Description

Through its significant free cash flow generation and the likely refinancing of high cost debt, BRSS offers a 30-50% upside with conservative assumptions on growth and multiple expansion.  BRSS trades at 6.5x EBITDA, 10x EPS and an unlevered LTM 9% FCF yield while being exposed to GDP growth type end markets and taking limited/no commodity risk. 

Company Description:

BRSS was formed by KPS Capital Partners in October 2007 to acquire the metals businesses of Olin Corporation, which included Olin Brass, Chase Brass, and A.J. Oster. Before the acquisition, the metals business of Olin Corporation, the majority of what is the current business operated for nearly 90 years under Olin. Olin’s metals segment expanded over decades through increasing capacity, developing new products and technologies, establishing long-term customer relationships, and acquiring a distribution business to operate alongside its core metals manufacturing business.  KPS IPOed the company in 2013 and fully exited the position 2 years ago. 

Company operates under three segments: Olin Brass is the market leader (~35% share) in the North American copper and brass alloy market. Chase Brass is the market co-leader (~40% share including imports; ~50% share exclusive of imports) in the North American brass rod production market. A.J. Oster is the market leader (~33% share) in the North American distribution, processing, and rerolling of copper and copper-alloy sheet and strip market.

The main end markets are:

Building and housing: applications include strip, welded tube, and stamped parts for a number of products used in commercial and residential buildings, such as faucets, door hinges, and locksets. Strip is also used in plug outlets, switches, and wiring devices. Brass rod is used for faucets and valves in building and housing applications. Growth in the building and housing end-market is a function of new housing starts, existing-home sales, and remodeling and construction activity,

Automotive: Copper strip and fabricated products are used as lead frames and electrical connectors for use in automobiles. High-performance alloys are also featured in automotive applications to ensure reliability in high-temperature environments. Brass rod is used in automotive and transportation applications including heavy-truck braking systems, tire valves, heat sensors, and other fittings Industrial

Machinery and Equipment: Brass rod is used in various industrial applications, particularly for valves and fittings. Demand in the industrial machinery and equipment end-market is affected by capital spending, industrial production, and the health of the overall economy. Customers in the end-market include diversified manufacturers and machining companies supporting OEMs.

Electronics and Electrical Components:  Brass strip is used in sockets for circuit boards, electrical connectors for computers and consumer electronics, and foils for flexible circuit applications. Brass rod is used mainly in telecommunication applications, including coaxial connectors and filters for cable television. Demand in the electronics and electrical components end-market is driven by consumer spending on electronics and new-home construction. Customers in the end-market tend to be major manufacturers of home and commercial construction products and also electronics manufacturers.

Munitions: Copper and copper-alloy munitions applications include strip and cups used in shot shell bullet jackets, centerfire, rimfire, and small-caliber military munitions. Munitions customers consist of major munitions producers and ammunition-producing government facilities. Demand in the munitions market is affected by government security policies, military activity, regulations, and consumer demand for firearms and munitions. Defense budget cuts and sequestration had an adverse effect on demand in the munitions market for copper strip providers and drove significant destocking across the supply chain.  As of the end of the third quarter, the company believes the destocking in munitions is largely complete.

Overall I view these end markets as growing at a GDP like pace with the exception of housing starts (which are still below normal) and munitions which can be driven by exogenous factors both downwards (generalized peace, gun control) or upwards (new wars, fear of gun control).

BRSS has a lean, flexible structure that should generate high incremental margins on increases in volume in the near term and (more importantly) allow for the ability to handle future increases in demand without needing additional capacity/capex. The company has been operating at roughly 65% capacity utilization since 2012.  LTM capex of ~16MM should be sufficient to run operations for the foreseeable future. 

Commodity Price Exposure:

BRSS takes no commodity risk (or at least tries not to) on its business.  Sales that require the use of the balanced book approach are known as non-toll sales, meaning that BRSS is responsible for metal procurement. For sales on a toll basis, the customer is responsible for metal procurement, removing the metal price risk. Toll sales account for ~24% of volume.  The company achieves its balanced book on the remaining volumes through one of three mechanisms:

•  Metal sales and replacement purchases are priced on “price date of shipment” terms, meaning that metal sale prices and the metal replacement prices are set on the date of shipment. Under this scenario, the customer bears the risk of metal price changes from the date of the order until shipment. This method is used on about 65% of non-toll sales.

•  Metal sales and replacement purchases are priced on a “firm price basis,” meaning that metal sale prices are fixed on the order date, and a matching replacement purchase at a fixed price is established with a metal supplier. Under this scenario, the metal supplier bears the price risk from the date of the order until shipment.

•  Financial hedges if the sale is on a “firm price basis” but no matching replacement purchase is available. Under this scenario, the company executes a forward purchase on “price date of shipment” terms and enters a derivative transaction in the form of a forward purchase contract. Therefore, any change in the price of the metal is offset by gains or losses on the derivative contract. The price risk is borne by the hedge counterparty.

To prove this out, you can see that as the price of copper has come down significantly, EBITDA/lb shipped has remained stable. 

The graph above is from a company presentation when 2014 was the last available data, but so far in 2015, LTM revenues have declined ~10% and gross profit is marginally up, so the trend has continued. 

Valuation

Side note on book value – BRSS acquired Olin Corporation’s metals businesses in November 2007. The fair market value of the net assets acquired exceeded the purchase price in the acquisition, resulting in a bargain purchase event. Under U.S. GAAP, the excess fair market value was allocated as a reduction to the amounts that otherwise would have been assigned to the acquired long-term assets. Resulting from the bargain purchase event, all identified intangible assets and other noncurrent assets, including property, plant, and equipment, was recorded at zero value on the initial balance sheet in 2007. Therefore, fixed assets on the balance sheet today reflect only post-acquisition capital investments. Company and various sell side estimates for replacement cost at the time of the IPO of were ~$1Bn, with current pricing implying a discount of ~25% on an EV basis or ~50% on an equity basis. 

Catalyst

BRSS has Senior Secured Notes $375mm, 7 year NC4, 9.5%, maturing 2019 - No call period expires June 2016.  There is the Potential to refinance with a combination of cash on hand and partial ABL draw to significantly reduce interest expense.  Even a modest reduction of debt/interest expense down to 7.5% would be ~15% accretive to EPS and I expect they will do significantly better than that. 

Company has targeted a 3.0 Debt to EBITDA leverage level- which they have just basically hit in 3Q15.  Should increasingly see FCF deployment either directly returning it to shareholders or accretive acquisitions.