ILF - Ternium: Shares Attractive On Valuation Earnings On Tap

2023-08-01 10:10:07 ET

Summary

• iShares Latin America 40 ETF has reached fresh 5-year highs on a total return basis.
• Ternium S.A. is the leading flat steel producer in Latin America, with the potential for improving industrial activity in the region.
• Ternium offers an attractive valuation and solid technical momentum ahead of earnings.
• I outline key price levels to monitor into and through earnings, along with key risks to be aware of for this cyclical foreign stock.

There is a lot of fanfare going on in the world of stocks right now. Consider that the S&P 500 (SP500) is just a handful of percentage points from a new all-time high, and recent economic developments in Japan regarding the BoJ's monetary policy have helped the Nikkei climb. Europe, meanwhile, has seen resilient price action amid a rising euro currency. Not much attention is being paid to strong moves in Latin American stocks. The iShares Latin America 40 ETF (ILF) recently notched fresh 5-year highs on a total return basis. One key cyclical company offers investors exposure to potentially improving industrial activity in that region.

I am reiterating my buy rating on shares of Ternium S.A. (TX). I continue to find it attractive on valuation while its momentum has recently taken a tick higher. The stock reports after the close today, August 1, and there are a few key risks to be aware of.

Latin America Stocks Climbing To Fresh Multi-Year Highs (Total Return)

According to Bank of America Global Research, TX is the leading flat steel producer in Latin America, with a crude steel capacity of 12.4M tons. Its facilities are located in Mexico, Argentina, Brazil, Colombia, and the U.S. The company is controlled by Techint Group, which directly owns 63% of the total capital, and the market free float is 18%. Ternium sells most of its products in domestic markets, and the majority of shipments are flat steel products.

The Luxembourg-based $8.8 billion market cap Steel industry company within the Materials sector trades at a low 6.4 trailing 12-month GAAP price-to-earnings ratio and pays a high 8.1% forward dividend yield (I expect this yield to fall, which I will explain later). Shares are expected to move 5.6% after Q2 results hit the tape tonight, August 1st, per the at-the-money straddle options pricing, while the stock's short interest is next to nil at 0.8%.

Back in April, TX reported a solid EPS beat. Per-share operating earnings came in at $1.91, handily topping estimates of just $0.99. Revenue, however, missed analysts' expectations. Sales were down 16% year-on-year, but it was a tough comp given strong steel prices toward the tail end of the first quarter of 2022, but a recent dip in wholesale steel is a significant risk. Perhaps not surprisingly then, BofA downgraded the stock amid soft commodity prices two months ago.

Looking ahead to the Q2 report tonight, the consensus calls for $2.02 of EPS on $4.15 billion in revenue (another YoY decline). BofA actually expects a decent quarter to be reported, with EBITDA growth having been robust, according to a note published in early July. Quarterly earnings comps turn easier later this year. Sanguine news hit on June 20 when the firm said it would start construction on a new steel plant in Mexico.

Steel Prices Dipping Once Again

On valuation , it is key to recognize that the firm's profit cycle is highly dependent on the steel industry in North America and among some South American nations. Given some improving trends, such as rising U.S. construction spending, TX's earnings should benefit. Moreover, the company's robust balance sheet allows its management team to be flexible and pounce on new opportunities to expand capacity.

Earnings are expected to decline this year following 2022's strong year for commodities, but per-share profits are then expected to sustain near $6 per share through the out year. Dividends, meanwhile, are flexible with TX, so the distribution rate might decline over the coming quarters. But with a price-to-book ratio under 1 and P/Es deep into the single digits, shares remain compelling on valuation despite the price rise since my initial report. A concern to me is its negative expected free cash flow, despite robust profitability .

Ternium: EPS Seen Settling Near $6 To $6.50

If we assume a normalized EPS of $6.50 and apply the stock's 5-year average earnings multiple of 7.8, then shares should be in the low $50s. And that P/E may be low given some troubles that have gone on in the industrial metals space over the last few years in its main regions, but a risk is if EPS falls under $6 by 2025. Moreover, TX trades extremely cheaply compared to Materials' sector median valuations.

TX: Compelling Valuation Metrics

TX & Peer Comparison

Looking ahead, corporate event data provided by Wall Street Horizon shows a confirmed Q2 2023 earnings date of Tuesday, August 1, after market close with a conference call the following morning. You can listen live here . No other volatility catalysts are seen in the coming months.

Corporate Event Risk Calendar

The Technical Take

Back in April , I noted that a bearish head and shoulders pattern appeared to be negated care of a stock price rally through the low $40s. While shares dipped at times over the ensuing weeks, a broader rally has indeed taken shape. Today, I spot further upside potential. Notice in the chart below that TX broke out from a symmetrical triangle pattern. I see resistance coming into play in the low $50s - about matching where I see fair value.

The multi-year high of $57 could be a target if momentum runs strong. Speaking of momentum, the RSI (14) indicator at the top of the graph has confirmed the upside thrust to the stock price. Also, the long-term 200-day moving average is now positively sloped, which tells me that the bulls are in charge. On the downside, support should be seen in the $37 to $39 zone - the range lows from February through late June.

Overall, the chart remains constructive in my view, and I would like to see a jump through the $46 near-term peak post-earnings.

TX: Bullish Breakout, Eyeing A Test Of The Low $50s

The Bottom Line

I reiterate my buy rating on Ternium. The valuation is attractive while technical momentum is solid ahead of earnings tonight.

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