January 27, 2012 - 5:12pm EST by
2012 2013
Price: 0.71 EPS $0.14 $0.20
Shares Out. (in M): 17 P/E 5.1x 3.6x
Market Cap (in $M): 12 P/FCF 5.1x 3.6x
Net Debt (in $M): -3 EBIT 3 4
TEV (in $M): 10 TEV/EBIT 3.1x 2.4x

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  • Micro Cap
  • Australia
  • Steel


Alloy Steel, an Australian wear plate manufacturer with a patented technology, was introduced on VIC in October 2010. The company is a thinly traded (average daily volume of 22k) microcap company that is based in Australia and listed in the pink sheets the U.S. (AYSI.PK). After some persistent calls to the CFO and the independent director, we have gained some insight into the company's plans, which, if executed well, has the potential for several-fold gains in the stock over the next 2-3 years. Meanwhile, at $0.71, the stock trades well under TBV of $0.82 per share and at only 2.5x F10 (Sept.) EPS of $0.28 (all-time record year) and 5.1x F11 EPS of $0.14. These multiples become even cheaper if you back out net cash of $0.19 per share.

Please see prior write-up for some background and competitive position of the company. Also, see the company's website for technical and financial reports. The stock is hovering around 52-week lows (down from its high near $2 in early 2011) after results in F11 lagged the record results in F10. The issues that have caused investor concern and driven down the stock by 65% include:

* Lower sales in F11. Sales were 10% lower in F11 from a record F10, with some softness and increased competition in its key market of Australia.

* Lower gross margin in F11 of 38.9% versus 46.2%. However, if you add back D&A, then adjusted gross margin was 42.7% in F11 versus 47.6% in F10. Perhaps 100-200 basis points of the gross margin decline is due to sales mix (some customers moving the finishing of their wear solutions offshore to reduce labor costs). Rising labor costs have also pinched the company in Australia, where the company must deal with local unions.  

* Higher SG&A in F11 than F10. However, in the recent quarter 4Q11, SG&A was $1.65 m, down y/y from $1.74 m in 4Q10. SG&A should be flattish going forward, per the company.

* The related party transactions (five of them) were revealed in the Annual Meeting information statement in December. In addition to the royalty agreement where CEO Gene Kostecki gets a 2% royalty on net sales for the patents, the CEO owns the company's building in Australia, which is leased back to the company. Also, CEO's company Kostecki Engine purchases raw materials (e.g. steel) and consumables at a discount by aggregating orders for the company and some other construction-related Australian customers. Also, AYSI sponsors Western Speed Racing (racer Brodie Kostecki is Gene's grandson) in the amount of $100k a year, which is used as advertising for the company in the U.S.  However, the new directors have reviewed each of these related party transactions. Purportedly, the lease rates are competitive and the discounts on raw materials are beneficial to the company.

* Shareholders are in minority position (CEO owns 10.3 million shares or 59.6% of outstanding shares).and the company has had very weak corporate governance historically and rarely speaks with investors.

We think these issues are over-blown with the stock down by 65% from highs in early 2011. The stock now trades under TBV of $0.82 and at only 5.1x TTM EPS, or 3.6x TTM EPS net of cash.

Based on our conversations with the CFO Barry Woodhouse and independent director Brian McMaster, the company has some hugely positive things in its favor:

* As of a few months ago to today, the company is currently operating at or near capacity in Australia (the capacity for its 2 mills is about $32 million in annual sales). A few months ago, CFO Barry Woodhouse hinted that the company was "sold out" until mid-2012.

* After over a year of deliberation, the company is close to finalizing its plan to build a new facility (in stages) in Indonesia, the first stage of which could double capacity and be completed within 12-15 months (though this timeline could always be shifted further out). The land has already been fully paid for and permits are in place. As of this date, the company is close to hiring a construction company to start building the facility. The new facility in Indonesia would have considerable labor savings as a full-time unskilled laborer costs around $5k a year, versus as much as $100k a year in Australia (because of shortage of workers and union influence). While raw materials make up the bulk of CGS, the labor savings would still be significant. The company would not break out the cost estimates to build the new facility but agreed that to build a facility with the same sales capacity as in Australia could roughly cost the same as the land purchased ($2.8 million), which could be funded from operations and the cash position ($3.2 million as of September 2011). The company would maintain its Australian operations, which would refocus on a few product lines and remain the company's headquarters (e.g. sales/marketing, R&D). 

* The company is "comfortable" that it will have adequate demand for the new Indonesian facility. This confidence is due to: 1) currently operating at or near capacity in Australia, 2) the potential growth in its two largest customers, BHP and Rio Tinto (both of which are growing their iron ore as well as coal operations), and 3) recent success in penetrating several top distributors of Caterpillar (especially in the Americas) as well as other international sales wins. As can be seen in the company's recent financials, the company has been steadily growing international (non-Australia) sales: F11: "Americas" $5.3 million (24% of sales), "Other" (Asia, Europe) $4.4 million (20% of sales) versus F10: "Americas" $3.7 million (15% of sales), "Other" (Asia, Europe) $3.2 million (13% of sales). The company is also seeking to have better contracts with its major customers, possibly including minimum order quantities, which could reduce the lumpiness we have seen in quarterly sales in the past.

* The new independent director Brian McMaster (since February 16, 2011), who was a Partner at E&Y, is taking some steps to improve corporate governance, which has been terrible in the past. For example, company quarterly and annual financials are being released sooner. Also, the company had an annual meeting, with an information statement for investors, in December. Importantly, director Brian is currently pushing the company to remove a significant related party transaction, having the company acquire all IP from CEO Gene (who licenses it back to the company in an agreement that expires in 2025, with renewal periods), which purportedly Gene has already verbally agreed to and which could be completed as soon as the end of March. Furthermore, CEO and his team are working on patent extension(s) by the end of this year, which could eliminate the patent expiration risk. The current patents, which are available to view on Google patents, include U.S. patents #6,854,808, #5,362,937 and #4,514,443.


The stock is sitting at a low valuation with low downside risk, trading under TBV of $0.82 and at only 5x TTM EPS, or 3.6x TTM EPS net of cash.

If the Indonesia facility enables the company to double sales to $50 million and improve gross margin to 50%, then EPS could approach the current share price of $0.70. A 6-8x multiple would result in a stock as much as 6-8x higher in 2-3 years. As a check, Australian competitor Bradken (BKN AU) acquired two traditional wear plate manufacturers in July 2011: Norcast Wear Solutions for 1.8x F12E sales of A$110 million and Australian and Overseas Alloy Pty Limited for 2.2x F12E sales of A$35 million. Similarly valuing AYSI at 2x $50 million in sales (in 2-3 years) would be $100 million, or nearly $6 per share. Anecdotally, CEO Gene has even bigger goals, including eventually growing sales to $300 million by 2015.


Indonesia facility is built and capacity of first stage is filled (in 2-3 years).

Continued improvements in corporate governance (e.g. more financial disclosures, new board committee structure, IP fully owned by company).

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