TX - Ternium: What Goes Up Many Times Comes Down

Summary

• We rode this steel play to the upside in the initial innings of its rally, but the stock's fortunes seem to have changed here.
• Cyclical plays do not behave like conventional stocks. Buyers beware.
• The sustained dialing down of earnings revisions could continue to take their toll on Ternium's share price.

Intro

Shareholders of Ternium S.A. ( TX ) made a lot of money in the 17-month period from March 2020 to August 2021. Since that August top though almost 13 months ago, shares of Ternium have lost close to half their value as lower lows continue to play out on the technical chart. Furthermore, as we can see below, the monthly MACD indicator (which is a solid read on both Ternium's long-term momentum & trend) reached a much higher level (overbought compared to past times) compared to previous cyclical tops (2014, 2018, etc). Suffice it to say, given how high the MACD indicator remains and given the fact that history repeats itself many times in cyclical plays, long investors need to remain watchful here. Remember, the chart below encapsulates the psychology of the stock's participants and has fully digested all of the known market fundamentals (such as prices, costs, order book, etc) at this point. This includes the recent second quarter GAAP earnings beat announced last month.

Many may disagree with the above assertion but cyclical plays do not obey the general rules of investing. What we mean by this is that the current ultra-low trailing GAAP earnings multiple of 1.54 is not a reason in itself to become interested in this play. In fact, an ultra-low earnings multiple in a steel play such as Ternium combined with strong profitability (Trailing EBITDA margins of 32%+) as well as a bumper dividend (8.44% forward yield) can many times lure investors into putting capital to work on the long side. As mentioned, these are not the areas where Ternium investors should be doing their due diligence.

Just remember this. Back at the end of 2019/start of 2020, Ternium was far less profitable and had a much higher valuation with respect to its sales and earnings than it currently has. This did not stop the stock from undergoing a blistering rally over a 17-month period alluded to above. Suffice it to say, this industry is all about anticipation (By getting in front of the crowd) and until shares can once more rally convincingly above their 10-month moving average, we deem Ternium a sell at this point for the following two reasons.

Earnings Revisions

Although forward-looking earnings estimates in this industry can be very difficult to predict, management said itself on the recent earnings call that adjusted EBITDA will decrease sequentially on lower margins. In fact, as we can see below, it is the pace at which consensus is worryingly expecting the contraction to occur. Q3 & Q4 bottom-line estimates have already been revised down over 20% over the past month alone which means the expected fall-off is accelerating. Astute investors in this industry look far more closely at where earnings are going instead of how elevated they very well may be at this point in time. We see this trend more closely also in Ternium's multiple growth metrics also.

Growth

Top-line sales for example which essentially drives the income statement have grown by almost 50% year-over-year but the forward revenue growth rate comes in at 17%. This fall-off in growth can also be seen further down the income statement with forward EBITDA growth of 18% much lower than the 60% EBITDA growth year-over-year. Although we believe growth rates are actually emphasized too much in standard consumer defense plays, for example, growth rates are imperative in cyclical plays. In a standard play, the market will usually be lenient on the stock in a negative growth environment as it knows generated cash flow will eventually lead to sustained growth once more. In a cyclical play, however, it is all about forward-looking growth rates as participants aim to anticipate to a far greater degree the contraction in growth. Suffice it to say, the "state" of the business comes in a far distant second to what we have discussed above.

Conclusion

Investors can lose their shirts in cyclical plays because they do not follow the same rules as conventional stocks. The lure of Ternium at present is its excellent dividend, its low valuation, and its continued strong earnings. However, if steel prices stumble and selling intensifies to the downside, Ternium's valuation will change on a dime leaving investors perplexed in the process. We continue to let the chart guide us and do not recommend long exposure until the 10-month moving average can once more be taken out to the upside ($37+ per share). We look forward to continued coverage.

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