New Investment: Ternium S.A.

In my last post I mentioned that I  intend to recommend stocks in one industry as it is cheap. I'd like to retract that. I was talking about the oil industry but I have found a few other stocks I think are interesting to look into. So I will  give an oil stock or two in the coming days, but for now let us go into one of my favourite industries, actually my favourite, Steel & Iron.

I always loved mining, a simple business that anybody could understand. Just find a mine with some precious metals in it, acquire it which is the majority of the cost and then you pay people to excavate which is a lot cheaper than you think (relative to revenues). But this industry does not lend itself easily to financial statement analysis. Typically every few years they have a bad year, and with no explanation. Free cash flow is always very low and still means nothing. Though I have never been able to verify it, my theory has been that they spend a lot of capital expenditures on acquiring more mines or doing research on them. Either way, I have found over time these businesses are worth       8-10x earnings.

The stock I am recommending is Terniu SA (TX). When we look at the balance sheet, we don't exactly see a fortress balance sheet, but a solid one nonetheless. Current assets are only slightly below twice the current liabilities and total assets is only slightly below total liabilities. So highly unlikely to go bankrupt anytime soon.

Next comes the income statement. Margins in TX was about 6%-7% in 2013 and 2011. Bad years happen and in 2012 it was only 2%. Cost of Goods Sold was a bit higher that year relative to price. From what I've seen, even good companies in this industry periodically have a bad year, but we shouldn't let it affect us. After all the balance sheet has remained solid through this. So income statement seems solid.

Now the cash flow statement. As you may notice capital expenditures are very close to operating cash flow giving it a free cash flow of approximately 0. I have never fully understood why but for mining capital expenditures tend to equal operating cash flow quite often and it has never been a worrisome figure. If it was deep in the red I would be worried about if there is any real money in this business but as this business has paid dividends for years and remained so well capitalized I tend not to worry too much.

As the business is right now at 5x earnings and the analysts expect it to continue for the next year or so I recommend this stock as a buy with a selling price of approximately $30.

You may also be wondering why I like this industry so much when so little can be evaluated. I find that it is easier and faster because cash flow statement just needs to be glanced over to make sure free cash flow is not too far negative, balance sheet was always an easy calculation and the income statement shows your profits. Doesn't mean I can't be wrong, just that it is simpler to put the odds in your favour in this industry.