I first noticed Ternium SA (TX, Financial) towards the end of 2014. Back then, the stock was trading at around $18 a share. I was initially attracted to the company because it was trading at a significant discount to book value, and the stock offered an attractive dividend yield of around 4%.
Looking back at my limited notes from the time, I can see that the stock was trading at a price-book ratio of around 0.7 and a single-digit price-earnings ratio (based on a range of outcomes). Considering its valuation, dividend yield and potential for re-rating in a growth environment, the stock looked attractive.
Earnings turnaround
Ternium is a vertically integrated South American steel producer. Back in 2014, the company was just coming out of a steel down cycle and extended period of capital spending. Investors seemed to be avoiding the company due to low earnings and high capital spending levels.
According to my notes, Ternium was investing in growing the output of its specialist steel products, including but not limited to wire rods, hot dipped galvanized and electrogalvanized sheets, steel pipes and tubular products. These products tend to attract higher margins than unprocessed or lower-quality steel.
The group's capital spending yielded results. Net profit rose from $8 million in 2015 to $600 million in 2016, $886 million in 2017 and $1.5 billion in 2018. After a downturn in 2019 and 2020, when profits dropped as low as $564 million, the company is on track this year to earn $3.6 billion thanks to high steel prices and booming economic demand.
At the same time, Ternium has reduced debt from a high of $2.8 billion in 2017 to $467 million on a trailing 12-month basis. Book value per share has also expanded. From $20.50 in 2015 to $44 at the end of the last quarter.
On the dividend front, the company's track record is less impressive. Since 2015, it has paid a total of $3.10 per share in dividends. This year, Wall Street analysts have penciled in a dividend of $2.10 per share, giving a yield of 4.6%.
The stock has produced a total annualized return of 15.9% for investors over the past five years. Unfortunately, after I bought the stock in 2014, I did not stick around long enough to watch the recovery.
Cyclical value stock
Ternium is a classic example of a cyclical value stock. It becomes cheap in cyclical downturns, but investors pile in when the market turns. The trick is trying to buy at the right moment, the peak of pessimism among investors, at the best valuation. Companies that pay a dividend are even more attractive in this scenario because investors will still receive a return even if they have to wait years for the value cycle to turn.
I have written this article partly to rub my nose in a past mistake and partly because I think Ternium is a good example of a value investment that worked.
The great thing about cyclical plays is that they are repeatable. Ternium has proven itself over the past five years. The company has created a lot of value for investors through book value and earnings growth. As the steel cycle turns, the stock may become cheaper again, although it is not particularly expensive right now. Based on Wall Street estimates, the shares are selling at a forward price-earnings ratio of 2.5 and a forward price-book ratio of 1.1.
The enterprise-value-to-Ebitda ratio is 3. On this metric alone, the company is in the cheapest 5% of the U.S. market. While these figures might look attractive, I should point out that the enterprise currently benefits from record steel prices, so the figures are somewhat distorted. The five-year average price-earnings ratio is around 5. Overall, Ternium is a cyclical value play that could be worth a close look as the steel cycle turns.
