a 2 times coefficient versus steel prices. I'd rather buy the lows than sell the highs as dividend could be reinstated. TY for the article.

[shota_showtime]

Current assets -/- all liabilities = 54M ($ 7,83 per stock)
MC = 67M (Stock price $ 9,65)
"It also expects to reclassify a loss of around $14.7 million into earnings during the quarter related to derivatives designated for hedge accounting."
4 * insider buying between $ 11,04 and $ 12,86 (july - november).

[Gold Panda]

@shota_showtime yeah but the inventories also decline with steel prices