December 20, 2004 - 10:33am EST by
2004 2005
Price: 41.13 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 2,000 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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- IPSCO is the North American market leader in plate steel with a 40% market share
- Top 3 North American plate steel producers control 80% of the market
- Plate steel forecast to be strongest steel segment in 2005
- Capacity utilization effectively 100%
- No new production capacity planned for North America
- Uneconomical to import plate steel into North America: Asian pricing of $680 per ton vs. North American pricing of $650 per ton. Plus, transportation costs from Asia are approximately $100 per ton, if shipping capacity is available at all
- Enormous free cash flow ($1.2 billion forecast EBITDA for 2005)
- Valuation: approximately 2x forecast 2005 EBITDA and less than 3x 2005 forecast EPS
- No U.S. analyst coverage of company

Company Description

IPSCO is the leading North American manufacturer of plate steel. Plate steel is most commonly used across a wide variety of industries for infrastructure-related projects and heavy equipment for mining, construction and transportation end-users (ships, railcars, barges, etc.) as well as in oil rigs, pipelines and military armor.

IPSCO is the only pure play plate steel producer in the world.

The company is also a major producer of energy tubular products for the North American oil and gas industry. Energy tubular products are largely made from plate steel and used for oil and gas drilling and pipelines.

The company’s two primary production facilities are in the United States. Both facilities are non-union. The company is headquartered in Chicago, despite its Canadian listing.

IPSCO’s CEO, Dave Sutherland, has been with the company for 25 years. He takes 25% of his base salary in the form of IPSCO common shares. IPSCO’s CFO, Vicki Avril, takes 33% of her base salary in shares. Ms. Avril was the CFO of Inland Steel before joining IPSCO. The company does not issue options to any employees.

Market / Demand / Pricing

The top three plate steel manufacturers in North America have 80% market share. IPSCO is the largest, with a 40% share, followed by Nucor and ISG, each having approximate 20% shares.

IPSCO supplies customers across a wide variety of industries. The company’s major customers include heavy equipment manufacturers (Caterpillar, Deere, Ingersoll-Rand) as well as railcar and barge manufacturers (Trinity Industries). IPSCO also supplies armor for military uses. No end user customer accounts for more than 5% of the company’s sales.

Plate steel pricing is very strong and IPSCO’s customers are all on allocation, with demand outstripping supply.

Demand for plate steel for infrastructure-related projects in the United States is expected to increase given the recent passage of the expanded highway spending bill which specifically stipulates use of U.S.-produced steel.

IPSCO received higher prices for its steel during every month over month period in 2004. Plate steel prices are forecast to increase throughout 2005. The lack of new production capacity and forecast continued high demand point to sustainable pricing for plate steel for several years.

IPSCO’s primary raw material is scrap steel for its mini-mill production process. Increases in scrap steel prices are passed through dollar-for-dollar to IPSCO’s customers based on an established surcharge pricing mechanism. Therefore, the company’s margins are protected from scrap price increases.

Supply / Capacity

During the steel industry slump of the late 1990’s and early 21st century, approximately 4 million tons of plate steel production capacity (or 30% of total capacity at that time) was removed from North America. This capacity was not just idled, but completely shut down, dismantled and permanently removed from the market. Today, there is approximately 9 million tons of plate steel production capacity in North America.

There is no meaningful new plate steel capacity coming online in North America. ISG has approximately 400,000 tons of older, less competitive capacity that could hypothetically be brought online. However, with the strategic goals of ISG’s new owner, Mittal, lying elsewhere, it seems very unlikely this outdated capacity would be brought back into production. IPSCO has the capacity to produce an additional 500,000 tons of plate steel (in addition to its current production of 3.5 million tons) by making an investment of approximately $35 million. (The payback on such an investment would be only 3-4 months at current rates of profitability for IPSCO.)

It is not feasible to produce plate steel from steel mills designed to make other types of steel, so there is no “changeover risk”.

The North American plate steel market is very insulated from foreign imports due to very high global demand for plate steel for shipbuilding and infrastructure projects, as well as the high cost to ship steel to North America. For example, South Korea, the leading shipbuilding nation, can only supply approximately 70% of its plate steel needs for shipbuilding and must import the rest, mainly from Japan.

Plate steel pricing in Asia, including China, is sufficiently strong relative to North American pricing to prevent exports to North America. Asian plate steel pricing is approximately $680 per ton vs. $650 per ton in North America, plus shipping costs from Asia are approximately $100 per ton and delivery could take 4 months, if shipping capacity is available at all in an extremely tight global shipping market.

There is only one plate steel facility in all of China. The entire Asian market is short plate steel supply.

The falling U.S. dollar further protects U.S. steel producers by making foreign imports more expensive.

Cash Flow / Valuation

The company is underfollowed and misunderstood on Wall Street. The Company was originally a Canadian producer of energy tubular products. However, today the company is headquartered in the United States, has 75% of its assets in the United States and reports in U.S. dollars. IPSCO is listed in both New York and Toronto (the ticker is the same, IPS, on both exchanges). Yet, the company is exclusively covered by Canadian brokerage firms and trades a significant discount to U.S. steel companies.

The company is currently generating enormous amounts of free cash flow (forecast to be approximately $280 million in the first quarter of 2005) and net income (forecast to be approximately $190 million in Q1 05). This is forecast to accelerate in 2005 based on increasing demand leading to higher pricing and no new supply.

NOLs provide a tax shield on the company’s U.S. earnings. At current rates of profitability, the NOLs will be used up sometime during the third quarter of 2005.

Consensus earnings estimates for IPSCO for 2005 are currently $5.35. This is excessively conservative. Even if plate steel prices only stay flat during 2005, IPSCO could earn net income of $14 to $15 per share (making the current stock price of $41.13 a multiple of 2.8x 2005 EPS). If one assumes plate steel prices drop 5% per quarter during 2005, the company will still likely earn approximately $12 per share (3.4x 2005 EPS multiple). Plate steel prices are actually forecast to increase throughout 2005.
IPSCO is trading at a multiple of 1.4x tangible book value. This is the lowest book value multiple of any North American integrated or mini-mill steel company. IPSCO trades at approximately 1.0x its forecast year end 2005 tangible book value.

IPSCO can immediately pay significantly higher cash dividends and buy back a large amount of common shares. This trend can continue for at least several years. The company’s CEO is in favor of increasing the dividend and the company is studying a share buyback program.

The company recently retired preferred stock and subordinated convertible notes. Taken together, this reduced the company’s fully diluted shares outstanding by 17%, from 60 million to 50 million.


Enormous Cash Flow to Pay Dividends and Buy Back Shares. The company will be net debt free by the second quarter of 2005. The Company’s current market capitalization is $2.0 billion. However, even under a conservative flat plate steel pricing scenario for 2005, IPSCO will earn approximately $1.2 billion of EBITDA during 2005. Given the lack of any significant capital expenditure requirements, this cash flow will fund significantly expanded share buyback and dividend programs.

Takeover Target. It would cost a competitor at least $3 billion and three years to replicate IPSCO’s current production and marketing capacity in North America. An acquirer wishing to secure the dominant position in North American plate steel and energy tubular goods could buy IPSCO’s best in class production facilities and customer base to generate significant immediate cash flow during the current strong demand and pricing conditions. Given IPSCO’s low valuation, an acquisition of IPSCO would be highly accretive to any acquirer with the resources to make the acquisition. The weaker U.S. dollar makes an IPSCO acquisition less expensive for a foreign acquirer.

Energy Tubular Products Spin-Off. IPSCO’s energy tubular products business accounts for approximately 1/3 of the company’s sales volume. There is a significant opportunity for IPSCO, or an acquirer of IPSCO, to spin-off the energy tubular business in a transaction that would equal the current valuation of the company. For example, assuming the energy tubular business accounts for 1/3 of IPSCO’s EPS (it is likely a higher ratio as the energy tubular products are higher margin than traditional plate steel), or $4.83 per share utilizing the conservative flat plate steel pricing scenario for 2005, and applying a 10x 2005 EPS multiple yields a per share value for the energy tubular business by itself of $48. Both Maverick Tube (NYSE:MVK) and Lone Star Technologies (NYSE:LSS), the bellwether energy tubular products stocks, currently trade at 10x 2005 EPS estimates.
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