Leveraged Buyout: Steel Industries, Inc

Inc. is an American company specializing in steel processing and conversion with a product list ranging from flat-rolled steel of varying thickness, temper, width, and finish, and processed steel. The company’s processed products are delivered to further steel processors or steel mills and also serve large end-users such as automobile manufacturers, hardware, construction companies, and appliance producers, among others. In its 35 years of existence, the company has grown from a single facility steel processor to 23-facility operations by way of several joint venture agreements with other companies all throughout the United States. In recent years, the company has embraced 4 growth strategies: acquisitions, greenfield growth, expansion of existing operations, and further development of its joint venture operations. In 2006 alone, the company completed an acquisition, expanded its operations facility in Mexico, and initiated another joint venture in Canada.
I believe that in view of Steel Technologies’ overall growth trend and strategy and the developments of the past few years, the company would make a good candidate for a leveraged buyout. The strength of the company is most of all obvious in its price-earnings ration of 33.09 as opposed to the industry level of only. Recent acquisitions of Kastle Steels present growth opportunities in terms of eliminating acquired redundancies in the company, as is the case in typical acquisitions. This, in addition to pre-existing inefficiencies as acknowledged in the company’s growth and further shown in the 6% increase in operating expenses are opportunities that can present added value from the implementation of efficiency measures. Room for efficiency improvements is indicated by a relatively high asset turnover yet a low return on assets which are at 205% and 7%, respectively.
The current market capitalization of the company amounts to only 384M as opposed to an industry weighted average of 31,628M and an industry high of 73,304 which indicates a high capacity to absorb further leverage. Debt to equity ratio is only at 31.1%, while times interest earned is at 6.79 which clearly suggests the capability to handle interest payments given their leverage structure. The total asset level is at 513M and is projected to grow in the following years as the company is aiming to further expand capacity and implement efficiency measures. If needed, the asset base can be used as a collateral base to support transition operations, but even this seems unnecessary at this point as the company has not had any difficulty maintaining its working capital requirements. Future capital requirements of the company, on the other hand, seem reasonably low as the strategy is leaning more towards joint ventures than outright expansions with the exception of the recent one in Mexico. In 2006 alone, capital expenditures were a mere 16M compared to the overall asset level of 513M.

Multiples of the company show relative strength relative to other industry players. PE  and TTM Price to Sales are 33.09 and 0.44 compared to industry averages of 15.06 and 1.74 respectively. The former indicates high expectations on the performance of the STTX while the latter connotes underpricing of shares relative to earning ability. The operating results of the company took a dip in 20006 generally because of weak demand due to higher national steel imports in the United States. While there is still a possibility of this reoccurring in the future, there is a general clamor to level trading practices specifically in importing practices and investors are still convinced that the steel industry is “performing phenomenally” and will continue to be bullish regardless of any trading intervention (AP, 2006). In addition, I think that the operating results of the company are still very promising in view of the various joint ventures that it has entered into, as well as the possible contribution of the new acquisition.  The latter is most exciting as I believe the South American market for steel is about to take off and having a facility in Mexico at this point will help STXX to enter that market.
I am convinced that demand for steel in the next years will continue to grow as a result of several factors among which is the recent positive movement in the mortgage industry resulting from deregularization and overall infrastructure. World demand for steel is projected to grow annually at 7-8% and since the US plays a major role in the global steel industry, I think that North American steel producers and processors will enjoy a good ride as well. Another characteristic of the company that makes it a good candidate for a leveraged buy out is that it has already established synergic working relations with other industry players via its joint ventures, and these can be taken advantage off later when there is a need to strengthen the cash flow position if needed. In addition, a strong management team seems to be in place as evidenced by the continuous progress of the company in its three decades of existence. This management has placed the company in an overall strong, or at the least, defensible position.
Valuation Ratios
A.

Company
Industry
Sector
S&P 500
P/E Ratio (TTM)

33.09
12.43
21.41
20.32

B.

P/E High – Last 5 Yrs.
NM
P/E Low – Last 5 Yrs.
NM

78.63
38.32
36.29
5.40
11.16
14.49

C. Beta

0.37
2.19
1.22
1.00

D. Price to Sales (TTM)

0.44
1.31
1.89
2.84

E. Price to Book (MRQ)

1.43
3.91
3.79
3.96

G. Price to Tangible Book (MRQ)

1.58
4.50
6.45
7.36

E. Price to Cash Flow (TTM)

13.26
10.00
12.61
14.26

G. Price to Free Cash Flow (TTM)
NM

14.82
37.54
33.46

F. % Owned Institutions

69.62
54.72
39.64
70.63

J. Sales (MRQ) vs Qtr. 1 Yr. Ago

-0.18
20.95
13.28
13.30

K. Sales (TTM) vs TTM 1 Yr. Ago

-5.28
21.22
12.74
15.77

M. Sales – 5 Yr. Growth Rate

14.94
23.91
13.45
13.28

N. Capital Spending – 5 Yr. Growth Rate

11.52
9.54
9.43
6.14

H. Learn about Growth Rates

Financial Strength
Company
Industry
Sector
S&P 500

O. Interest Coverage (TTM)

11.26
22.80
8.60
13.06

P. Operating Margin – 5 Yr. Avg.

4.86
8.59
10.48
19.50

I. Pre-Tax Margin (TTM)

2.03
15.80
11.95
18.49

U. Pre-Tax Margin – 5 Yr. Avg.

4.57
7.79
9.11
17.97

L. Effective Tax Rate – 5 Yr. Avg.

34.75
27.52
30.56
30.82

Q. Return On Assets – 5 Yr. Avg.

5.60
8.67
5.61
6.80

V. Net Income/Employee (TTM)

11,570
85,368
60,450
108,418

W. Receivable Turnover (TTM)

8.48
10.35
8.40
10.64

T. Inventory Turnover (TTM)

5.06
7.33
6.70
11.80

Z. Asset Turnover (TTM)

1.87
1.60
1.04
0.97

References

US steel imports may hit record in 2006 due to unfair trade practices, industry group says. 2005.
[Electronic Version] International Herald Tribune Business. December 28, 2006.
Retrieved from http://stocks.us.reuters.com/stocks/ratios.asp?symbol=STTX.O. March 26, 2007.
Retrieved from http://www.investor.reuters.com. March 26, 2007.