Universal Stainless: Valuations Not as Attractive as Miss Universe
Universal Stainless & Alloy Products Inc. (USAP) headquartered in Bridgeville, Pa. and established in 1994, manufactures and markets semi-finished and finished specialty steels, including stainless steel, tool steel and certain other alloyed steels. USAP's products, sold to service centers, forgers, rerollers and original equipment manufacturers, are further processed by customers for use in a variety of industries, including aerospace, power generation, oil and gas and heavy equipment manufacturing. Its specialty bar facilities have one of the broadest and diverse size range and product capabilities in the industry. USAP also offers conversion services on its Radial Forge and Universal Rolling Mill.
After divesting 144,592 shares of USAP in the second and thrid quarter of 2012 at prices ranging from $37 to $42, he added to his position in USAP again in the fourth quarter of 2012 with a purchase of 2,700 shares at an average price of $33.05. Two guru investors Chuck Royce and Alan Fournier own 569,908 shares and 1,052,668 shares in USAP at average prices of approximately $27 per share and $38 per share.
USAP currently trades at a trailing twelve months P/E of 13.6 and a trailing twelve months EV/EBITDA of 8.5. Its current P/E valuations are at a slight 4% discount to its five year average P/E of 14.2. On an asset valuation basis, it is also trading close to parity with its five year average P/B of 1.22. USAP achieved a trailing twelve months ROE of 9.8% and a five year average ROE of 9.0%.
USAP Historical P/E-ROE Comparison
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USAP has a decent historical earnings track record with positive earnings in eight of the last ten years and positive operating cash flow in almost every single year in the past decade except for 2004. USAP's gross and net margins swing wildly from year to year across various commodity and economic cycles, and is reflective of the specialty steel industry.
USAP Earnings-Cash Flow Comparison
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USAP Profit Margins Analysis
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Financial and Business Risks
USAP is highly geared with a debt-to-equity ratio of 57%. It has geared up considerably in the past two years; USAP's gearing remained below 10% from 2007 to 2010.
USAP Cash-Debt-Market Capitalization Comparison
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On Nov. 5, 2012, USAP announced that it was correcting the results for the third quarter of 2012 previously reported on Oct. 24, 2012, as a result of the discovery of an incorrect customer invoice, for which a credit memo has now been issued. The effect of this correction is that previously reported sales for the third quarter of 2012 were reduced by $0.9 million to $61.4 million from the $62.3 million originally reported. While the amount is small and relatively insignificant, it does raise potential concerns about the robustness of USAP's internal controls.
The steel industry is very competitive and USAP competes with both domestic and foreign producers of specialty steel products, and other producers of products fashioned from alternative materials such as aluminum, composites and plastics. According to its 2011 10-K, unfair pricing practices by foreign producers have resulted in high import penetration into the U.S. markets, with 2010 import penetration for stainless bar and stainless rod at 50% and 37% respectively.
USAP faces considerable customer concentration risk, with its two largest customers, Carpenter Technology Corp. and Fry Steel Co., accounting for 12% and 11% respectively of its 2011 sales. In addition, USAP has a significant exposure to the cyclicality of the aerospace industry, with 42% of its sales and 33% of tons shipped representing products sold to customers in the aerospace market in 2011.
Raw materials costs represents more than half of USAP's total cost of products sold in 2011, 2010 and 2009. USAP purchases scrap metal and alloy additives for its melting operation. A substantial portion of the alloy additives is available only from foreign sources such as Australia, Canada, China, Russia, Brazil and South Africa.
USAP had 518 employees out of a total of 661 who were covered under collective bargaining agreements as at Dec. 31, 2012, including 34% of its employees who are employed at the company’s Dunkirk facility, whose collective bargaining agreement expires in October 2012. On Nov. 12, 2012, USAP announced that its Dunkirk Specialty Steel LLC subsidiary has reached a new five-year collective bargaining agreement with the Dunkirk hourly employees. Its other collective bargaining agreements for the Bridgeville and Titusville facilities expire in August 2013 and September 2015 respectively. Hourly employees are entitled to receive 8.5% of their respective facilities’ annual pre-tax profits in excess of $1.0 million at Bridgeville and Dunkirk, and in excess of $500,000 at Titusville, under USAP's collective bargaining agreements.
Business Quality and Capital Allocation
USAP has had a history of transformational investments. In 2002, USAP acquired steel facility in Dunkirk, New York for a purchase price of $4.1 million, which transformed the company to a fully integrated manufacturer of specialty steel products. In 2011, USAP acquired a construction stage Forge, VIM and Remelt facility in North Jackson, Ohio for a purchase price of $116 million, excluding costs to complete equipment installation. The facility includes state-of-art radial forge, Vacuum Induction Melting furnace, two Vacuum Arc Remelting furnaces and other heat treating/finishing equipment. USAP views this as a strategic step to strengthen its industry position, replace third party forging with in-house state-of-the-art forging equipment, improve yields & reduce operating costs, reduce cycle times and expand product portfolio into higher margin products.
USAP sees opportunities to grow in its key end-markets: aerospace, oil & gas and power generation which accounts 47%, 21% and 16% of trailing twelve month sales as at the second quarter of 2012. The ramp of its North Jackson facility will enable USAP to introduce new products and capabilities to its aerospace customers with shorter cycle time and cost reductions. In its power generation end-market, USAP is expanding its market share in the maintenance market and management anticipate new turbine market growth between 2013 and 2015.
USAP does not pay a dividend.
Valuations are reasonable, but not particularly attractive at current price levels as USAP is trading at parity to five year average mean P/E and P/B valuations. The increase in financial leverage and the absence of dividends further reduce the attractiveness of the stock.
The author does not have a position in any of the stocks mentioned.