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
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.
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