SDVKF - Alleima: A Debt-Free Specialty Stainless Steel Producer At 4x EBITDA

Summary

• Alleima was recently spun out of Sandvik.
• The company will be debt free and has pledged to pay 50% of its normalized net income as a dividend.
• Q3 and Q4 2022 will have been difficult, but the performance should gradually increase from this year on.
• I have no position yet, but I will keep an eye on Alleima.

Introduction

Alleima ( OTC:SAMHF ) is a relatively new company as it was spun out off Sandvik ( OTCPK:SDVKF ) ( OTCPK:SDVKY ) in the second half of 2022. Separating Alleima from Sandvik will allow the former to execute a company-specific strategy to pursue growth rather than being just a division of the much larger Sandvik group.

Alleima is a producer of advanced stainless steel, special alloy and heating systems. While the general stainless steel market represents an annual production of 50 million tonnes per year, the so-called ‘advanced’ stainless steel segment represents just 2-4 million tonnes per year, and it’s exactly in this segment Alleima is active.

The specialty alloys market is separate from the advanced stainless steel market as this market also covers for instance titanium, zirconium and nickel alloys. Alleima specifically focuses on the industrial furnaces niche market. This means Alleima focuses on the production of for instance seamless stainless tubes and pipes, a very specific segment of the market (think about heat exchangers, umbilical tubing in the oil and gas sector, and even specific steel for kitchen knives).

Alleima’s primary listing is on the Stockholm Stock Exchange where it is trading with ALLEI as its ticker symbol . There are currently just under 251M shares outstanding resulting in a current market capitalization of 10B SEK. At the current exchange rate of 10.7 SEK per USD , the current market capitalization is approximately $935M (I will use the SEK as base currency throughout this article). The average daily volume in Stockholm is approximately 1.2M shares per day, resulting in a monetary value of approximately $5M.

The first quarter as a standalone company was very decent

Although Alleima was able to hike prices, its margins are still compressed. During the third quarter, the company reported a revenue of just under 4.3B SEK and although that is an increase of about a third compared to the third quarter of last year, the COGS increased by more than 50% resulting in a decrease of the gross profit.

Unfortunately other expenses increased as well, resulting in an operating loss of 26M SEK. There were quite a few non-recurring elements (including separation costs related to effectively spinning off Alleima from Sandvik) included in this, and according to Alleima the underlying and adjusted EBIT was a positive 195M SEK. That actually is a good result compared to the third quarter of last year, which included 172M SEK in positive non-recurring items, which means the Q3 2021 EBIT was just 123M SEK. This confirms the Q3 2022 EBIT was almost 50% higher on an adjusted basis.

This also means we should take the net loss of 154M SEK with a grain of salt as the underlying result would likely have come in at or around break-even. That’s fine because there is seasonal impact here: the summer months are traditionally the weakest for Alleima as that’s the summer period in the northern hemisphere.

That also has an impact on the working capital evolution as Alleima traditionally increases its inventory levels in the first half of the year, before seeing those assets being monetized in the second half of the year.

That’s why we cannot just extrapolate a quarterly result or even the 9M 2022 result to figure out the full-year performance.

That being said, the 9M 2022 cash flow statement does offer an interesting look at how the company is performing on an underlying basis. The image below shows the cash flow statement, and you see the reported operating cash flow was a negative 419M SEK. You also see the working capital build-up was almost 2.1B SEK and this means the adjusted operating cash flow was approximately 1.67B SEK, and just over 1.6B SEK after also deducting the lease payments.

The full-year capex (sustaining + growth) is estimated at 600M SEK, which means the normalized capex for the first three quarters should be 450M SEK, slightly higher than the 348M SEK the company actually spent. Based on these results, the normalized free cash flow during the first nine months of the year was approximately 1.15B SEK.

The balance sheet should contain a net cash position by the end of this year

The fourth quarter may still be a bit tough as Alleima expects a negative impact of 150M SEK on the Q4 result due to currency rates, stock levels and metal prices. That being said, there usually is a pretty strong order intake and higher margin thanks to the winter period in the northern hemisphere. I think we may have to wait for 2023 (and perhaps even late 2023) before seeing the company absorbing the current temporary headwinds.

This doesn’t mean Alleima is in a bad shape. Despite the temporary headwinds, I expect Alleima to be profitable in the fourth quarter and post a net income of 1.1-1.2B SEK and a slightly higher result in the current financial year. A net income of 1.15B SEK represents an EPS of approximately 4.6 SEK, indicating the stock is trading at roughly 8.5 times earnings.

One of the elements I appreciate the most is Alleima’s very strong balance sheet. Sandvik played a fair game when it decided to spin out Alleima and as of the end of Q3, the balance sheet contained 1.1B SEK in cash and just 1.5B SEK in current and non-current debt. This means the net debt was just around 400M SEK but in its corporate presentation Alleima also included lease liabilities and pension liabilities in this number. The total net debt was estimated at 325M SEK according to the company. I’m waiting for the full annual report to really dig deeper into the ‘official’ net debt, while I would also like to see how changing interest rates may have an impact on the pension deficit.

In any case, it is quite likely Alleima’s net financial position (excluding pension liabilities) will show a positive net cash position (although it still depends on working capital changes). Running a debt-free company will also lend more credibility to Alleima’s dividend policy to distribute 50% of the normalized profit. If my estimates for FY 2023 are correct, we can expect a dividend of 2.2-2.3 SEK per share to be paid out, for a dividend yield of 5.5-6%. The standard dividend tax rate in Sweden for non-residents is 30%.

Investment thesis

Although Alleima may need some time to really show the market the free cash flow it can generate, the stock appears to be relatively attractive. Assuming a net cash position of 500M SEK by the end of next year and a normalized and adjusted EBITDA of 2.3B SEK, the company is trading at less than 4 times its EBITDA. The free cash flow result will likely exceed 1B SEK in 2023 which should pave the way for an attractive dividend while further fortifying its balance sheet.

I currently have no position in Alleima but I think this Sandvik-spinoff has its merits as a standalone company.

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