A Steal in Latin American Steel

11/01/2007 12:00 am EST


John Christy

Founding Editor, Forbes International Investment Report

John A. Christy, editor of Forbes International Investment Report, finds a Latin American steel company that's very profitable, growing rapidly-and dirt cheap.

Ternium (NYSE: TX) might best be described as the biggest steel company you've never heard of. Organized as a Luxembourg-based holding company in 2003, Ternium's principal operations are in Argentina, Mexico, and Venezuela. The company, built through a series of acquisitions, began trading on the New York Stock Exchange in February 2006.

Most recently, Ternium acquired Mexico's Grupo Imsa in a $3-billion deal that closed over the summer. Other holdings include Hylsamex (also in Mexico), a stake in Venezuela's Sidor, and Siderar in Argentina. About 80% of Ternium's output is flat steel products (plates, sheets, pipes) with the remainder in long steel, such as rails and structural beams.

In Latin America, Ternium is a dominant player in nearly all of the region's major steel markets. It commands number-one market share in Argentina, Venezuela, Mexico, Colombia, Ecuador and Paraguay, according to CreditSuisse research.

More importantly, it's one of the most profitable steel companies in the world. In 2006, the company posted earnings before interest, taxes, depreciation, and amortization (EBITDA) of about $2 billion on $6.6 billion in revenue, a 30% margin. That's more than double US Steel's (NYSE: X) EBITDA margin of 14%.

Ternium's combination of highly efficient production methods and access to cheap iron ore from its own Mexican mines gives the company a huge cost advantage over its global peers. Ternium also sells some of its excess ore to third parties, but this is a fairly small part of their business.

Like any steel producer, the company's fortunes are tied to commodity prices. Although steel prices have risen in recent years, the outlook continues to be robust. Steel is a huge beneficiary from the global infrastructure story, particularly in emerging markets. At the same time, supply has tightened somewhat, leading to favorable conditions in the year ahead.

Most analysts are now looking for steel prices to rise in the 3% to 5% range in 2008. Ternium's volume will grow at an even faster pace after the integration of the Imsa acquisition. Put that all together, and you have the potential for nearly 30% revenue growth in 2008.

One big area of concern is the company's exposure to Venezuela, with Hugo Chavez running around nationalizing assets. But Ternium appears to have cut a cooperative deal with the Venezuelan government that should keep Chavez at bay for at least the next few years.

At a recent $37, Ternium is trading for a mere 6.5x estimated 2008 earnings and [just above] five times cash flow. Its price-to-sales multiple is around 1.0x. This is very cheap on an absolute basis, but it also puts Ternium at a significant discount to many of its peers in both emerging markets and the developed world.

Combine all of this with Ternium's conservative balance sheet, and you have an extremely compelling combination of growth, profitability, value, and financial strength.

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