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Monish Pabrai Does a Post Mortem on His Ternium (TX) Investment

June 10, 2011 | About:

I was fortunate enough to be forwarded a copy of some notes from the 2010 Pabrai Funds annual meeting. I like Monish and I like how he is willing to share his thoughts on the investment process. I also respect the fee arrangement in his funds and how he only earns when his investors make money (no 2 and 20).

Here are his comments on his investment experience with Ternium (NYSE:TX):

Ternium was an investment we made in the second quarter of 2007. We invested almost $15 million in Ternium. At the time, I had estimated the intrinsic value was about $55 a share and a market cap of about $11 billion. It was trading at less than half of that. I was willing to buy and invest as long as I could get it below $27.50 a share. We bought it on average about $27 a share. We sold it a year ago at about $28.40.

The pieces didn't work out the way I expected it to, but we didn't lose any money. We made about a 5 percent return over a two-year period. That two-year period was a very tumultuous period because it includes the whole financial crisis and the great recession. Our first buys were around $26 in the second quarter of 2007. We were going to start selling the stock at about $50 a share and it got up to $44/share in mid 2008. Then the financial crisis hit. Ternium is a world class steel producer, and their order book got wiped out. Pretty much everyone canceled their orders. No one had any financing, and no one had the ability to buy anything from them. Their business almost came to a standstill.

At the same time, while this is going on, Hugo Chavez in Venezuela decides to nationalize their Venezuelan assets, which are pretty significant, about 1/4th of the total assets. There was a lot of uncertainty at the time about whether they would collect any compensation or if they would completely lose the value of that asset. This nationalization, along with the combination of the financial crisis, the great recession, and the wipeout of their order books collapsed the stock price to the $5/share level - an 85 percent drop in price. Pabrai Investment Funds did nothing through that period. We just held the stock.

Ternium is a very unusual steel company in the sense that it is vertically integrated. It owns a large amount of iron ore assets and coal assets, so it's not subject to all the volatility of the commodity prices. When commodity prices rise, Ternium gets a tail wind because they have their own captive mines. Ternium is similar to Walmart (NYSE:WMT) and Costco (NASDAQ:CSCO) in the sense that it's not like they do one thing better than the rest. They do a hundred things slightly better than the rest, and when you add those hundred things together, in aggregate it becomes a strong competitive advantage.

They were a company which on the outside looked like a normal steel maker, but when you drilled down you would find they set best practice after best practice in how they ran their operations. I liked the way they ran the business. They always ran their business under leveraged with plenty of cash on hand. They were able to ride out the storm without too much of a problem, and they were also, during that period, able to very successfully negotiate with Chavez in Venezuela. About a year after the nationalization, Ternium started collecting cash from Venezuela and they got paid a fair price for that business. Then I got to a point in 2009 where we could exit at breakeven or better. We had some other opportunities in front of us in 2009, which looked more promising.

The Ternium business is coming back. In fact, the whole thesis will play out pretty similar to what I had thought, but it will play out with a delay. It might take two or three years to get there. But we had other fish to fry in the meanwhile. I would say that one of the rules I have about selling is that I will typically not have an interest in selling a stock just because a price has dropped. The price might drop, but I won't sell unless I'm convinced that the present intrinsic value is below the present stock price. For example, when a stock's at $5/share, I have to have a high degree of confidence that the intrinsic value is below $5/share.

The only thing I would say to this point with Ternium is that things were very murky. I couldn't even figure out what the intrinsic value was at that point when the order books were wiped out. There was no clarity. In the absence of clarity, in general, I won't act. I'll just sit there and wait.

About the author:


Rating: 3.5/5 (8 votes)


Hschacht - 6 years ago    Report SPAM
Talk about murky... Ternium's balance sheet is beautiful, still flush with cash and its best practices are still practiced. Not sure from reading this article where he stands on TX, but we continue to like it and own it. One thing I can say for certain... anyone owning another steel company is clearly unaware or ignorant of TX.

Rgosalia - 6 years ago    Report SPAM

I own POSCO (I know that Mr. Pabrai owns it too based on gurufocus data) and have spent a lot of time understanding its cost structure relative to other steel makers. Although biased, I rank it very highly in comparison to other steel makers.

I may post a more detailed article on POSCO sometime soon, but just to site its profitability, I am posting the ROIC data for TX and POSCO:


2010 8.06% 13.41%

2009 9.26% 7.88%

2008 8.72% 12.80%

2007 11.75% 12..68%

2006 16.62% 13.57%

2005 23.84% 18.95%

2004 39.78% 20.35%

So, I am not sure if I completely agree with "anyone owning another steel company is unaware of ignorant of TX".

It's quite impressive that POSCO was able to achieve a high profitability despite been dependent on raw materials from other countries. As POSCO expands its capacity by 12mmt in India over the next decade (current capacity is 36 mmt), it will have access to huge reserves of iron ore at very low cost. This will help boost its profitability even more so. The new projects will use FINEX, a technology that POSCO owns that has a much higher raw material flexibility. It can use low-quality coal, instead of dependent on scarce coking coal. The operational savings are about 15% at today's iron ore and coking coal prices.

I haven't looked at TX in too much of detail, so I am not discounting the merits of owning TX. Just wanted to point out to POSCO's competitiveness.

Any thoughts or comments?

- Rishi

Hschacht - 6 years ago    Report SPAM
Posco would be a close second on my list... but I'd be careful using any one measure to determine superiority.

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