Rising Star Buy: Ampco-Pittsburgh

This article is part of our Rising Star Portfolios series.

Forged hardened steel rolls. Strip mill cast rolls. Plate finned heat exchange coils. Don't these phrases just scream huge stock market profits?

As obscure as these products may be to most people, they are a big deal in the steel industry, which relies on products like these every day in production facilities all over the world. Many of those steel mills rely on Ampco-Pittsburgh (NYSE: AP  ) for these crucial pieces of equipment.

Big fish in a small pond
Ampco-Pittsburgh is the largest producer of equipment used in making cold-rolled steel, a niche type of steel used primarily in construction and in automotives. Its customers are the steel mills actually cold-rolling the steel, including some of the largest steel producers in the world.

All of Ampco-Pittsburgh's products are made custom -- the company takes an order and builds the equipment to given specifications -- which means they are not as exposed to the normal risks associated with holding inventory, such as obsolescence or falling prices. It also means that the company's order backlog offers pretty decent foresight into its business at any given time.

Cold-rolling steel is a small niche within the much larger steel industry. Making the equipment used in the process, as Ampco-Pittsburgh does, is a capital-intensive process that only makes economic sense when done on a large scale. Combined, these facts mean two things for the industry. First, steel producers are disinclined to make their own equipment, since they can get it more cheaply from Ampco-Pittsburgh, which has the cost benefits of scale. Second, the small size of the industry means that there is not room for many players to reach that scale. In my opinion, Ampco-Pittsburgh's No. 1 position in the industry is secure.

Like a (cold) rolling stone
Much of the growth in global steel production over the past five years has come from China. Even as steel tonnage in the rest of the world fell in the aftermath of the financial and housing crises, growth in China has kept strong. In fact, China is on track to produce almost as much steel this year as the rest of the world combined.

Ampco-Pittsburgh has been working to get in on that growth. The company has been selling rolls to Chinese steel manufacturers for years, but more exciting to me is the company's joint venture with the fifth-largest Chinese steel producer to begin producing rolls in China. Started in 2007, the plant should begin manufacturing this year (it takes a while to get these complex facilities up and running). The rolls the facility will produce are megasize, far bigger than anything Ampco could produce in its U.S. or U.K. plants, and represent a niche within their niche. In addition to selling the rolls to their joint venture partner, the company is also allowed to sell the equipment worldwide under its own name.

Built to last
Long-term projects like the deal in China are only possible with the right management in place. Ampco-Pittsburgh is very much a family business. Founder Louis Berkman, now 102 years old, is chairman emeritus. His son-in-law, Robert Paul, is CEO and chairman and has been on the company's board for more than 40 years. Two of Paul's sons are directors. All told, the family owns 15% of the company, and the way they run it tells me that they want it to be even more valuable when they hand it off to the next generation.

To that end, management has a strong track record of investing for the long term. For example, in 2008 the company undertook a three-year, $60 million capital expenditure program to improve the efficiency of its main factory. The investments made the facility more efficient and, more importantly, more self-sufficient -- but didn't add capacity. And I'd bet that Wall Street analysts looking for the company to hit short-term numbers would have slammed management for what was a smart long-term investment.

I say analysts "would have" slammed management because, well, no analysts even follow the company. Make no mistake; this is a small company. There are no analysts, no conference calls, no presentations or slide decks. When I called, the CEO answered his own phone. What does all this mean? It means that the stock may be volatile, but also that management has no distractions and no reason to chase short-term earnings estimates (because there aren't any estimates!).

Steel trap value
Ampco-Pittsburgh is a cyclical company, so my valuation is all about averaging out cash generation over the course of a cycle. My base case assumes 6% revenue growth for the next eight years (low relative to the past decade) and a 17.5% operating margin on its rolls. That might be a low-ball number -- despite low-cycle demand levels, margins have remained in the 23% range the past three years, thanks in part to the aforementioned efficiency investments -- but even at that lower level, my model values shares at $33, more than 30% higher than their price today.

Small, unknown, unloved -- Ampco-Pittsburgh is just the kind of company I love putting my money behind. At today's price, I'm happy to open a 3.5% position for the Young Gun Portfolio. You can stay fresh on all Young Gun Portfolio moves on Twitter.

This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. See all of our Rising Star analysts (and their portfolios) here. 

Neither Alex nor The Motley Fool owns shares of any company mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (5) | Recommend This Article (21)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 10, 2011, at 4:11 PM, summitclark wrote:

    Great piece on an unknown(to me) company. It boils down to being a play on steel demand, and that boils down further to china and india mainly china.

    What are your thoughts on the steel market as a hole, and why choose a small cap with only 30% upside as opposed to a major player in the steel markets. Like MT, or I personally like TS Tenaris for steel and exposure to steel pipeline(drilling). TS poised to sell big time to all the new drilling in Brazil and elsewhere.

    I really like this kind of original work not the same old atvi sells video games yada yada....

    Just my thoughts ,

    Andrew

  • Report this Comment On February 10, 2011, at 4:51 PM, afleetfeet wrote:

    I've been riding AP from $8.10. Still has a way to go.

  • Report this Comment On February 10, 2011, at 7:40 PM, stan8331 wrote:

    I bought some AP below $10 and ended up cashing out after the big run up to the mid-20's, but I have been keeping an eye on it. Given the amount of time that's elapsed since I sold and the degree to which it has lagged the market, I think it does look attractive. I just haven't been able to decide whether it looks relatively more attractive than the other stocks currently in my portfolio...

  • Report this Comment On February 11, 2011, at 1:39 PM, shredlee wrote:

    Any thoughts on the asbestos liability? I'm having trouble determining the true long term costs of this. Its a pretty large component in their last earnings.

    Also you don't mention anything about their other segment the air and industrial stuff, which accounts for nearly half their business.

    Good insight into the management and ownership, thanks for that, but overall a pretty incomplete picture of this business.

  • Report this Comment On February 11, 2011, at 5:29 PM, blaueskobalt wrote:

    I second shredlee comments. I have been holding AP for two years with a fair value estimate of $38-40, but I don't like the recent re-re-re-assessment of the asbestos liability. What is your take on this versus their sizable cash position?

    Also, any thoughts on the possibility of a spinoff of the air and liquid handling portion?

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