2023-03-08 09:38:56 ET
Summary
- FY2022 was a slight miss, but in my opinion still good. Share price rallied 30% YTD.
- Mixed opinions on where the economy is heading in the next 12-24 months and the health of the metal industry are being questioned.
- Solid management is reflected in the company's financials; however, the macroeconomic outlook calls for patience. The opportunity to add or start a new position is close.
Investment Thesis
Solid financial metrics and decent FY22 results have prompted me to investigate Ryerson Holding Corporation ( RYI ) as a future potential long-term investment. With such a cyclical company, I have modeled a DCF valuation that takes into account a recession in ’23 and ’24 where revenues decrease by quite a bit and subsequently recovered in the following years. With Fed Chair Jerome Powell coming out with more hawkish views on interest rates, I speculate that we have not seen the worst in the markets yet. I recommend a hold rating for now, based mostly on economic uncertainty, as the company itself seems to be operating quite well and is a good potential long-term hold after the dust has settled.
While scouring my stock screener for a decent company, I found Ryerson Holding to be promising. In the last couple of years, the company managed to achieve quite a good ROIC and FCF, which prompted me to look into it further. In this article, I will look at how the company might be affected if we see a recession in the next year or two, any potential growth catalysts that could limit the downside of the recessionary period, and apply reasonable growth assumptions over the next 10 years based on the research, views on the economy and the metal industry itself.
Growth Prospects and the Metal Industry Outlook
The cyclical nature of the metals industry will have a big effect on how the company will perform in the upcoming recession in the next year or two. A lot of the sources still predict that the industry will grow in 2023 and 2024 driven by strong demand in China and India. This makes sense especially now that China has eliminated its zero covid policy and will see an increase in demand for metals, however, a company like Ryerson may see a drop in demand for its products during these tough years as we have seen in the past when lockdowns started in 2020, the revenues went down by over 20% for the year and then shot up over 60% in the following year, or going down 43% during the financial crisis of ’08 and then increasing 26% once the dust has settled.
The PMI has been under 50 since October 2022 indicating contraction in the manufacturing industry, however, last month it ticked up a little higher. Over the next while, we will see what the industry is going to do with more interest rate increases and what the demand for the products will look like.
The industry will keep growing at a steady pace at around 2% to 4% in my opinion, but on the other hand, could we see something similar happening to the industry when in ’08 the industry declined by 37.2% ? I think that the leaders are much better prepared now than they were 15 years ago, and I know I shouldn’t be saying it, but I do feel that this time is different. That is my hope at least.
For my conservative approach to valuation, I predict a large decline in revenues in '23 and '24 just to be on the safe side. If the company can withstand this harsh stress test, it could be a great investment in the long run.
At their latest financial earnings call , the management said they are seeing strong demand for their products going into 2023 which has continued since November 2022.
The company is growing organically by improving the efficiencies of its operations, improving its e-commerce offerings so it can compete with other companies and also they don't shy away from acquiring small businesses that can synergize well with its current offerings. Most recently, the company has acquired BLP Holdings LLC, which isn't very big in terms of the revenue it can generate, however, if the management continues growing through further strategic acquisitions, it will be in a good shape in the long term and will reward its shareholders handsomely.
I do not see many catalysts that can change anything in a meaningful way in terms of propelling revenues further, it is a cyclical company at the end of the day, and it will keep chugging along and the results will largely depend on demand and prices of metal products.
Financial Metrics
The company is trading at one of the lowest EV/EBITDA valuations in recent history and is the lowest out of the competitors that I have compared, which could signal that it is undervalued.
EV/EBITDA comp (Seeking Alpha)
The profitability margins are also very good compared to the competition, which means the management is doing something right. The management sees the margins improving even further in the coming quarters.
The cash conversion cycle of the company has been longer than what the management would like. It is over their target range of 70-75 days, mainly due to inventory buildup, but the management is working on it and will expect the cycle to normalize soon.
The management has done a good job at paying off outstanding debt over the last 5 years and seems to be very proud to be done with their high-yield notes now are utilizing their credit facility, which I assume does not carry the same interest payments as the 8.5% notes. I am not the biggest fan of debt, however, here the management seems competent and can use the debt in a smart way that does not raise a red flag. In the company's case, with the credit facility, they will be able to reward shareholders further with share buybacks, dividend increases, and strategic acquisitions when the time comes.
The company has a very good current ratio that hovers around 2.0 for a while now. That is a very acceptable ratio, and I wouldn’t be surprised if it stays at these levels in the future. I do not foresee any liquidity issues coming up.
Other metrics that show me that the management is performing very well are ROIC, ROA, and ROE. These might trend a little down in the future, due to the recession but I see them picking back up again once the economy returns to normal. I'm not sure if we will see the same negative returns as we did in 2020, but I wouldn't be too surprised if they do dip considerably.
Overall, I think the management is doing a good job running this company. They can generate great cash flow which will translate into decent returns for the shareholders over the long run, in my opinion. Now let's look at what should an investor pay for a great balance sheet, free cash flow generation, and competent management.
DCF Valuation
My model is based on the premise that we will see a recession in the next 12-24 months, which will drive down demand and prices for the company's products and will see a recovery in 2025. I have 3 scenarios: A base case, a conservative case, and an optimistic case. In all three scenarios, I have a recessionary period included. For the base case, I assume a decline in revenue by a whopping 35% in '23 and 25% in '24, followed by two years of 20% increases, and then an average of 9% growth over the next 6 years, giving me around 3% growth over 10 years.
The conservative and the optimistic cases have a couple of percentages above and below the base case to give me a range. A conservative case scenario's growth is around 1% per year for the next 10 years and optimistic growth at 5% a year for the next 10.
I may have beaten up the estimates quite a bit, but since the company is cyclical, it would be hard to forecast, so I am staying on the conservative side. The large drops in demand seem to make sense to me, as in 2020 the demand dropped by 23%, and in the '08 financial crisis the revenues dropped well over 35%, so I'm just simulating what would happen if we see a similar situation. And on top of these estimates, I also added a 25% margin of safety on the final share price, just in case my estimates are off and that would give me a good cushion. With all the discounts and inputs added, the implied share price for the company is $38.36, which if you believe these assumptions, the company is at fair value right now.
The main reason for such low assumptions is that I believe we will see a further drop in the markets. J Powell recently came out in the minutes saying that the Fed is not going to ease in interest rate increases anytime soon and that it will be a long and tough road ahead for the economy. I believe these remarks warrant a pessimistic outlook for now.
Closing Remarks
Based on how the company has been running, the outlook of the economy, and the industry's cyclicality, I would suggest caution before investing money into the company at this time. Even after such a beating on estimates that my model incorporated, the free cash flow that the company can generate tells me that if the recession won't be as bad as I model, then we have ourselves a winner here in the long run for sure. My watchlist is updated with some price alerts set up at lower prices just because I believe we have not seen the lows yet, and since the company is up 30% YTD, I would expect a pullback to be inevitable. Just 10 days ago, the company was trading at $33 a share. If it comes down to more reasonable levels I wouldn't mind opening a small position, to begin with, and then adding more if we see more drops in the future.
For further details see:
Ryerson Holding: A Solid Metal Processor In A Challenging Environment