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Alloy Steel International: Weak Hands Sell The Headline To Their Detriment
Sep. 8, 2014 11:17 AM ET | About: Alloy Steel International, Inc. (AYSI)
Disclosure: The author is long AYSI. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Summary
AYSI Q3 earnings of 2.2 cents/share disappointed investors recently.
The stock is currently down 27% from its pre-earnings price of $1.77.
By normalizing the tax rate and excluding the effects of currency hedging, I show how the quarter was better than its headline.
I believe that the 27% sell-off in the wake of these earnings has re-presented a very attractive entry point into a company with substantial upside.
On Tuesday, September 2, Australian wearplate maker Alloy Steel International (OTCPK:AYSI) released fiscal Q3 earnings that disappointed investors. The stock sold off to an absurd degree, falling from $1.77 to $1.05 before rallying back to $1.30.
Make no mistake: the headline earnings number was disappointing. But as I looked further into the information released by the company, I saw that the quarter was not as bad as it seemed on the surface, for a number of different reasons which I will explain in this article.
For the quarter, AYSI earned 2.2 cents on $6.2M of sales vs. 14.8 cents on $9.3M a year ago.
Sales
AYSI had a very tough comparison this quarter. A year ago, they had one of their best quarters ever. As you can see from the chart, Q3 2013 was an outlier quarter. This year's sales were actually in line with average revenues over the past two years, excluding the year ago quarter.
AYSI Historical Sales - Quarterly
In their release, AYSI said the sales decline was "driven primarily by the drop off in mining activity". I honestly don't see much drop-off in this chart, again barring the one outlier quarter of $9M+. Maybe the effect of the mining downturn is merely to hold AYSI at $6M sales per quarter until things turn back up. If so, they're in good shape. They are profitable and debt-free and should outlast any cyclical downturn.
Earnings
Going from 14.8 cents to 2.2 cents in earnings sounds awful, but for many reasons it is not that bad.
Alloy Steel gave three reasons for the poorer quarter:
"The drop off in mining activity..."
"A 14% decline in gross margin resulting from the recognition in the current quarter of volume rebates prospectively payable..."
"A swing from exchange profits to losses equivalent to 5.4¢ per share..."
Reason #1, the drop off in mining activity, is a negative, for sure. For reasons stated above, I am not sure quite how much it impacted AYSI, at least on the top-line number. I do believe AYSI will remain profitable throughout this downturn, and that it will survive and thrive on the other side. Of course, I am not a mining expert, but that is just how I see things from a financial standpoint. Alloy Steel, with a market cap of $22.6M, has $5.9M of cash on the balance sheet and no debt.
Reason #2, the volume rebates, is hard to get a handle on. Last quarter, we saw the company retroactively apply these rebates to the prior year's results, resulting in 2013 earnings dropping from 32 cents to 28 cents. Yet apparently they were not present in last quarter's earnings themselves, because AYSI posted a 60% gross margin. At this point my best guess is that these volume rebates will apply sporadically quarter to quarter, and will make the gross margin very choppy.
AYSI's quarterly earnings are typically choppy:
AYSI Historical Earnings - Quarterly
Finally, Reason #3 states that foreign exchange swings caused a 5.4 cent difference in year over year quarterly results. That is a huge amount. In the recent quarter, AYSI lost 1.1 cents per share on this hedging mechanism. If we add that back into results we get a new "normalized" EPS of 3.3 cents. Likewise, the standout quarter a year ago would need to be lessened by 4.3 cents per share (of foreign exchange gains), bringing its EPS to 10.5 cents.
It is worth noting that these foreign exchange swings are typically negated on the balance sheet via the Accumulated Other Comprehensive Income line. That is why AYSI's book value grows more steadily than its earnings. In fact, AYSI grew its book value by 3.6% from April 1 to June 30, which equates to a 15% annualized rate. (Not bad for a "disaster" quarter.)
One final factor negatively impacting results, which the company did not mention, is that they paid a 55% tax rate this quarter. This must be an anomaly, and if we were to change that rate to a more typical 32%, then we can add another 1.0 cent per share to this quarter's earnings, which brings our new adjusted EPS to 4.3 cents per share.
Simply by adjusting the tax rate and the forex hedge, we have doubled earnings and gotten a more accurate and positive picture of operations. So maybe the market over-reacted just a tad bit? At the current price of $1.30, AYSI is selling below book value ($1.42) for the first time in a couple months, and at 6X TTM earnings of 21 cents/share.
OTC Markets
One last interesting update is that Alloy Steel filed their earnings at the OTCMarkets site for the first time. For years, they have been posting results only on their corporate website. They simultaneously filed past reports with OTCMarkets, and as a result have become "current" with the site. Their Stop sign was replaced with a Yield sign - signaling less risk to investors. I don't know why management all of a sudden wants to get legit with OTCMarkets, but I'd say it's a small positive sign.
Mikey
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