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Friedman Industries: Book Value for Steel Is Too Expensive

December 10, 2012 | About:
Incorporated in 1965, Friedman Industries Inc. (FRD) is engaged in steel processing, pipe manufacturing and processing and steel and pipe distribution. It has two product groups: coil and tubular products. The coil business segment, which accounted for 43% of FRD's fiscal 2012 sales, engages in the processing and distribution of hot-rolled steel coils at its locations in Hickman, Ark. and Decatur, Ala. The tubular business segment of FRD, which accounted for 57% of FRD's fiscal 2012 sales, operates under the division, Texas Tubular Products. Texas Tubular Products is located in Lone Star, Texas, and engages in the manufacturing, processing and distribution of steel pipes.

Valuation

FRD currently trades at a trailing 12 months P/E of 8.67 and a trailing 12 months EV/EBITDA of 3.49. In terms of asset-based valuations, it is currently valued at 1.03x P/B, a 15% premium to its five-year average P/B of 0.89. FRD achieved a 12.2% ROE for the past 12 months and a five year average ROE of 13.0%.

Financial and Business Risks

FRD is debt-free with net cash of $20.7 million representing 30% of its current market capitalization of $67.1 million.

In its coil products segment, FRD sells coil products and processing services to approximately 190 customers, with no single coil product customer accounting for more than 10% of its total sales. In its tubular products segment, sales to U.S. Steel, FRD's largest customer among more than 160 customers, accounted for 24% and 20% of its fiscal 2012 and 2011 revenue, respectively.

FRD purchases its principal raw materials, tubular products and steel coils, from a limited number of primary steel producers. FRD processes hot-rolled steel coils which are purchased primarily from steel mills operated by Nucor Steel Company in its coil products segment; and it purchases steel coils from U.S. Steel Tubular Products Inc., an affiliate of United States Steel Corporation.

Business Quality and Capital Allocation

The steel industry is highly competitive, with a small number of extremely large companies dominating the market and a large number of relatively small companies, including FRD and other steel mills, importers and steel service centers, competing for limited market share.

FRD is profitable in the last decade and has paid dividends in every single year since 1995 and currently sports a dividend yield of 4.3% (excluding special dividend) with a 45% dividend payout ratio. Dividends are paid quarterly. On Dec. 7, 2012, FRD announced that its board of directors declared a special cash dividend of $0.50 per share.

Conclusion

A P/B of 1.03x is too expensive a price to pay for a steel company, notwithstanding a good dividend yield and a strong track record of profitability.

Disclosure

The author does not have a position in any of the stocks mentioned.

About the author:

Mark Lin
Mark is a private value investor and runs the Cheapskate Investing website which borrows from the wisdom of value investing giants, using a systematic quantitative screening approach to filter the global stock markets for cheap cigar-butts and wide-moat compounders. He is also a regular contributor to various value investing communities.

Visit Mark Lin's Website


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