Summary
- Shares of FRD have fallen by 16% YTD and 30% in the last 12M.
- Company currently sells for less than liquidating value.
- Friedman Industries is benefitting from tariffs and already experiencing greater demand.
- Strong balance sheet allows it to withstand cyclicality and competition. Company has paid cash dividends for 190 consecutive quarters.
- Recommend: Buy FRD (hedge against steel prices by shorting SLX).
Situation Today
About Friedman Industries
Friedman Industries, Incorporated (NYSE: FRD) ("Friedman", "Friedman Industries", or the "Company") is a manufacturer and processor of steel products and operates in two product segments: coil products and tubular products. The Company is engaged in a non-seasonal, highly-competitive business and competes with other processors of hot-rolled steel coils. The steel industry, in general, is characterized by a small number of extremely large companies dominating the bulk of the market and a large number of relatively small companies, such as Friedman, competing for a limited share of the market.
The coil products segment processes hot-roll coils into sheet and plate, as well as customer-owned coils on a fee basis; and sells these products on a wholesale basis. It offers its coil products and processing services primarily to steel distributors and customers manufacturing steel products, such as steel buildings, railroad cars, barges, tanks and containers, trailers, component parts, and other fabricated steel products through its own sales force. The tubular products segment uses hot-rolled steel coils that the Company will manufacture into line and oil country pipes, as well as pipes for structural applications. It sells its tubular products principally to steel and pipe distributors through its own sales force. Friedman Industries was founded in 1965 and is headquartered in Longview, Texas. (Source: Annual report fiscal 2019, Finviz)
The Company's results are mostly determined by prices (cost of inputs, selling price), demand and competition. In simple terms, the Company buys "raw steel", transforms it into pipes and sheets, which it then sells at a higher price (reflecting the value added). As a small player in this commodity-based market (offering relatively generic products (rarely specific, although FRD does occasionally process customer-owned coils on a fee basis)) Friedman is a price taker and subject to fluctuations in steel prices. Generally the Company will perform best when prices are rising and demand is strong - then it will be able to purchase inventory at an average cost that is well lower than the eventual selling price, produce more economically at scale and earn more with greater quantities sold. Although FRD will still experience rising costs with higher steel prices those higher costs will be associated with higher selling price (just think about the inventory listed at cost which the Company will then be able to sell at higher prices in a rising market). And with stronger demand the Company is able to produce more economically, achieving lower cost per ton produced that further improves results.
As an example, in fiscal 2017 prices (cost and selling price) rose while energy markets experienced a downturn. This increased the cost of raw materials while sales were simultaneously negatively affected due to lower demand (partially offset by higher selling price, but costs negatively affected by less economical production), causing the Company to report a loss for the year. This was reversed the following year as demand grew while prices rose moderately. All in all, results are significantly impacted by prices, competition, input cost management and demand.
(It is worth noting that the Company shifted its inventory cost accounting method from LIFO to Average Cost in fiscal 2019. With rising prices in 2017 the LIFO method was particularly unhelpful as cost of goods sold rose significantly while low demand further hurt in terms of quantity and selling price.)
