As Seen in The Canton Repository:
When Will TimkenSteel's Stock Price Bottom?By: Ryan T. Fulmer
Tuesday, October 25, 2016
In the July edition of Ask the Investor, I wrote about The Timken Company (TKR) and the transformative changes that have occurred after the spin-off of TimkenSteel. I am often asked by clients and friends about TimkenSteel (TMST) and whether the stock price has finally bottomed.
Shareholders continue to ask this question with good reason, as TimkenSteel’s stock price fell to $3.99 in January and hit a low of $2.79--a far cry from $35 a year earlier.
Over the last several months, oil prices have stabilized, and the rig count has increased 17 of the last 19 weeks, which may be a leading indicator for TimkenSteel’s end-market clients and may potentially accelerate revenue and earnings growth.
It is important to understand that TimkenSteel operates in a small segment of the global steel market, which produces around 1,650 million tons of steel per year. The United States produces about 100 million tons of steel a year, but Timken’s niche market represents only about 6% of the U.S.’s production.
Furthermore, Timken specializes in seamless mechanical tubing and special bar quality (SBQ), which represents about 6% of the 108MM tons market--a special niche inside a subset of the overall steel market. While the majority of TimkenSteel’s business is attributable to SBQ, they also have high-margin, value-added solutions, such as machining, honing, drilling, and components.
According to company filings, TimkenSteel believes they are the only focused SBQ steel producer in North America and also have the largest production capacity. By focusing on SBQ steel, Timken is able to create custom steel products for their clients by restricting the chemical compositions, allowing them to create custom blends for specific applications in small batches.
One of the key tenets of our investment philosophy is to determine a company’s key competitive advantages and how they will be able to protect and grow their margins. Warren Buffett, who is often cited in the press, describes a similar concept of how he likes to invest in companies with “moats” around their businesses.
TimkenSteel’s unique focus and cost advantage in the SBQ steel market are key competitive advantages, which have, over time, resulted in top-of-the-class return on capital. However, the profitability of the steel business has been extremely cyclical, and their specialty focus has not protected them from these cycles.
The oil and gas and heavy construction business lines have the greatest profitability. We anticipate oil prices to stabilize and drilling to gradually increase, which should help profitability. Longer term, we think the automotive segment could see improvement in profitability as companies work to increase power density, which requires customized solutions, allowing them to sell their products at higher margins.
We think the political election may impact the steel industry positively due to the protectionist nature of both candidates as well as the need for significant infrastructure spending.
International trade impacts the steel industry differently than most imports due to Chinese steel dumping in the United States and Europe. In late July, the European Union imposed an anti-dumping tariff on Chinese steel imports, and in March, the U.S. Department of Commerce increased some tariffs on Chinese steel by 500%!
For long-time readers of our column, you may be wondering how we argued the importance of free trade in our March article titled “Is Ohio getting TRUMPed in trade deals?” and now are suggesting the steel market may benefit from tariffs.
A distinct difference exists between FAIR trade and FREE trade. Free trade allows companies to access the United States market without restrictions, tariffs, or duties. (Keep in mind it also allows us to export under the same or similar conditions.)
Fair trade relates to trade partners deliberately dumping product in the United States below the cost to produce in order to push domestic businesses out of the market. Companies like U.S. Steel and Nucor may benefit more than TimkenSteel, however, because Timken focuses on high-quality, clean steel that the Chinese steel companies cannot compete with.
We have also been asked whether or not TimkenSteel is an acquisition target. We certainly think TimkenSteel’s expertise could be a benefit to many competitors. One of the most recent comparable deals took place in late 2013 with the SKF acquisition of Kaydon Corporation, which was about a 20%+ premium to the current stock price and almost 13 times trailing 12-month earnings before interest, tax, and depreciation (EBIDTA). This multiple was higher, however, than the average multiple for industrial companies at about 5-8x EBITDA.
It would be our hope that TimkenSteel remains independent and perhaps the Timken family, Ellwood Group, and employees could fend off a hostile takeover.
So, back to our question on when TimkenSteel’s stock price will bottom.
Stock prices bottom at the point of maximum pessimism. With the benefit of hindsight, last January’s price of $2.79, during fears about liquidity issues, was likely the bottom. Going forward, the stock price will respond positively to evidence that profitability has returned.
Beese Fulmer Private Wealth Management was founded in 1980 and is one of Stark County’s oldest and largest investment management firms. The company serves high-net-worth individuals, families, and non-profits and has been ranked as one of the largest money managers in Northeast Ohio.
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