Ternium S.A.: Excellent Opportunity In An Industry With Envisioned Mayhem

Investment Thesis

The inflation risk fully materialized in 2022, along with other significant headwinds like the Russia-Ukraine war and China’s lockdowns, significantly worsening the world economy. The war between Russia and Ukraine interrupted energy and food supplies. It interfered with the normalization of supply chains, which fueled inflationary pressure caused by post-lockdown supply and demand imbalances.

Recovery in developed economy steel demand was severely hampered in 2022 due to persistent inflation and long-lasting supply-side limitations. There has been an increase in inflation and disruptions in the supply chain as a result of the conflict in Ukraine. High inflation and an energy crisis have made things particularly difficult economically for the European Union. High energy costs are leading to plant closures, which has dampened optimism and slowed industrial activity.

Despite all of the mayhem in the global steel sector, TX appears to be a promising company, with solid profit margins and a better price return than the industry average over the past year by about four percentage points. Disruptions in the steel industry’s supply chain, along with rising demand as economies worldwide begin to recover, have led to high demand. For this reason, steel prices have increased, which is good news for TX. Also, with the closing of AHMSA in Mexico, TX will have a big supply gap to fill, which I think will be a big sales booster. Considering these things, I am optimistic about this company and would recommend buying it.

AHMSA closure in Mexico: Ternium’s Role In The Conundrum

As Altos Hornos de Mexico (AHMSA), a prominent Mexican steel producer, continues to shut down, it is beginning to reduce exports to the United States. Steel production at the company’s Monclova, Mexico facility, with a capacity of 3.5 million short tons per year (st/yr), has been halted since at least November 29 when the Mexican government’s power utility, CFE, cut off the company’s electrical supply for failure to pay its bills.

US steelmakers have raised their prices, so buyers who usually buy cheaper steel from Ternium in Mexico are finding that Ternium has to cut back on its US sales to meet the Mexico demand left by Ahmsa’s absence. Following repeated pricing announcements since November, the price of Argus US hot rolled coil [HRC] in the Midwest ex-works evaluation increased by $22.50/st reaching $750/st. According to information compiled by Global Trade Tracker, the United States imported at least 1.24 million metric tons (T) of flat steel products manufactured in Mexico by November 2022. These will include hot rolled coil, cold rolled coil, and hot dipped galvanized coil.

As this conundrum still exists, TX is playing a key role that may benefit them. To begin with, the supply shortage created by AHMSA closure implies an opportunity they can meet at a premium hence capitalizing on that. Similarly, shifting some of its supplies from the US to Mexico implies a shortage in the US, which I anticipate will attract higher prices to fill since demand will go up. In this situation, I expect the company to capitalize on the most lucrative market and boost its revenues significantly.

Low Steel Production Driving Prices Up

With output falling, rising demand, and a shortage of supply, global steel prices have surged by 29.5% over the past three months, leading to a significant increase in building materials and housing prices. A ton of steel on the New York Stock Exchange steel index was going for $1964.12 about a week ago, up from $1458.37 at the beginning of October, when prices had fallen from historic highs seen in March and April. This is because crude steel production has slowed worldwide, especially in China, which makes 52 percent of the world’s steel.

With the global steel supply still low due to factors highlighted in this article, I expect steel prices to soar higher, considering that world economies are recovering and demand for the product will keep going up. With some steel producers closing down due to a number of reasons and exceptionally high operating costs, the supply challenge will likely escalate further, something that might push prices to record highs.

I foresee a crisis in the still industry, but I also see a glorious opportunity for TX because, given its track record of resiliency, I don’t anticipate its collapse. Instead, I anticipate it will seize the opening presented by the upheaval in the industry and increase its margins even further.

Profitability: Healthy Margins Despite Tough Economic Times

Despite a challenging macroeconomic environment, which has resulted in the closure of some steel industries, TX has proven resilient, registering strong profit margins. Apart from the gross profit margin, the company has outperformed its peers in profitability margins, a testimony of how it is strong enough to weather tough economic times and maintain healthy margins. In some cases, it has exceeded its peers with a margin of more than 80%.

I anticipate even greater success for this company in the following quarters, as the current supply problem is expected to increase prices.

Valuation

Despite outperforming its peers with a significant margin in terms of profitability, TX seems to be undervalued, going by relative valuation metrics.

The company’s valuation metrics all sit well below their respective industry medians, indicating the firm is extremely undervalued compared to its competitors. I am convinced that the firm’s stock price will rise because I expect the company to strengthen its financial position and increase its profitability.

Conclusion

Despite the challenging financial climate, which has resulted in the closure of some steel businesses, TX has shown remarkable resilience by posting excellent profit margins. Low production levels in the face of rising demand have contributed to soaring steel prices. With some companies closing down, the supply shortage could escalate further, driving higher prices, which will benefit TX. Although the industry seems chaotic, it poses an excellent opportunity for TX to leverage and expand its margins. However, as investors enter this promising venture, it’s good to note that the current economic challenges are still persistent and may hurt the company’s bright future. This, in my view, is the greatest risk of investing in the company.