Tweedy, Browne Comments on Vallourec
Facing higher costs in Europe, and with the potential to lower its production costs abroad, Vallourec recently embarked on a major expansion of its production facilities, adding new capacity in the U.S. and in Brazil. These facilities will allow Vallourec to produce its products locally, instead of producing and exporting from Europe. In May 2012, Vallourec's management made a number of announcements, including delays in qualification for the Brazilian plant and higher than expected capital expenditures to bring the U.S. plant on line. The stock sold off significantly and reached what we thought were quite attractive levels over the next month, eventually bottoming near two-thirds of book value. This caught our interest. We began building a position in our Funds in Vallourec at around 28 to 29 Euros per share in late June. At this price, we felt we were paying roughly 69% of the company's stated book value, 82% of tangible book value, and two-thirds of a conservative estimate of the company's intrinsic value. Given the rather concentrated nature of the seamless pipe industry, there were not a lot of comparable M&A deals to examine. However, in 2007, Tenaris, one of Vallourec's major competitors, acquired Hydril, a leading North American manufacturer of premium connections and pressure control products for 15 x EBIT. Consistent with our conservative appraisal policies, we used a lower multiple of 10 x 2013 EBIT to value Vallourec, and purchased shares at approximately two-thirds of that value.
Despite the delays in qualification and the higher than expected capital expenditures, we believe that both projects will ultimately be successful, particularly given the favorable outlook for unconventional shale plays and deepwater. Our evaluation of the business, specifically the connections business, leads us to believe that Vallourec's intrinsic value is greater than its stated book value. Although in the short term the company's legacy exposure to European manufacturing could weigh on the stock, we believe the long term prospects for Vallourec's oil & gas business are quite strong. It has a solid balance sheet with very little debt, which should allow it to weather near term disappointments that may arise. For investors such as ourselves, who are willing to look further out on the investment horizon for our returns, we felt we were being presented with an unusual pricing opportunity.
From Tweedy Browne's Investment Advisor's Letter and Semi-Annual Report.