Ternium S.A.: Major steel producer with 26.9% upside potential of 4.5% dividend yield

Reason 1. Fundamental changes in Latin American steel market

Steel is a crucial material for the global economy due to its exceptional combination of strength, formability, and versatility. Its impact spans across numerous sectors, including building and infrastructure, mechanical equipment, and automotive industries, which collectively account for 80% of the world's steel consumption, which amounted to 1,762 million tonnes (Mt) in 2022. Going forward, the growing need in creating durable, yet lightweight designs that meet increasingly stringent environmental standards will spur demand for strong and eco-friendly materials. Thus, the World Steel Association forecasts the global demand for finished steel products to increase to 1,854 Mt by 2024, up by around 5%.

World steel use by sector in 2022; source: World Steel Association

In 2022, global crude steel production, as reported by the World Steel Association, stood at 1,886 Mt, reflecting a 3.9% decline compared to the previous year. Crude steel, which represents steel in its primary solid or usable form, encompasses ingots, semi-finished products like billets, blooms, slabs, and even liquid steel used in castings. One of the primary drivers behind the decline is the sluggish Chinese economy, where steel production declined in the past two years: to 1,018 Mt in 2022 from the record-high of 1,065 Mt in 2020. The decline in China’s steel production has had a significant impact on the global steel industry, given the country’s dominant market position with a share of 54%.

Furthermore, the tight monetary policies implemented in developed countries in order to curb record high inflation, have slowed down economic growth. This, in turn, has hindered demand for steel in economies facing challenging economic conditions, such as Japan and the US, which are the world’s 3rd (4.7%) and 4th (4.3%) largest steel producers, respectively. Among top-5 steel producing countries, only India displayed an increase in 2022 steel output, from 118 Mt to 125 Mt (+6.6 YoY).

World production of crude steel in 2018–2022; source: World Steel Association

Ternium S.A. is Latin America’s leading steel company with a vertically integrated business spanning from iron ore mining to comprehensive service centers. This ensures cost control and production efficiency. The company has an extensive footprint across several countries in Latin America and owns production facilities in Mexico, Argentina, Brazil, Colombia, the US, and Central America. Its primary markets include Mexico, Argentina and the US, with 57%, 20% and 9% shares in 2022 total steel shipments, respectively.

Ternium’s production facilities; source: Investor Presentation 2023

The company boasts a substantial production capacity, with approximately 12.5 Mt for crude steel (slabs and billets) and 15.2 Mt for finished steel products. Ternium focuses on high-value-added steel products including hot rolled coils, cold rolled coils, rebars & wire rods, galvanized products, tinplate products, etc. Products and services offered by Ternium are demanded mainly in the automotive, home appliances, heat, ventilation and air conditioning (HVAC), construction, capital goods, container, food and energy industries.

Ternium’s steel shipment destinations; source: Investor Presentation 2023

Throughout the 1990s and 2000s, Latin America witnessed a significant surge in steel consumption, particularly in Mexico and Brazil, where the industry expanded at a CAGR of about 6%, driven by increased demand from manufacturing industries. However, the 2008 financial crisis affected the region’s economies, and steel demand growth has been sluggish since then.

Nowadays, Latin America and the Caribbean remain uncertain about the recovery of their markets. According to the International Monetary Fund, while the regional GDP showed robust growth of 6.9% in 2021, the expectations for 2022 and 2023 are more modest, with anticipated growth rates of 3.5% and 1.7%, respectively. Additionally, political uncertainties loom as potential obstacles, hindering the implementation of much-needed structural reforms. As a result, the 2022 forecast for finished steel production in Latin America made by the Latin American Steel Association stands at 55.3 Mt, representing a 1.1% decrease compared to 2021. Consumption of finished steel products is projected to drop by 9.5% to 67.8 Mt, which is higher than the global estimate (-2.3%). In North America, in contrast, a modest recovery of steel consumption of 1.2% is expected.

Finished steel production and consumption in LA; source: Latin American Steel Association

Nevertheless, Ternium is well-positioned to profit from several long-term trends in the steel market. First, as shown, Latin America currently faces a steel deficit of approximately 12.5 Mt. The deficit is covered by imports, notably from China, which supplied 10.4 Mt to Latin America in 2021. Leveraging its logistical advantages, Ternium can play a pivotal role in bridging this deficit and substituting imports in the market.

Secondly, Ternium can take advantage of growth in the USMCA region, encompassing the US, Mexico, and Canada. These markets have been increasingly attractive for companies’ moving their manufacturing capacities to the region, driven by highly developed industrial sectors that demand high-end steel products. Moreover, in 2023, the US imported more goods from Mexico than from China for the first time since 2003. Amid economic tensions in the US-China relations, US companies have been quick to diversify their supply chains out of China, e. g. US car producers such as Ford, General Motors, Chrysler, and others, have increasingly shifted production to Mexico over the past decade.

Reason 2. Short-term market opportunities and investment program

Ternium started 2023 with mixed results in terms of meeting analyst expectations: in Q1 2023, the company ыгкзфыыув its earnings per share (EPS) target by over 90%, but fell about 1% short of the revenue target due to steel price drop. By Q2 2023, macro environment in the Latin American steel market improved, with Ternium’s sales per ton rising slightly versus the previous quarter, which may be a sign of the end of a steel slump. According to MEPS International, in May 2023, prices for steel products in Latin America recovered from their lowest levels in December 2022–January 2023 and reached $1,066 per ton for hot rolled coil, $1,466 per ton for hot rolled plate, and $1,143 per ton for cold rolled coil. Further steel prices rebound may boost Ternium’s financial results in H2 2023.

Revenue per ton of steel; source: Investor Presentation 2023

In addition, Ternium has opportunities to increase its share in the core markets in the short-term. In November 2022, Mexican steel producer Altos Hornos de Mexico (AHMSA) shut down its 3.5 Mt/yr steel mill in Monclova, Mexico, when Mexico's state power company CFE cut the power supply to the company due to non-payment of electricity bills. In May 2023, AHMSA resumed operations once state-owned oil giant Pemex supplied the company with natural gas. However, in July, the company faced another obstacle: a strike of workers from the Sindicato Nacional Minero, which represents the steelworkers at AHMSA, blocked access to the coking plant at the Monclova site. The strike made it impossible for the coker to be maintained at the proper temperature, and consequently, the site returning to normal production was postponed indefinitely.

Ternium grabbed this opportunity and shifted some of its supplies from the US to Mexico, increasing steel shipments to Mexico from 3.25 Mt in H1 2022 to 4.09 Mt H1 2023, up by 25.9%, which marked a new record high for the company and boosted its market share in Mexico. Besides, shifting some of its supplies from the US to Mexico implied a supply decrease in the US, where domestic steel producers raised prices back in January 2023. As long as the AHMSA conundrum continues, Ternium’s US division is expected to capitalize on the most lucrative market and boost its revenues significantly.

Moreover, Ternium has outlined its investment program for 2023–2026 that includes the following projects:

• A new downstream project at the industrial center in Pesquería is expected to increase push-pull pickling line capacity to 550,000 t per year, cold rolling mill capacity to 1.6 Mt per year, and hot-dip galvanizing line capacity to 600,000 t per year. The project is planned for launch in 2024–2025, with total investment estimated at $1.0 billion.
• A new electric arc furnace slab mill in Pesquería is expected to add 2.6 Mt per year of EAF-based steel and 2.1 Mt per year of dry reduced iron. The launch is planned in H1 2026, with total investment estimated at $2.2 billion. The unit will strengthen Ternium’s facility base in Mexico, substantially accelerating the company’s capacity to respond to changes in the market.

Reason 3. One of the highest dividend yields in the industry

Ternium has been operating profitably for the past two decades. Over 2016–2022, its margins have varied to some degree, but now they stay at its average levels: about 26.7% for gross margin and 19.0% for adjusted EBITDA margin. This allows the company to continuously increase annual dividends. Except for 2020, when Ternium did not pay dividend due to the COVID-19 pandemic, it has increased annual dividend from $0.9 per American Depositary Share (ADS, each ADS represents 10 shares of Ternium’s common stock) in 2016 to $2.7 per ADS in 2022, implying a CAGR of 20.1%. This resulted in an average dividend yield of 4.46%. More importantly, Ternium maintains a payout ratio at around 20%–30%, which is reasonable since it allows the company to continue increasing an annual dividend in the future without the need to borrow loans for this purpose.

Dividends and dividend yield; source: compiled by the author

In 2023, Ternium has already paid a dividend of $1.8 per ADS, which signifies the management’s confidence in the company’s financial sustainability. The company’s recent financial results demonstrated that it is able to at least sustain dividend payments at the same level:

• H1 2023 net income stood at $1,215 million, while net income in the last 12 months (TTM) was $1,494 million.
• H1 2023 free cash flow (FCF) reached $265 million, while TTM FCF was $2,051 million.
• Given total shares outstanding of 1,963 million and ADS of 196.3 million, Ternium is expected to earn $530.0 million to pay $2.7 per ADS.
• In May 2023, $1.8 per ADS, or $353.4 million, was already paid to shareholders, which gives a payout ratio of about 29%.
• Thus, despite macroeconomic uncertainties, the dividends appear safe for 2023, and may even increase, given historically stable cash flows. As a result, 2023 dividend yield may vary from 7.1% to 7.9% depending on the payout ratio.

Cash flow from operations and free cash flow; source: Investor Presentation 2023

Ternium’s debt burden and interest expense do not pose significant threats to future dividends. As of December 31, 2022, the company had $1,032 million of total debt, including $499.2 million of short-term debt and $532.7 million of long-term debt. The long-term debt can be broken down by maturity: $523.4 million (98.3% of total long-term debt) is due to be paid in 2024, while $9.3 million (1.7%) is to be paid in 2025. Most of the total debt is denominated in USD (85.4%), and only 14.6% of total debt is denominated in foreign currencies (MXN, COP, GTQ and ARS). In Q2 2023, the company’s total debt decreased by 13.5% to $892.3 million.

As for interest expense, it has surged by 2.4x, from $13.9 million in H1 2022 to $33.7 million in H2 2023. This seems to be a significant increase, but given EBIT of $1,089 million, it results in a solid interest coverage ratio of 32.3x. Therefore, Ternium proves to be financially healthy even in such a cyclical industry as steel manufacturing. Plus, the company has promising dividend prospects.

Thus, Ternium is well-positioned to cater to specialized markets and meet the growing demand for premium-quality steel products. Its strategic advantages, coupled with the potential to bridge the steel deficit in Latin America and tap into the thriving USMCA region, underscore the promising opportunities that lie ahead for the company.

Financial performance

Ternium’s TTM financial results can be summarized as follows:

• Revenue decreased to $15.2 billion, down by 7.6% compared to FY 2022, driven by lower prices.
• Gross profit went down by 26.1%, from $3.9 billion in FY 2022 to $2.9 billion TTM, with gross margin decreasing from 23.9% to 19.1%.
• Operating income plummeted by 40.5%, to $1.6 billion. Operating margin declined from 17.0% to 10.9%.
• Net income declined from $2.1 billion in FY 2022 to $1.5 billion TTM. As a result, net margin decreased from 12.7% to 9.9%.

The main reason for such underperformance during the last 12 months is lower steel prices that plummeted in winter 2022–2023, while COGS and total operating expenses slightly declined (-1.8% and -0.9% YoY, respectively). However, by summer 2023, prices recovered to July 2022 levels, so Ternium may deliver better financial results in H2 2023.

Dynamics of annual financial results; source: compiled by the author

Nevertheless, Ternium’s cash flows remained stable over the last 12 months. Its TTM operating cash flow decreased by mere 1.5% to $2.7 billion, while free cash flow declined by 6.8% to $2.1 billion versus $2.2 billion in 2022 due to increased capital expenditures (+18.9%).

Dynamics of annual financial results; source: compiled by the author

The company's financial performance in H1 2023 is presented below:

• Revenue decreased from $8.7 billion to $7.5 billion YoY.
• Gross profit tumbled by 38.0% to $1.7 billion.
• Operating income decreased from $2.1 billion in H1 2022 to $1.1 billion in H1 2023.
• Net income declined by 33.0% to $1.2 billion in H1 2023.

As previously mentioned, overall underperformance is attributed to lower steel priceseven though steel shipments increased by 2%, from 5.91 Mt to 6.05 Mt.

Dynamics of half-year financial results; source: compiled by the author

Ternium maintains a robust balance sheet:

• The leverage ratio, defined as the ratio of total debt to assets, stands at 6%, which is lower compared to the industry average of 11%–22%.
• As of June 30, 2023, total debt accounted for $892 million, down from $1,032 million in December 2022. With reported cash and short-term securities of $2,952 million, this results in negative net debt of $2,060, as of June 30, 2023.
• TTM interest expense increased by 42.4% to $66.5 million compared to $46.7 million in FY 2022. Given TTM EBIT of $1,658 million, current interest coverage ratio stands at 24.9x, which proves that Ternium is financially healthy, while being able to finance its investment program and distribute capital to shareholders.
• Inventory turnover ratio constituted 3.4x in 2022, meaning the company turned over its inventory every 109 days on average during the year. Over the past four years, the average inventory turnover was 105 days. Despite a 8.3% increase in inventories in H1 2023 compared to the beginning of the year, Ternium’s TTM turnover ratio stand at its average level of 108 days.

Stock valuation

Ternium trades close to the average multiples of peer steel producers: EV/Sales — 0.48x, EV/EBITDA — 3.20x, P/FFO — 2.63x, P/E — 6.02x. However, Ternium has sufficient financial resources to award investors the highest dividend yield in the industry, which combined with established position at its core markets and potential to increase its market share offers the best return per unit of risk taken.

Comparable valuation; source: created by the author

The minimum price target set by Santander is $44.0 per ADS, while Scotiabank GBM values Ternium at $53.0 per ADS. According to the Wall Street consensus, the stock’s fair market value stands at $49.4, implying a 26.9% upside potential.

Price targets of investment banks; source: compiled by the author

Key risks

• Steel demand is sensitive to trends in cyclical industries, such as the construction, automotive, appliance and machinery industries. A downturn in economic activity would reduce demand for steel products, which would have a negative effect on Ternium’s business.
• China is the world largest steel producer, and Chinese exports of steel products, including exports to Mexico. A decrease in steel consumption in China could stimulate aggressive Chinese steel export offers, exerting downward pressure on sales and margins of Ternium.
• As the AHMSA case demonstrated, strikes at steel producing facilities may impede Ternium’s operations, given that a substantial majority of its employees are represented by labor unions and are covered by collective bargaining agreements, which are subject to periodic renegotiation.
• Ternium is exposed to various political, economic and social conditions and government policies in Mexico, Brazil, and Argentina. For example, in the last few years, the Mexican government made various attempts to modify rules and regulations governing the energy market in Mexico with potential impact on the energy supply and its costs.

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