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Can I interest you in a stock with pathetic liquidity and a management team that only reports once a year?  Wait, it gets better:  they also don’t hold conference calls, and no one on the Street has covered them for something like 15 years.  Please, don’t all rush in at once.

No stranger to the VIC, Schuff has been written up by scott265 in 2005 and again in 2006, and more recently by gocanucks97 in 2009.  Now that non-residential construction is finally starting to creep out of its worst downturn in 50 years, Schuff is a timely idea yet again, so here goes:

Schuff is the nation’s largest structural steel fabricator and erector.  For the most part they work on buildings, but also make large-diameter water pipe for aqueducts and have a manufacturing segment that makes stuff for the oil/gas/petrochemical sectors.  Not quite a national business, I’d call Schuff a “multi-regional” with an emphasis on the Southwest (California, Nevada, Arizona, and Texas) as well as a meaningful presence in the Midwest (around Kansas) and the Southeast (Florida and Georgia).  They work out of 10 fabrication shops plus various admin and sales offices.

This is a good business, and it’s really cheap:

At $14.75, shares are trading for only 68% of book and 76% of tangible book.  I estimate mid-cycle EPS to be roughly $3.70, implying a 4X P/E.  I’m assuming just 5% revenue growth over 2012, flat SG&A, and a gross margin of only 13%.  Take another look at the gross margin history above … 13% is pretty conservative. 

Obviously the past few years have been tough, but nothing about this company has really changed.  The problem is just a cyclical downturn. 

I wasn’t expecting a track record this good.  After all, welding steel doesn’t sound like the toughest thing to break into.  Often it isn’t.  There are something like 2,600 steel fabricators in the U.S. – mostly tiny mom & pop shops with 10-100 employees.  But when you’re the biggest guy out there (1,500 employees) you can do stuff that few others can.

While the total non-residential construction market is in the hundreds of $billions in size, Schuff’s addressable market – highly complex superstructures – is only about $4billion.  There are only a handful of large players in steel structures that can compete for many of the projects they look at – e.g. stadiums, semiconductor fabs, convention centers, etc.  According to the CEO, at the high-end of this high-end, "we really don't have any competitors." 

While most firms outsource engineering and detailing, Schuff has its own team, putting it into the roughly 5% of firms that can do design, fabrication, and erection all in-house.  There’s an advantage to having all three.  Often when clients have another firm design the project, they don’t like it and request a lot of costly change orders.  But when Schuff’s team does it all in-house, the client gets the lowest cost and time to completion can be accelerated up to six months.  Thus, Schuff tends to seek out highly-visible, fast-track projects where this advantage commands a premium.

Size has its advantages:

• While most competitors have to purchase steel thru service centers, Schuff can buy direct from the mills, giving it as much as a 10% cost advantage on materials, which in turn make up about 1/3 of a project's cost.  Also, they can lock in the steel price upon landing a big project.
• They’re bonded, whereas tough bonding standards eliminate a lot of weaker players.
• By being a dominant player in markets they serve, they can provide the most consistent flow of work to the union hall in exchange for getting the union’s better workers (note: only 1/3 to ½ of employees are unionized).
• They can “overbook” their own fabrication shops while outsourcing the simpler commodity type work (e.g. stairs, handrails, etc.), leading to numerous advantages: 1) it keeps competitors' shops full and thus unable to bid against Schuff, 2) keeps their own shop utilization high, 3) allows the salesforce to work continuously, rather than trying to match projects to available capacity, 4) they earn a spread on all subcontracted work.

One last advantage to note is the fact that they can bill customers for materials when purchased.  This keeps inventories to a minimum and prevents general contractors from using them as a source of financing.

Run for shareholders:

At year end 1995, Schuff had a tangible book value per share of $1.35.  At year end 2012, TBVPS was $19.45, after having paid-out a cumulative $5.90 in dividends.  That works out to a CAGR of 18.8%.  In other words, this company has been run for shareholders, which shouldn’t be too surprising given that the Schuff family owns 60.8% of it.  Scott Schuff has been CEO during this entire time, and at 54 years of age I doubt he’ll be leaving anytime soon.  (By the way, his father David founded the company in 1976 and serves as Chairman today.  His son Ryan also works in the business.)

Interestingly, Schuff wins my award for “most aggressive share buyback that I’ve ever seen.”  At year-end 2011, Schuff bought 58.1% of total shares (5.6M) at $13.25 each from two institutional investors – equivalent to roughly $30.50 using the current share count.  Funding came from the existing credit facility and $31.4M of new borrowing, most of which has already been paid back.  I estimate current net debt to be only $13.3M.

The cycle is finally turning:

Let’s be clear: I am not suggesting that there’s a full-blown recovery underway in non-residential construction.  I’m simply saying that we’re past the bottom and demand has improved meaningfully, albeit gradually and not in every single geography or subsector.  But as I said above, EPS will go way up if this company’s gross margin gets just halfway to the long-term average.  Maybe it takes a few years to get there.  In any event, I think we’ll likely see good progress when Schuff reports next May.

Signs of recovery:

First, the AIA Billings Index has shown YOY growth in billings at architectural firms for 11 of the past 12 months.  Historically, construction spending tends to follow the direction of this index with a lag of approximately 9 months.  Last week, the AIA’s chief economist said that: “It is fair to say that design professionals are in recovery mode… This upturn signals an impending turnaround in non-residential construction activity.”

Second, the Fed’s survey of bank lending shows easing credit standards for CRE loans, as well as increased demand.  http://www.federalreserve.gov/boarddocs/snloansurvey/

Third, the comps are doing well.  There are only two public companies in North America that are even remotely comparable to Schuff, and they’re both based in Canada.  Fortunately, however, they both do a big % of revenues in the US, and they both report quarterly.  Take a look at the charts:

http://www.stockhouse.com/companies/quote/t.cam/canam-group-inc

http://www.stockhouse.com/companies/quote/t.drx/adf-group-inc

Finally, recent commentary from related companies is generally positive:

5/1/13 Tutor Perini:  “our building business had awful 2012, but now seeing gradual recovery and return to profitability.  1q13 sales up 21% due largely to hospitality and gaming projects in CA, AZ, NV”

7/18/13 Nucor:  “We also take a look at our downstream businesses and they tend to be leading indicators for non-residential construction.  We look at our backlogs, our order entry rates, and although they haven't been spiking to the level we would like to see them we do see an improvement in those areas.”

7/18/13 Steel Dynamics:  “Directionally, fabrication continues to be a bright spot for us, which is a positive sign for non-residential construction.  Shipments increased 11% [sequentially] in the quarter … beyond the macro market indicators, we are seeing these improvements incrementally in our order book.”

7/25/13 Reliance Steel:  “Nonresidential construction is showing signs of life, mainly through industrial construction projects throughout North America.  These would include refineries, Power Generation plants, LNG facilities, etcetera, along with some schools and hospitals, just to name a few.”

7/27/13 Commercial Metals Corp.:  “non-residential continues to strengthen, just at a slower rate than we would like.  The stronger markets outside of the Texas market happen to be in California, South Florida, and the Beltway”

9/10/13 United Rentals:  “our primary market is nonres construction.  We stated that we thought the back half would be stronger than the first half - that still holds true.  We're seeing some delays on that, to Bill's point, we see that play out in 2014 and 2015”

Risks:

• Competition from concrete, which is a substitute for steel on many - though not all - structures.
• Projects are generally contracted on fixed price basis.
• Schuff’s could attempt a low-ball MBO.  They’ve tried to take this thing private before, once in 2004 and again 2006.  I’m not too worried as I doubt they’d succeed with an offer anywhere near the current quote.  Interestingly, Houlihan Lokey’s fairness opinion declared the 2006 offer to be inadequate.  Houlihan’s midpoint valuation was $21/share, which equates to nearly $35.50 on the current share count.  And again, they repurchased 58.1% of the company on 12/29/11 at an equivalent $30.50 price, declaring that they were “taking advantage of a unique opportunity to enhance stockholder value while demonstrating confidence in the long-term outlook for our business … we believe that the commercial construction market is at or near the bottom”.

By the way, you might think that a company that doesn’t hold conference calls and or even report quarterly results would be unwilling to talk to shareholders.  On the contrary, I’ve found the CFO to be a pretty friendly guy.

www.schuff.com

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