Friedman Industries: A Steal of a Steel Stock
The steel industry is not one for the weak at heart. Commodity prices ebb and flow like raging rapids and leave investors on a roller coaster ride that can make even the strongest stomachs queasy. These types of stocks are not for everyone, but there is something that they are great for.
They are great opportunities for the brave.
Today’s stock in focus lines up like this:
Price-to-Book = 0.76
Price-to-Sales = 0.16
Price-to-FCF ~ 7
Market Cap < $100M
If these four clues interest you then we are cut from the same cloth, my friends. We are from the Little Shop of Value Investing.
Introducing Friedman Industries, Incorporated.
Company Description
Friedman Industries is a pretty simple operation that is easy to understand. Friedman processes steel, manufactures and processes pipe, then distributes them both. That’s pretty much it. The main revenue producer for FRD is steel processing and distributing, where they take hot-rolled steel coils and then cuts them to length. This business segment, known as the “Coil Segment”, provided about 90% of the total revenue for the nine months spanning from April 1st, 2022 to December 31st, 2022 The remaining 10% of revenue came from the manufactured pipe or “Tubular Segment”.
The company does split its coil segment into three parts: Prime Coil, Non-Standard Coil, and Customer Owned Coil. The prime coil accounted for around 95% of revenue so when I speak of steel, just think prime coil.
MOAT
Sometimes there is hard evidence for a case and sometimes there is simply circumstantial evidence that could be thrown away by a good lawyer with a sharp tongue. This moat falls into the latter. While the barrier to entry into the steel industry is real, that can’t necessarily be used for a company as small as Friedman. What Friedman does have though is a strategic set of locations that are aligned to service the largest steel-importing markets in the United States. Below is a picture of their locations in comparison to the largest steel-importing states.
As you can see Friedman has directly aligned itself to provide quick transport of goods to many of the top importing states while also positioning all of their locations on or near the water and 5 of 6 having rail receiving capability.
PROS
Plateplus, Inc. Acquisition. Okay, so let’s start with the biggest news to Friedman in the past 12 months: the acquisition of Plateplus’ East Chicago, IN, and Granite City, IL facilities, including their inventory and customer relationships for $68 million in cash and ~550k shares in stock. That is a long sentence that means what exactly? Well, it means that there has been a significant change in the revenue being produced by Friedman. What was $210 million in the first nine months of 2021 has now doubled in the same period in 2022. The company was able to produce over $400 million in net sales while the average price of HRC ton sold has decreased by almost 30%. Add to this the increase in geographic reach for Friedman and it’s a no-brainer that this is lining up for future returns.
Book Value. There is nothing a value investor loves more than to speak about book value. While some shy away from the metric I love to take a look at it when it comes to companies in a cyclical industry. For FRD book value has been somewhat steady, ranging from $9 to $11 per share for the past ten years until the recent acquisition raised the bar. What is notable for me is that a very common pattern persists with FRD; the stock typically sits about 20-30% under book value during lower steel prices and then will meet or exceed book value when the inevitable wave higher comes. This seems like common sense of course, but with Friedman sitting around 25% under book value and HRC taking a recent turn northward there seems to be a disconnect.
Insider Buying. Few things make me happier in life than insiders buying up their own stock. Currently, FRD insiders hold almost 4% of outstanding shares and they have been adding at a pretty significant pace. While the price was more advantageous for insiders than they are for those reading this article, the amount of transactions shows me confidence in the future plans of Friedman and the belief in the turnaround in HRC price.
CONS
Cyclicality. This is a C-word that many investors hate to hear. With HRC being a cyclical material there are expectations that stocks will follow the prices and Friedman is not immune to this. While the rise in tonnage sales is nice to look at, the margin compression due to the dropping steel prices has been nothing to shake your head at, with gross profit as a percentage of sales falling from ~20% in 2021 to ~7% in 2022. This of course led to a fall in FRD stock price and left many investors wondering why they wanted to hold on to this little steel company. This should be a fear of any investor looking into a cyclical stock as it is imperative to understand where we are at in the commodity’s cycle. One wrong piece of analysis and you could be underwater for a significant portion of time.
Recession Risk. We can’t speak about steel prices without bringing up the risk of recession. Unless you are living under a heavy stone for the past year then you know that every news station has an analyst that is calling for an imminent recession. How does this affect steel prices though? Well just like most things a recession would mean bad news. With steel currently sitting at long term highs, a slow down in demand would lead to a significant decline in pricing power. Not ideal for those holding the bags.
The Dividend. There is not a lot of pros for a dividend yield of under 1% that hasn’t seen a raise since 2018. While there hasn’t been much light on the dividend bear cave, investors can see that the history of Friedman should lead you to believe that they actually want to help investors. Paying a dividend every quarter since 1972 says something and while they are currently keeping it at $0.02 per quarter it is only a matter of time until the newly acquired cash flow begins to pay back investors in something other than revenue. Right? Well based on the last release, the company sees an increasingly advantageous margin environment ahead and this should lead to more cash to hand out but they haven’t committed to raising the microscopic dividend that they have been sticking with. Add to this the extra shares that have been handed out and a raise may sting a bit more now than it did previously. I will hold some optimism here still but don’t count on this one paying you back in yield.
Conclusion
There are a lot of clues in the curious case of Friedman Industries, Inc. While many are more circumstantial than they are hard evidence it is overly apparent to me that we are looking at an undervalued stock. With the addition of the two Plateplus locations, the potential for higher transactional savings, and a greater geographic reach it seems like a no-brainer that the revenue increases are very sticky and long-term. While steel prices are fluid, the recent actions by many steel companies to set a floor as well as raise prices show that the rebound is real. Add to all of this that we have not seen an environment yet where Friedman has combined higher revenue with high HRC prices and I am happy to say that I think we have found a value!
In my opinion, Friedman Industries, Inc. is a long-term buy at its current price and I look for it to push higher as it produces significant free cash flow for its investors. I will be adding this to my portfolio soon.
Thanks for reading, and as always, happy investing!
The Profit Investigator