Description

WHEELING - PITTSBURGH CORPORATION: BUY
(Ticker: WPSC; Recent Price: $25.92; Market Cap: $259.2 mm)

Wheeling-Pittsburgh (WPSC), which emerged from Chapter 11 in August 2003, is the sixth largest integrated producer of steel in the United States. WPSC is in the process of transforming itself from a traditional integrated producer to a “hybrid” producer through the construction of a mini-mill (EAF or electric arc furnace) that will replace one of the Company’s blast furnace operations in the first half of 2005. The introduction of the mini-mill will (i) increase WPSC’s overall production capacity, (ii) enable the Company to sell excess coke, and (iii) provide flexibility to optimize raw material costs – e.g. provide the ability to switch to scrap as a raw material when iron ore costs are high and vice versa. The recent S-1 for WPSC gives an excellent overview of the Company.

Based on extremely positive fundamentals for the steel industry and WPSC’s low valuation (it currently trades at 3.7x EBITDA and 3.2x net income using CY2004 projections), we recommend purchase of the shares. We believe a $35.00 to $40.00 share price target is reasonable based on comparable company trading levels and the possibility of an acquisition of the company.

Macro Thesis

As we emphasized with a recent write-up on Bayou Steel (BYUA), the economic environment for steel producers continues to be strong with steel prices continuing to increase through August. Many points are worth repeating, and it is worth emphasizing that most public steel producers have commented that second half results will continue to be solid. A number of factors support this environment continuing into 2005:

1. The U.S. economy is relatively strong – capital goods orders, industrial production and non-residential construction all have positive outlooks.
2. Chinese demand continues to be robust – this demand is not going to go away overnight. In addition, efforts by the Chinese to limit investment in the steel sector may tighten steel supply in the short run.
3. A weaker dollar (relative to 1999 and 2000) should shield the U.S. industry from imports.
4. High shipping costs should also shield the U.S. industry from imports.
5. Inventories are at (near) record low levels.
6. U.S. steel-making capacity is still well below recent (2000) highs.


Micro Thesis

Given the macro environment, WPSC remains undervalued despite huge increases in earnings. Our model incorporates WPSC’s results for the second quarter with adjustments to project full-year 2004 results. The model is summarized below:

Wheeling-Pittsburgh Steel Model

Ann. Calendar
1Q04A 2Q04A 2Q04 3Q04E 4Q04E 2004E
Revenues $274,206 $356,121 $1,424,484 $409,539 $409,539 $1,449,405
% growth 29.9% 15% 0%

COGS 256,069 292,820 1,171,280 339,820 339,820 1,228,529
% growth 14.4% 16% 0%

Gross Margin 18,137 63,301 253,204 69,719 69,719 220,876 % margin 7% 18% 18% 17% 17% 15%

SG&A 14,946 16,349 65,396 16,349 16,349 63,993

Depreciation 7,689 7,512 30,048 7,601 7,601 30,402

Op Inc (4,498) 39,440 157,760 45,770 45,770 126,481

EBITDA 3,191 46,952 187,808 53,370 53,370 156,883

Interest Expense 5,219 5,058 20,232 5,058 5,058 20,393
Other Income 3,012 4,653 18,612 5,000 5,000 17,665

Income before Tax (6,705) 39,035 156,140 45,712 45,712 123,753

Taxes (79) 11,997 47,988 15,999 15,999 43,916

Net Income (6,626) 27,038 108,152 29,713 29,713 79,837

Shares O/S 9,500 9,684 9,684 10,000 10,000 9,829
EPS -$0.70 $2.79 $11.17 $2.97 $2.97 $8.12


Assumptions

Revenue: 15% q-o-q Q3 growth (per mgmt comments); Q4 equal to Q3
COGS: $47 million increase in Q3 (per mgmt comments); Q4 equal to Q3
SG&A and Interest: Q3 and Q4 equal to Q2
Depreciation: Q3 and Q4 equal to the average of Q1 and Q2
Other Income: $5 million Q3 and Q4
Tax Rate: 35% in Q3 and Q4


EV:259,200 = mkt cap (10,000 shares at $25.92)
104,767 = cash (incl. value of affiliates(1); excludes restricted cash)
422,645 = debt
$577,078 = EV


Valuation 2004E
EV/EBITDA 3.7x
P/E 3.2x


Notes

1. We have valued WPSC’s JV affiliates, which contributed $4,248 in equity income in Q204, at approximately $100 million using a 6x valuation of 2004 income. We believe this multiple is conservative since the JV’s have been relatively stable earnings generators.

Valuation

The below chart displays trading multiples for comparable companies:

Comparable Company Valuation Analysis
EV/
P/E EBITDA
Ticker 2004 2004 Note

AKS 6.2x 3.9x integrated
ISG 6.3x 5.0x integrated
NUE 7.2x 3.7x mini-mill
OS 4.1x 3.0x integrated
SCHN 8.7x 5.4x mini-mill
STLD 6.2x 3.5x mini-mill
X 5.9x 3.9x integrated

Average 6.4x 4.1x

Integrated Avg 5.6x 4.0x
Mini-Mill Avg 7.4x 4.2x

Source: First Call


Valuation Target
EV/
P/E EBITDA
2004 2004

Valuation Multiple 6.4x 4.1x

WPSC EPS/EBITDA $8.12 $156,883

WPSC Target $51.82 $31.88

Average $41.85


Blending implied valuations using peer group multiples results in a $41.85 implied valuation. As a result, a price target of $35.00 to $40.00 per share is very reasonable and makes for a potential gain of 35% to 54% from current levels.

Potential Upside

1. A take-out. One of the larger steel companies may seek to acquire WPSC in order to broaden its manufacturing and customer base and improve logistics. WPSC’s low P/E multiple makes an accretive transaction possible at a much higher price. In addition, WPSC’s new EAF facility and excess coke production capability are likely to be sought after by potential buyers such as ISG, which is short coke.
2. Based on the current pricing environment and due to the excess production capacity and potential coke sales in 2005, WPSC could potentially produce EBITDA of $250 - $300 million creating a 1.9x - 2.5x EV/EBITDA multiple.

Potential Downside

1. Demand for steel slows down and steel prices fall.
2. Announced 3.5 million share follow-on offering may create selling pressure.

Catalysts

1. Publication of strong third quarter results.
2. In 2005, results from EAF mini-mill operation operations and sales of excess coke should drive significant EBITDA and earnings gains.

The Bottom Line

WPSC is a cheap steel producer that should continue to perform well in a decent economy in which steel prices are firm. The Company offers upside from its new mini-mill operations and the possibility of a take-over given continued consolidation in the steel industry. As a hedge against weaker steel prices, a short of one of the more widely followed producers (X or ISG) may make more sense.

Catalyst

1. Publication of strong third quarter results.
2. In 2005, results from EAF operations and sales of excess coke.