SSAB: 5.5% Yield From Fossil-Free Steel Out Of Sweden – SSab Swedish Steel AB (OTCMKTS:SSAAF) No ratings yet.

(Author’s Note: Investors should be mindful of the risks of transacting in securities with limited liquidity, such as SSAAF and SSAAY. The SSAB listing in Stockholm, STO:SSAB-B, offers stronger liquidity).

SSAB Swedish Steel (OTC:SSAAF) (OTCPK:SSAAY) is a company that I’ve been looking at for some time. I’ve been on the sidelines for reasons of prospects, investments, and other things. Recently (last week), however, I finally pulled the trigger and bought a small, initial stake in the company.

In this article, I will present you with one of the oldest steel companies in Europe. I’ll talk about why I consider it investable, and why I consider the ownership structure appealing long term. While it doesn’t share the conservative and safe dividend policy that other companies in the space have, the combination of operating in extremely geopolitically stable and long-term appealing geographies with talented management makes for an interesting investment.

Let me show you why.

SSAB – Swedish Steel

I don’t have much in commodities/mining/basic materials stocks at this time. It’s one of my smallest portfolio allocations, only a small portion above 3%. This is something I want to change, and my SSAB investment is part of this.

So, what’s SSAB?

SSAB is a Swedish/Finnish company formed back in 1878, and it specializes in the processing of raw material to steel. Simple enough.

The company is headquartered in Stockholm and has listings in both Stockholm and Helsingfors, meaning you can get either SEK or EUR FX exposure (unless you buy the ADR). This company has been doing things for a very long time, and it’s by far the largest steel sheet manufacturer in all of Scandinavia.

Bildresultat för Luleå SSAB

(Source: Metal Supply)

It owns, among other things, blast furnaces, coking plants, and steelworks, located in Luleå, with rolling and coating plants in the Swedish town of Borlänge.

(Source: Intertechna)

The company owns a specialty steel plant in Oxelösund, which is the only steelworks in the entire nation to be entirely vertically integrated (from raw materials to steel plates in one place).

SSAB produces nearly all of the steel plates created in Sweden, and over the past 100 years, it’s perfected a national infrastructure network that relies on cheap and efficient train transports to bring steel from A to B. I don’t want to give the impression, however, that SSAB is a Swedish company. Its products are sold worldwide, and the company has large portions of the market share not only in Europe but in the Americas as well. The fact is SSAB is the largest producer and supplier of steel plate in all of North America, with an overall market share of 28% (Source).

SSAB’s business portfolio is a bit bigger than some companies. It’s easier to present it using the company’s own material.

(Source: SSAB Investor Presentation 2019)

Many of these businesses are completely synergetic in relation to one another. Tibnor and Services have a joint service agenda, and Tibnor works with Ruukki to source supplies. The portfolio segments give each other access to otherwise-fragmented markets, allow for technical competency transfer, production efficiencies, and other effects.

For the past few years, SSAB’s focus has been to basically “handle the market situation”. The market situation includes continuing margin compression and price/mix issues. The company has reacted with cost-saving actions in every segment, by increasing production flexibility and taking blast furnaces offline whenever macro required this. They’ve also reduced temporary manning and flexible working hours. Facilities or segments bleeding particularly badly have been put in restructuring programs – Tibnor is one of them. Of course, there’s also a continued focus on working capital optimization.

Medium term, beyond the current market situation, SSAB is targeting to grow specialty and premium products and develop market channels.

(Source: SSAB Investor Presentation 2019)

Thanks to heavy investing/CapEx, SSAB’s operations are now among the most flexible in the world, with some of the most modern facilities on the planet. SSAB is trying to innovate with new high-strength steel products. In essence, the company is trying to reach a more favorable mix, given the market demand where specialty and premium steels are becoming more and more desirable compared to “standard” steel.

(Source: SSAB Investor Presentation 2019)

New strategic targets for the company were set in 2019.

(Source: SSAB Investor Presentation 2019)

SSAB is the foremost company in the world when it comes to the research, production, and optimization of fossil-free steel. In Sweden, the company is working together with state-owned companies LKAB and Vattenfall to achieve this.

(Source: SSAB Investor Presentation 2019)

This sort of investment is more likely to drive profits and growth more in the future as opposed to now, but even now, the interest for the technology is high, and fossil-free steel is considered to be a premium product. When the cost of CO2-emissions rises and if punitive tariffs are enacted, fossil-free steel will become competitive (it’s not today). What’s more, this will further drive SSAB flexibility going forward.

The company already operates with the lowest blast furnace emissions in the entire world, but given Sweden’s large surplus of fossil-free electricity and SSAB still accounting for 10% of Sweden’s entire annual CO2 emissions, there’s still room for improvement here.

What about ownership? Who owns this business?

Well, we have some major players involved in the ownership of the company. The by-far largest owner with over 12.5% of the shares and 9.8% of the voting rights is a company known as Solidium OY. What, then, is Solidium?

It’s the Finnish state. 100% of Solidium is owned by the government/state of Finland, and Solidium invests in companies where they see their objective – Solidium’s task is to strengthen and stabilize the domestic ownership of the companies and increase the value of the holdings in the long term – as being relevant.

Apart from the Finnish state, major Swedish investment company Industrivärden owns another 10.4% of the voting rights in SSAB. Together, the companies own nearly a fifth of the voting rights to SSAB. The Finnish state involvement qualifies this as an at least partially state-owned company. This happens to be something I like, as I see it as ensuring the long-term shareholder interest (with the state itself being an interested party). Finland and Norway especially are very active in terms of state ownership (Solidium owns stakes in 13 companies), but Sweden has a few as well.

So, SSAB is a company that produces steel in a variety of grades and for a large variety of applications. It’s one of the largest producers in Europe (and America), and it’s also leading in terms of fossil-free steel production. Let’s take a look at some recent results, so see just how this company is performing.

Recent Results And Overall Financials

As with many commodities/metal companies, 4Q19 and FY19 as a whole didn’t exactly come in at record levels.

(Source: SSAB 4Q19/FY19 Presentation)

In fact, production was down, shipments dropped, and EBIT turned negative. Some significant effects during the quarter influenced EBIT, namely:

  • Overall strikes in Finland, providing a 250M SEK non-recurring cost.
  • Planned maintenance influencing 850M SEK.

For the most part, however, it was a weaker market full of destocking in Europe. Lower shipments due to continued destocking continued to impact SSAB’s earnings both quarterly and full-year. the EU/NA market also experienced a business-wide margin squeeze, which further lowered profits to give us the results we see above.

It’s not a strange thing then that we’re seeing significantly lower earnings.

Positives? There are several:

  • Destocking is finished – the company is already experiencing an order normalization going into 1Q20.
  • No further planned maintenance stops during the next 6 months impacting earnings.
  • Higher overall production levels and higher shipments are expected during 1Q20 and 2Q20.
  • Stable heavy plate demand in NA, one of the company’s main markets.
  • Underlying demand increase in Europe, though from a very low level.
  • Overall demand expected to increase, primarily due to demand increase from EU.

Let’s also take a look at some numbers here.

(Source: SSAB 4Q19/FY19 Presentation)

So, despite significant shipment drops, gearing is virtually unchanged with only a slight increase. Operational cash flow, despite dropping, is respectable. Without the one-offs and maintenance, EBIT would have been closer to 3B+ SEK – and note that, despite everything, sales are actually up. So, while earnings definitely came in lower, the underlying cash flows held up despite this – and this is one thing to look for.

This answers one question – how’s the debt? The answer here being that all things considered, company debt is rather low. Considering it at 2019 EBITDA would be possible, though this would be an outlier year, and it comes in at 1.83X net debt/EBITDA on the basis of FY19. On the basis of 2018 results, this number changes to 1.3X net debt/EBITDA. Either way, I argue it’s low enough to void any concern regarding company’s indebtedness.

Segment-wise results for 2019 were as expected, given current weaknesses. When it comes to reporting on an annual basis, the company reports in the areas of SSAB Special Steels, SSAB Europe, SSAB Americas, Tibnor and Ruukki Construction. This means that Fossil-Free Steels and Services are included in their respective segment, even though you’ll see them presented as individual segments in the company’s capital day presentations.

  • SSAB Special Steels saw a small shipment decline, but a distinct increase in profitability YoY, with EBITDA margins now approaching 12%. Most significantly, the company is targeting to convert Oxelösund into a fossil-free steel mill. All things considered, yearly results were excellent.
  • SSAB Europe represented part of the company’s troubles, with exceptional margin compression and very low demand. Shipments decreased 6%, though the company maintained a ~40% market share overall for the Nordics. EBITDA margins cratered, coming in at 3% (12.7% YoY)
  • SSAB Americas focused primarily on maintaining its leading position in the market, standing at 33% market share of premium products in 2019. EBITDA margins increased to record-breaking 16.3%, and FY shipments were down to 3%.
  • Tibnor was impacted by overall slowdowns, and EBITDA margins decreased to 2.3% sales went up due to an M&A. Tibnor is one of the segments SSAB is restructuring due to insufficient profitability, and this recent M&A of Sanistål is part of the project. EBITDA margin goal is 5% or more, which is more than double the current margin, and an RoCE of 15% in 2022.
  • Ruukki Construction delivered an impressive year despite everything. Sales increased by 6%, mainly due to roofing sales as well as an M&A, with clear increases in profitability, again primarily from roofing.

As mentioned earlier, the company really does not need to worry about its maturity profile and debt. It’s well-laddered, and the company has plenty of available cheap capital to finance upcoming maturities in the next 2 years. The average interest rate for SSAB is currently 3.1%.

(Source: SSAB 4Q19/FY19 Presentation)

So – closing the books on 2019, it was a mixed year, though the news seems to focus on company negatives (understandable). That’s not to say there weren’t highlights. SSAB delivered on many metrics – many of them soft.

(Source: SSAB 4Q19/FY19 Presentation)

The company has invested for the future, and in an environment where Co2 taxation is going to be a thing and pressure to reduce emissions will be central to most operations, SSAB is out in front.

Additionally, the company signaled financial strength through the commitment to a continuing, high dividend.

(Source: SSAB 4Q19/FY19 Presentation)

This dividend proposal represents an EPS payout of 144%. This might seem worrying, but the fact is that SSAB has plenty of cash on hand to handle this dividend payout. More importantly, the company sees a trend reversal incoming during 1Q20, which justifies this dividend. SSAB seems to be trying to create a long-term track record here and refers to the continued good generation of overall cash flow, not necessitating any sort of cut.

This means that, going forward, the dividend yield on SSAB is currently 5.5%, which again, has just been reiterated. Outlook for 2020 is somewhat mixed.

( Source: SSAB 4Q19/FY19 Presentation)

But again, even a small reversal will be enough to turn the negative sequential trend around. There’s little doubt that this is doable for the company, and when it delivers, this could result in multiple expansion.

So – one could argue (and many do) that this was a terrible year, and the company looks weak with only promises signaling any sort of reversal. Me, I see the positive underlying operational strength in many of the company’s core segments. I see the market-dominating positions in core areas around the globe, and a company that invests into flexible and future-proof methods for producing high-quality steel. Indeed, focusing on the type of specialty/premium steel I like to see. Combine that with an appealing dividend and signaling of financial strength, and this, to me, is appealing.

Let’s look at valuation.

Valuation

(Source: Börsdata)

While we’ve seen cheaper valuations for the company, it was also a different situation back in 2016, when the company posted negative EPS. The current valuation in terms of earnings is 26X (P/E). We’ve already established, however, that P/E for this year isn’t all that good an indicator, given the poor EPS (due to one-offs). P/E on the basis of last year comes in at 8.05X. I’m not saying that this should be considered indicative either, merely as showcasing the EPS volatility here.

Despite improvements in the last years, the company is currently trading below 1.0X P/B value – in fact, trading far below, at 0.47X. Similar tendencies can be seen in sales, where the company comes in at a 0.37X P/S ratio. The company can be tricky to value in terms of these metrics as well, however, given how much book value has declined compared to the high years of 2014.

What is clear is that the market doesn’t give SSAB much credence in any metric. Its revenues are priced at a low level, historically and in terms of peers.

(Source: TIKR.com)

The simple fact is, SSAB has been an exceedingly volatile company over the past few years – so the market is treating it as such, by only offering a small price and a great discount for its cash flows, revenues, and financials.

My argument isn’t that 2020 is a sort of turnaround year for the company. We can’t expect miraculously stable metrics going forward. What can be said, however, is this:

  • SSAB is profitable, despite a year fraught with troubles.
  • SSAB is among the leading positions in the industry in new technologies for producing steel.
  • SSAB has a market-leading position in multiple geographies.
  • SSAB operates in geopolitically appealing geographies and is backed by the Finnish state, ensuring a very motivated long-term shareholder.

What’s more, SSAB is significantly undervalued in terms of some public comps. Let’s take a look.

(Source: Authors calculation based on public data)

Out of similar companies and in this group, Nucor (NUE) seems a competitor. Nucor is a great company in its own right, but it’s also valued at three times in terms of book value and has a lower yield. This quick exercise was in part meant to show the volatility we see in this space – I’d be extremely hesitant, for instance, about buying a company at 2.5X earnings with a 4.16 net debt/EBITDA – and how wildly things can vary. SSAB is certainly no stranger to volatility, and this can certainly be expected to continue.

What should raise your interest is the fact that SSAB is currently being traded at a nearly 48% potential upside to the average market target since the FY19 presentation last week (40 SEK/share) (Source: S&P Global). This upside represents the company’s own guided earnings stabilization going into early 2020.

What should also interest you is the relative undervaluation in terms of tangibles when looking at peers, as well as the significantly better yield, beating almost every company in the space out there.

I won’t say that SSAB deserves a premium multiple of 16-20 times earnings. But the fact is, that’s the multiple we’re seeing only if we look at this year’s earnings.

S&P Global analysts are forecasting a 2.89 SEK/share EPS for FY20, which is not as high, but more in line with 2018 results and excepting the one-offs we’ve seen this year. This EPS would indicate that the company is currently trading at 9.5X in terms of FY20 EPS. When taking this into account, the 40 SEK target makes more sense, as this would represent a P/E of ~14X.

The upside becomes even more jarring if we look at expectations for 2021, where forecasts are pointing to a 3.85 SEK/share EPS, including some projects coming online and M&A synergies in place. If this materializes, today’s share price represents a P/E of 7.19X.

These are the things I look at, and why I put my own target for SSAB somewhere at the midpoint between current and target to model conservatively – 34-35 SEK/share. Once the share breaches this level, I’ll probably not buy much more, but below this, I find that the company is trading at an extremely pessimistic valuation, basically including 2 more years of harrowing financial results, pushing EPS down below the 1 SEK/share mark.

I don’t see this happening which is why, at this price, I’m a buyer of SSAB and am happy to enjoy my 5.5% dividend.

Thesis

Investing in commodity companies/metal companies such as SSAB is always a tricky thing. They’re volatile and fickle investments, even more so in the Nordics where dividend stability isn’t necessarily a thing. This means that investors need to be prepared for such volatility not only in the share price but in other metrics as well.

SSAB should be viewed as a very long-term investment. When viewed in such a way, investing in SSAB at a forward valuation of below 10X (in terms of 2020E EPS) isn’t all that unappealing, especially when the company communicates stability and confidence regarding recovery going into 1Q20, and especially when the price in terms of historical trends is this low (in terms of BV).

I can’t fault anyone for not investing here. The best reason for not investing here is that forecasting certainty and dividend stability isn’t really as stable/foreseeable as I typically like when I pick my investments. For me, made up for by the fact that SSAB is a partially state-owned company, the fact that the company is technologically advanced and the market-leading position in multiple geographies. I see a long-term value here, even if this will at times include years of dips and poor results.

In the end, it’s all about value and valuation – and that’s where I see a significant forward upside in SSAB. The upside I see, at the very least for 2020 with earnings recovering somewhat, is 20.8% at today’s share price.

Thank you for reading

Stance

Due to recent undervaluation and an expected recovery in 2020, I rate SSAB Swedish Steel as a “BUY” with a “Bullish” sentiment.

Disclosure: I am/we are long SSAAF, SSAAY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: While this article may sound like financial advice, please observe that the author is not a CFA or in any way licensed to give financial advice. It may be structured as such, but it is not financial advice. Investors are required and expected to do their own due diligence and research prior to any investment.

I own the European/Scandinavian tickers (not the ADRs) of all European/Scandinavian companies listed in my articles.

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