Ternium Hit Too Hard On Near-Term Steel Price And Margin Weakness

Tougher times usually see investors run toward quality, but that hasn’t benefited Ternium (NYSE:TX) this year, as the shares of this Latin American steelmaker have fallen about 13% since my last update, underperforming Steel Dynamics (STLD) and Nucor (NUE) by a wide margin, as well as ArcelorMittal (MT) and Gerdau (GGB). Given Ternium’s leverage to a recovering North American auto industry and longer-term reshoring, I think this underperformance is short-sighted, but it is also true that Ternium is looking at weaker EBITDA margins through 2023/2024 and a competitive Mexican steel market.

I still believe Ternium is undervalued, and I further believe that the relative valuation has become meaningfully more attractive. This is likely not a name that will get much love over the next six months, as prices and spreads continue to weaken, but I see upside into the $40s as investors eventually come back to the strong margins, cash generation, and balance sheet and the positive growth outlook.

 

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Ternium Hit Too Hard On Near-Term Steel Price And Margin Weakness

Ternium Now In The Muddle-Through Phase

 

The idea that steel prices would be lower in 2022, hitting the revenue and profits of steel companies, is not new, but the reality is still unpleasant. And as that reality takes hold, the quality names are rising once again, with Nucor (NUE) and Steel Dynamics (STLD) outperforming companies like ArcelorMittal (MT), Cleveland Cliffs (CLF) and United States Steel (X).

Ternium (TX) belongs in the “quality tier”, but the company’s fourth quarter miss (the first miss since the first quarter of 2020), uncertainty on capital allocation, and worries about the health/pace of the recovery in Mexico have all contributed to a very weak performance since my last update, with the shares down around 30%.

I mentioned the risk of investors overstaying their welcome at the time of that last piece, and I did sell down some of my stake, but I’m still an owner here on the longer-term opportunities for Ternium to replace imports in Mexico and leverage growth opportunities in Argentina and Brazil. This is a story that will take some time to work, but I think patient investors who can take the risk that steel sets an even lower bottom before stabilizing may want to take a look.

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Ternium Now In The Muddle-Through Phase

Ternium Leveraging A Steel Supply Imbalance, With Demand Growth Opportunities Coming Later

 

With supply still down relative to pre-pandemic levels and a strong demand recovery underway, North and South American steelmakers continue to enjoy exceptional price strength. The good times won't last for Ternium (TX), but stronger demand across its Latin American markets can offset some of the oncoming price weakness, and weaker volumes out of China could perhaps support prices at a higher-for-longer level than bears believe.

I've liked Ternium for a while (it's been my preferred steel pick), and with a 45% total return since my last update for Seeking Alpha - matching Cleveland-Cliffs (CLF) and Nucor (NUE) and outperforming ArcelorMittal (MT), Gerdau (GGB), Steel Dynamics (STLD), I don't regret that call at all.

At this point, I do still see some upside in the shares, and I think 2022 will still be a strong year for pricing and volume, but Gerdau is maybe more interesting on a risk/reward basis. Still, I think holding steel stocks into a down-cycle isn't the best idea, and while I can see growth drivers for Ternium beyond 2022 and I believe it's both well-run and undervalued, that cycle sentiment risk is a growing concern for me.

 

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Ternium Leveraging A Steel Supply Imbalance, With Demand Growth Opportunities Coming Later

Ternium Seeing End-Market Recoveries And Reaping The Benefits Of Higher Steel Prices

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 (NYSE:NUE) or Steel Dynamics (NASDAQ: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.

 

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Ternium Seeing End-Market Recoveries And Reaping The Benefits Of Higher Steel Prices

The Street's Risk Aversion Is Dialed Up To "11" On Ternium

I thought that there was already a steep risk premium in Ternium (TX) shares back in February, largely on the emerging economic weakness in Mexico and some Covid-19 concerns. Since then, that premium has expanded significantly as Covid-19 has swept around the globe and further worsened the near-term outlook for Mexico, Brazil, and Argentina. On top of that, I don’t think Ternium did investor confidence any favors by suspending the dividend, even if it was an action taken out of an abundance of caution.

My stock argument on Ternium basically comes down to this – this is still one of the most profitable publicly-traded steel companies in the world (on an EBITDA/tonne basis), and it still has an attractive growth profile on the basis of economic development in Mexico and Latin America, as well as leveraging auto production opportunities. If baseline assumptions like 2% long-term growth, mid-single-digit ROE, and a “full-cycle” EBITDA of $1,550M are credible, these shares are meaningfully undervalued today.

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The Street's Risk Aversion Is Dialed Up To "11" On Ternium

Ternium Hammered On Risk Aversion And Economic Uncertainty

Ternium’s (TX) performance since my last update has not been good, with the shares down about 17%. That’s better than the performance of steel peers like ArcelorMittal (MT), Nucor (NUE), and Steel Dynamics (STLD), but “less bad” is only worth so much. Honestly, I found the reaction to the company’s fourth quarter miss relatively restrained, but now there are a lot of worries about what the coronavirus may mean for a number of economies, and that’s on top of what was already a lot of uncertainty about the outlook for Mexico in 2020.

I still like the long-term value proposition here, but buying into sharp market declines often feels like playing chicken with a freight train. Ternium remains a well-run steel company with above-average profitability and exposure to attractive markets, but this is not a good stock for nervous investors.

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Ternium Hammered On Risk Aversion And Economic Uncertainty

Ternium Caught Between A Valuation-Sentiment Tug Of War

Ternium (TX) shares have risen 20% since my last update on this Mexican steelmaker, a pretty respectable result next to Nucor (NUE), POSCO, (PKX), Steel Dynamics (STLD), but not so impressive when compared to ArcelorMittal (MT) or Gerdau (GGB), and more or less in line with Voestalpine (OTCPK:VLPNY), another steelmaker with above-average auto exposure. You almost wouldn’t know it, though, as sentiment on the sell-side is still very cautious, if not outright negative, due to weak near-term demand conditions in two of Ternium’s key markets (Mexico and Argentina).

Near-term versus long term is almost always a tough dyad to reconcile in investing, and particularly so in the “it’s always near-term” world of commodities. I do believe that Ternium is going to have a challenging 2020, and I likewise believe that some peers like Gerdau will have a much better time of it. Still, given the quality of the company and the valuation, both intrinsic and relative, I still think this is a stock worth buying and owning here.

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Ternium Caught Between A Valuation-Sentiment Tug Of War

Ternium Seeing Heavy Near-Term Pressure, With A Tough Road To Recovery

My biggest fear for Ternium (TX) in 2019 was that macro factors, particularly the health of the industrial and non-residential construction sectors of Mexico, Argentina, and Brazil, would create greater than expected pressure on the business. That’s exactly what’s happened, as the shares have lagged the steel sector as a whole on a year-to-date business, even if they’ve done a little better than some global/emerging market competitors like Gerdau (GGB) and ArcelorMittal (MT) over the last few months.

I do believe that Ternium is likely to see its EBITDA/tonne bottom over the next quarter or two, but I’m skeptical about a sharp recovery thereafter, and I still see plenty of macro risks in Mexico, Argentina, and Brazil that could pressure the business. Although Ternium trades cheaply relative to its fundamentals (metrics like EBITDA/tonne, ROE, etc. compared to ArcelorMittal, Nucor (NUE), Steel Dynamics (STLD) and other peers), “should” only gets you so far in the market. I think Ternium has appeal for investors willing to try to predict a bottom in the steel sector, but this is a high-risk/high-return prospect.

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Ternium Seeing Heavy Near-Term Pressure, With A Tough Road To Recovery

Ternium Beaten Up, But The Quality Is Still There

The six months since my last article on Ternium (TX) have not been kind to the steel sector in general, nor this Mexican steelmaker in particular, with the shares down about 16% and roughly doubling the decline of the sector. While the sector has been pressured by weaker prices, rising costs, and concerns about demand growth in 2019 and beyond, Ternium too has been squeezed by pricing and costs, not to mention weaker-than-expected demand in its key operating regions.

Macro factors remain my biggest worry with Ternium, as construction activity has yet to turn in Mexico and Argentina’s “recovery” is at best looking like a drawn-out process. Improving demand in Brazil should help, but global weakness in the auto industry remains a point of pressure for the company. Given Ternium’s excellent margins (even in comparison to leaders like Nucor (NUE) and Steel Dynamics (STLD) ), longer-term prospects in both Mexico and Brazil, and the valuation, this is still a name I like within the steel sector.

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Ternium Beaten Up, But The Quality Is Still There

Gerdau's Share Price Weakness May Not Be Entirely Reasonable

I was skittish about the near-term performance prospects for Gerdau (GGB) back in early December, and the shares have fallen about 10% since then – modestly underperforming a weak steel sector over that time. Gerdau’s share price performance hasn’t been helped by weaker steel prices in the U.S., nor a slower-to-develop recovery in Brazil, and costs continue to rise in the meantime.

I’m not all that bullish on the U.S. steel sector, but I think Gerdau has significantly upgraded their U.S. operations, and I’m more bullish on the prospects for Brazil’s steel sector over the next few years as the country makes a tentative economic recovery. Like Ternium (TX), I think Gerdau could be positioned to post EBITDA and FCF growth at a time when U.S. steelmakers will have more lackluster results, and a stronger recovery in Brazil could maintain investor enthusiasm for that region. I’m less bullish on Gerdau relative to the sell-side, but below $4/share, I think these shares are worth a look.

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Gerdau's Share Price Weakness May Not Be Entirely Reasonable

Steel's Uncertain Outlook Certainly Complicates The Steel Dynamics Story

Steel Dynamics (STLD) continues to operate well in an increasingly challenging market, and I am relatively bullish on the quality of the management, the quality of the company, and the prospect for improving market share and valued-added mix to help offset some of the mounting challenges the sector is facing.

Cyclical stocks are always challenging to value, and I find that particularly true when the cycle starts to roll over. The market generally prices stocks in sectors like steel on the basis of next year’s EBITDA, but that gets tricky when you realize that the next year’s EBITDA is likely to be lower than this year’s, and the next, and so on. Looking at several different approaches, I think a mid-$30’s to low $40’s fair value is still valid and reasonable, but 2019 may still have some unwelcome surprises for the industry if demand starts to flag.

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Steel's Uncertain Outlook Certainly Complicates The Steel Dynamics Story

Gerdau Looking Toward Better Results

Brazil’s Gerdau (GGB) offers a curious investment proposition today. Although the shares have lagged Ternium (TX) over the past three months, Gerdau has been the best-performing steel stock of the group I follow closely, and by a fairly wide margin (outperforming #2 Ternium by close to 15%). Gerdau is also one of the few steel companies/stocks where there is basically a unanimous expectation of EBITDA heading higher for the next two to three years, largely on the back of an expected recovery in Brazil.

Metal spreads may well have peaked in the U.S. (where Gerdau generates close to a third of its EBITDA), but volume demand growth is expected to continue and Gerdau has under-utilized capacity it can bring into action. What’s more, spreads in Brazil could still improve and Gerdau is still reaping the cost savings benefits of digital investments. Gerdau’s valuation doesn’t scream “bargain”, but in the real world of stock performance, this is still a name to consider given its potential for further upward earnings revisions and its capacity to grow at a time when many peers will see earnings contraction.

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Gerdau Looking Toward Better Results

Despite A Host Of Challenges, Ternium Is Holding Up

Predicting how investors will react to particular pieces of news can be difficult, and I look at Mexico’s Ternium (TX) as a case in point. You might think that weak demand in Mexico, an ugly situation in Argentina, and a struggling rebound in Brazil would all be pressuring the stock, not to mention the announcement that Steel Dynamics (STLD) is planning to build a large (3Mtpa) plant that will export to Mexico, would pressure the stock, but Ternium has held up better than many others in the steel sector, including Steel Dynamics, Nucor (NUE), POSCO (PKX), and ArcelorMittal (MT).

Even with this recent run of better (or at least “not as bad”) performance, the shares don’t look expensive. While the pricing concerns that trouble me with Nucor and Steel Dynamics do apply here as well, as does the concern about buying shares into what is likely to be declining EBITDA, I believe Ternium could return to growth sooner and that valuation is even less demanding.

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Despite A Host Of Challenges, Ternium Is Holding Up

Steel Dynamics Getting No Love Despite Excellent Margins And Cash Flow

These remain tough days for the steel sector. Although protectionist policies and healthy end-markets have significantly improved the price environment for U.S. producers like Steel Dynamics (STLD), Nucor (NUE), and ArcelorMittal (MT), prices have softened and meaningful capacity expansions are now on the board. With Steel Dynamics planning the biggest expansion so far announced, there are renewed risks that this marks the peak of the cycle, even though the capacity expansion makes a lot of sense for the company for the long term.

When I last wrote about steel stocks in late September, I was concerned that the risk/perception of peaking steel prices and EBITDA would make it difficult for these stocks to get ahead, even though I thought Nucor looked a little too cheap relative to Steel Dynamics and other steel stocks. Since then, both stocks have weakened further, but Nucor has noticeably outperformed Steel Dynamics over that limited time period. The nearly 25% pullback in Steel Dynamics does make the stock more interesting today, and the “stronger for longer” bull argument could still prove valid, but this looks like a tough place to earn market-beating returns.

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Steel Dynamics Getting No Love Despite Excellent Margins And Cash Flow

Ternium's Investor Day Seems To Have Restored Some Confidence

Ternium (TX) shares have had a poor year, underperforming the ADRs of ArcelorMittal (MT) and Gerdau (GGB), as well as the shares of other steel companies like Steel Dynamics (STLD). Although Ternium is looking at an attractive long-term opportunity to grow its share of the Mexican market, investors have been scared off by a host of uncertainties, including the NAFTA renegotiations, the Mexican election cycle, the deterioration of the Argentine economy, uncertainty in Brazil, weakness in Colombia, and the prospect of peaking global steel prices.

Management’s investor day earlier this month did seem to restore some confidence to investors, but the shares continue to look surprisingly cheap on a relative basis, particularly when factoring in the company’s strong margins. Although I remain concerned we’re past the peak in steel and that it will tough for any steel stock to significantly outperform, Ternium’s share price and valuation just look too low to me.

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Ternium's Investor Day Seems To Have Restored Some Confidence

With Sluggish Demand, Is Ternium Really So Cheap?

Just so there’s no confusion later, I’ll state my conclusion right off the top – I still like Ternium (TX) and I still think this Mexican steelmaker is trading too cheaply. But the shares haven’t done much this year and they’re down about 14% over the past three months, while other steel companies like Steel Dynamics (STLD), Nucor (NUE), Gerdau (GGB), ArcelorMittal (MT), and CSN (SID) have done better … though “better” is a relative term here, as only CSN has outperformed the S&P 500.

Are the glory days over for steel? Certainly that’s a popular question now, and the market seems to think it’s likely that the U.S. will eventually negotiate on some of its protectionist measures, opening the door to more imports and lower prices. For Ternium in particular, a new NAFTA agreement is more likely to help than harm, but it’s hard to be wildly enamored of a company where demand in its two largest markets is weakening on a sequential basis. I do still think that Ternium shares are too cheap, but the risk of lower estimates and multiples is real and it may be hard to coax investors back into the steel sector at this late point in the cycle.

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With Sluggish Demand, Is Ternium Really So Cheap?

Nucor: Leveraging Higher Prices And Prior Growth Investments

Nucor (NYSE:NUE) is one of the best-run steel companies in the world, and is well-placed to continue benefiting from the combination of strong demand in the U.S. (fueled by still-healthy demand from construction and various manufacturing sectors) and protectionism-supported pricing. With capacity utilization now in the mid-90%'s and at much stronger prices, strong margin leverage and FCF generation are also coming through for this company.

Nucor wasn’t my preferred choice in the steel space back in February of this year, and the two I liked better (Ternium (NYSE:TX) and Steel Dynamics (NASDAQ:STLD)) have slightly outperformed Nucor since then, though Nucor has done well compared to others like Gerdau (NYSE:GGB), ArcelorMittal (NYSE:MT), and POSCO (NYSE:PKX), particularly since the protectionist measures went into effect. Looking at the shares again today, I’d still favor Steel Dynamics over Nucor in a head-to-head, but it’s close, and I think Nucor is a perfectly legitimate way to play whatever is left in this run for the sector.

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Nucor: Leveraging Higher Prices And Prior Growth Investments

Ternium Continues To Surpass Expectations And Still Seems Too Cheap

Ternium (TX) confounds me at times. This Mexico-focused steelmaker has an above-average track record when it comes to margins and returns on capital, operates in a pretty stable region, has access to multiple growth markets, and has been investing in growth projects at what appear to be good future IRRs. And yet, Ternium trades at one of the lowest forward multiples in the group even after a good run in the share price.

As Ternium continues to beat and raise, my expectations go up as well. I do see some risk that EBITDA could reach a near-term peak in 2019 or 2020, but the company’s leverage to recoveries in Argentina and Brazil makes that a tough call, and there are still significant opportunities to gain share in its home market. Even at 4x my new 2018 EBITDA estimate, it looks like there’s double-digit upside left in these shares.

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Ternium Continues To Surpass Expectations And Still Seems Too Cheap

Ternium Brings Strong Execution To A Strong Market

A better-than-expected steel market over the past 12-18 months has added a welcome tailwind to a story I already liked at Ternium (NYSE:TX). Although cost creep and higher working capital needs have created some near-term concerns, Ternium management has continued to do a good job managing overall profitability, while also intelligently re-investing for growth. That, in turn, has led to okay share price performance over the last year - the 22% rise in the shares, outperforming the S&P and Nucor (NYSE:NUE), but coming up a little short next to Steel Dynamics (NASDAQ:STLD), ArcelorMittal (NYSE:MT), and Gerdau (NYSE:GGB).

I don’t expect the steel market to improve as much from this point, but I still see opportunities for better results from Ternium. The CSA acquisition and internal greenfield opportunities offer volume growth opportunities, and a revised ownership agreement for Usiminas (OTC:USNMY) should allow for ongoing exposure to Brazil’s recovery. With a fair value in the mid-to-high $30s, there still appears to be value in Ternium shares even as the NAFTA renegotiation process drags on.

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Ternium Brings Strong Execution To A Strong Market

Both Brazil, And Steel, Appear To Be Improving For Gerdau

Picking winning Brazilian stocks hasn't been too hard this year, what with the iShares Brazil Index (NYSEARCA:EWZ) up about 80% year to date as the country's currency has strengthened and sentiment has improved that the economic situation has bottomed out. For steel company Gerdau (NYSE:GGB), things have been even better since my last update, as the ADRs have risen almost 75% since that April piece (with the local shares up about 55%), beating Mexico's Ternium (NYSE:TX) (up about 25%) and fellow Brazilian CSN (NYSE:SID) (up about 55%).

I see a more balanced risk-reward trade-off today. On the positive side, I do believe Brazil will recover from here and stronger demand in sectors like autos, appliances, and construction should be good for domestic steel demand, not to mention the prospects for long-term infrastructure investment. On the negative side, Gerdau is enmeshed in litigation tied to corruption and taxes, the Brazilian recovery could be prolonged, and management hasn't always been a good steward of shareholder capital.

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Both Brazil, And Steel, Appear To Be Improving For Gerdau