Some investors will only invest in companies with moats and will never touch commodity companies, even with a ten-foot pole. For me, anything is fair game at the right price. For steel producers, I assess the threat of import competition and consolidation opportunities before deciding if they are worthy investment candidates. Insteel Industries Inc (NASDAQ:IIIN), the country’s largest producer of steel wire reinforcing products used in the manufacture of concrete product such as welded wire reinforcement and prestressed concrete strand, ticks my boxes on both counts. Moreover, Insteel Industries Inc (NASDAQ:IIIN) is debt-free and undervalued at a PEG of 0.65.
Import competition deterred
There are two common barriers to entry that exist to deter import competition in commoditized industries. In some cases, like the cement industry, high transportation costs make it uneconomical for importers to compete. In other cases, certain industries benefit from anti-dumping provisions that protect the interests of domestic players. Chinese imports of prestressed concrete strand became a big threat to domestic producers like Insteel Industries Inc (NASDAQ:IIIN) in 2008, when they seized more than 40% of the prestressed concrete strand market. Insteel Industries and two of its peers subsequently filed anti-dumping and countervailing duties petitions, which resulted in Chinese competitors exiting the market in 2009. In addition, Insteel Industries is also a beneficiary of the Federal Highway Administration’s Buy America provisions, which stipulate that certain steel products, such as prestressed concrete strand, used in public construction projects have to be manufactured in America.
M&A and consolidation is the way to go for growth
Commoditized industries like steel aren’t going to experience explosive growth like cloud computing, nor quantum market share shifts like in the handset industry. Acquiring other companies, their assets, and the associated market share, represents the only substantial area of growth. For Insteel Industries, much of the activity is happening in the area of welded wire reinforcement. Insteel Industries recently acquired all of Tatano Wire and Steel’s concrete pipe and box culvert reinforcement production equipment in April.
But, the acquisition that really cemented Insteel Industries Inc (NASDAQ:IIIN)’ position in the welded wire reinforcement space was the acquisition of Ivy Steel & Wire, formerly the second-largest producer of welded wire reinforcement behind Insteel Industries, in November 2010. With Ivy Steel in its bag, Insteel Industries Inc (NASDAQ:IIIN) expanded its geographical presence to become a truly national player, allowing it to serve bigger customers with multiple offices and facilities across the country. Furthermore, Insteel Industries Inc (NASDAQ:IIIN) also increased the proportion of engineered structural mesh in its sales mix, which positioned it to benefit from the trend of engineered structural mesh replacing hot-rolled rebar as a reinforcing solution.
Peer comparison
Insteel’s peers include Nucor Corporation (NYSE:NUE) and AK Steel Holding Corporation (NYSE:AKS).
Being in a cyclical industry, a strong credit profile and a low cost structure allows Nucor to mitigate the adverse impact of such cyclicality. Nucor Corporation (NYSE:NUE) is lowly geared, with a gross debt-to-equity ratio of 47%, and delivered positive free cash flow for every single year in the past decade. In November of last year, Nucor Corporation (NYSE:NUE) entered into a long term natural gas agreement, which will supply its steel mills and direct-reduced iron plants with more than two decades of natural gas. This will allow Nucor to maintain a flexible low-cost structure. In addition, Nucor sports a forward dividend yield of 3.2%, and recently declared its 160th consecutive quarterly dividend in February.
AK Steel has a strong sector focus, deriving close to half of its revenue from the automotive market. Its advanced high strength steels help its customers reduce vehicle weight to meet the Corporate Average Fuel Economy (CAFE) requirements. Similar to Nucor, AK Steel Holding Corporation (NYSE:AKS) has various vertical integration initiatives in place to ensure the supply of inputs. For example, AK Coal Resources, which owns more than 20 million tons of met coal reserves, will commence mining in the second quarter of this year, with the eventual aim of meeting at least half of AK Steel Holding Corporation (NYSE:AKS)’s met coal needs.
AK Steel is loss-making for the trailing twelve months and will be excluded in the valuation comparison. Insteel Industries is valued at a higher forward P/E, but lower PEG, compared with Nucor. Based on Yahoo Finance analyst estimates, Insteel Industries is expected to grow EPS at a five-year CAGR of 33%, given a low earning base post Global Financial Crisis.
Conclusion
In a cyclical industry like steel, dividend-paying stocks with strong balance sheets are a safer bet. Insteel Industries Inc (NASDAQ:IIIN) is debt-free and sports a forward dividend yield of 0.6%. While the dividend yield may seem meager, it does not take into account special dividends that were paid in 2008 and 2012, respectively. In addition, laws and regulations protecting domestic producers like Insteel Industries have helped it to fend off some hostile competition in the past.
The article Does It Take Nerves Of Steel To Invest In This Stock? originally appeared on Fool.com and is written by Mark Lin.
Mark Lin has no position in any stocks mentioned. The Motley Fool recommends Nucor. Mark is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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