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After a year of spectacular gains, the stock market seems to be taking a breather to kick off the new year. Investors are justifiably cautious after the Nasdaq Composite (NASDAQINDEX: ^IXIC) notched gains of 43% last year. Given those stellar gains, investors are left to wonder i
Steelmaking is a cyclical business, but I believe you can make excess returns investing in steel companies with a cost moat,
strong balance sheet, and low valuation. Enter Ternium (
NYSE:TX
), the leading steelmaker in Mexico and an extremely well-run business headed by Italian billionaire Paolo Rocca. With an $8.8 billion working capital position, a $7.8 billion market cap, and a nearshoring tailwind, I'm bullish on Ternium S.A.
Ternium is a Nearshoring Beneficiary
Companies are moving more and more of their manufacturing production to the Americas. With geopolitical tensions soaring in China and the waters surrounding it, companies want to strengthen and diversify their supply chains, and who can blame them? The last few years have been turbulent. Thus far, Mexico has been a major beneficiary with its low labor costs. As companies continue to build in Mexico, Ternium is there to provide them with steel.
In Ternium’s Q2 earnings call, management and analysts discussed this nearshoring at length. In the auto industry alone, management said that plenty of part manufacturers are moving into Mexico and that Tesla is building a factory in Mexico in a couple of years. A significant investment by Kia is also expected. This is important because auto manufacturers need steel to build factories, equipment, and automobiles. This should create a consistent stream of earnings for Ternium.
Ternium’s stock has risen on the back of strong steel prices, but, in my opinion, the enduring growth of Mexico is not yet priced in. Here are the end markets for Ternium’s steel shipments:
Source: Ternium's August 2023 Investor Presentation
The Commercial segment would be things like infrastructure, construction, manufacturing equipment, pipelines, oil rigs, and renewable energy projects. White goods are appliances like refrigerators, ovens, and washing machines, while HVAC represents heating, ventilation, and air conditioning. These are all things that a developing economy like Mexico will need.
Mexico has just 1/7th the GDP per capita of a country like the United States. So, there’s tons of room for growth. The key word is “tons,” as in tons of steel. Ternium also operates in the following regions:
Source: Ternium's August 2023 Investor Presentation
A Competitor Shutters Its Doors
Another tailwind for Ternium is the shutdown of AHMSA, which closed its operations in late 2022. AHMSA was Mexico’s largest integrated steel plant. One analyst speculated it could take one and a half to four years to get it back up and running after a myriad of internal issues and a January 2023 bankruptcy.
So why does this matter? Because someone has to fill the production hole left by AHMSA, and it’s likely to be Ternium. AHMSA had $2.65 billion in sales in 2021. AHMSA’s bankruptcy is also a testament to Ternium’s moat (competitive advantage), which we’ll discuss next.
The Cost Moat
Ternium claims it is “vertically integrated, from iron ore mines to service centers.” So, it can exert control over the entire manufacturing process, providing itself with some of its own iron ore (a key commodity used to make steel) and delivering its finished goods to customers.
With Ternium’s intelligent management, efficient technology, robust supply chain, strategic positioning, and low costs, the company has maintained about a 22.5% gross margin on average through the cycle (from 2007 to 2023). Competitors Gerdau (
NYSE:GGB
), ArcelorMittal (
NYSE:MT
), and Nucor Corporation (
NYSE:NUE
) had gross margins in the high single digits to mid-teens over the same period.
Ternium has a large market share in Mexico and Argentina, giving it substantial power. The company can also sell its low-cost goods across the border into the United States.
Uptrending Steel Prices, Strong Earnings
Ternium’s free cash flow profile has been pretty strong, with the exception of 2017 (due to a change in working capital). On the net income side, the company has averaged $1.02 billion of earnings from 2013 to 2022. Over that time frame, steel prices have also trended higher, rising from $655/ton at the beginning of 2013 to $744/ton at the end of 2022 and $943/ton now.
Ternium has slightly increased its level of production and long-term assets over that period, so I estimate that the company’s normalized earnings are around $1.1 billion ($5.60 per share). This implies a normalized P/E ratio of 7x versus the current P/E ratio of 24.8x for the S&P 500 (
SPX
).
Headed into Q4 earnings, Ternium should benefit from elevated steel prices. HRC steel prices above $750/ton look sustainable, given the enormous increase in the money supply from 2019 to today.
What About Growth?
Ternium is by no means a fast-growing company. But, it does have the tailwinds of nearshoring in Mexico, the closure of a major competitor’s plant, the construction of its own $2.2 billion plant in Northern Mexico, and rising steel prices.
South America should continue to see its infrastructure and economic output expand over time. Also, over the very long term, the price of steel tends to increase alongside inflation, which is a boon for revenues and profits.
Is TX Stock a Buy, According to Analysts?
After a recent
upgrade from Bank of America (
NYSE:BAC
), all four analysts covering Ternium now give it a Buy rating. The
average TX stock price target is $49.63, implying upside potential of 24.95%. Analyst price targets range from a low of $47.00 per share to a high of $53.00 per share.
The Bottom Line on TX Stock
Ternium SA stock certainly looks undervalued, given its cost moat, strong balance sheet, and nearshoring tailwinds. It may also benefit in the short term as steel prices remain elevated relative to historical levels and a major competitor in Mexico closes down.
Disclosure
Medical devices company InMode (
NASDAQ:INMD
) has fallen out of favor with investors in the past two years for various reasons, which we'll explain below. However,
now that it's down 76% from highs, the stock looks poised for upside. In our opinion, InMode has two major catalysts that could send shares notably higher in the blink of an eye. These two catalysts include the potential for an activist investor to take a stake in the company and push for buybacks or for InMode to finally make an acquisition.
These sound like generic catalysts that can apply to any company, but we'll illustrate why they're important for INMD specifically. Nonetheless, even if these catalysts don't materialize, InMode is still trading at a low valuation and can rise eventually. Therefore, we're bullish on the stock.
What Does InMode Do?
InMode describes itself as a "leading global provider of innovative, minimally-invasive aesthetic and wellness solutions, with strong brand recognition." In simpler words, INMD sells high-tech devices for beauty and health treatments, including procedures like skin tightening. Its clientele primarily includes professionals in the healthcare sector, such as plastic surgeons, dermatologists, gynecologists, and other medical specialists. The company is headquartered in Israel.
As many people are obsessed with how they look (especially due to social media), this is a money-making industry. In fact, the company's net income in the trailing 12 months sits at $180.5 million.
Before Explaining the Catalysts, Here's What You Need to Know
Before diving into what can send INMD stock higher, it's important to learn about why it has been underperforming the market. On top of this, it's key to look at its
flawless balance sheet, as that's what makes the two aforementioned catalysts possible.
Why Has INMD Stock Been Falling?
InMode was loved by the market up until late 2021, as you can see in the chart below. So what happened? Well, the first things that sent INMD lower were rising interest rates and the overall market falling in 2022. But many stocks have recovered since then, while InMode stock hasn't. So, what gives?
First, the company has lowered its guidance in recent months. Prior to October 2023, InMode expected FY2023 to come in at $530-$540 million. This expectation then got lowered to $500-510 million in mid-October, and it got lowered again in December to $485-495 million before getting revised slightly higher to $495-505 million on January 16. EPS guidance was revised lower as well in the past few months. These revisions hurt investors' confidence in management's projections.
On top of this, the Israel-Hamas war added more uncertainty to the stock, as it's headquartered in Israel. Nonetheless, INMD released a statement in October saying that it doesn't expect to be affected by the war. Specifically, InMode stated, "We don't anticipate any interruption to production. Our inventory levels globally and in Israel are sufficient and include components and subassemblies for the next three quarters." Therefore, we're not too worried about this risk.
Next, here's one of the more important points. Investors are frustrated with the company's deliberate decision to not buy back its own shares (you can find this frustration on social media), especially since the stock trades at a low forward P/E ratio of 9.2x based on 2023 estimates (with more earnings growth ahead), and the company has plenty of cash on hand. This brings us to our next point -- InMode's strong balance sheet.
InMode's Balance Sheet is Flawless
InMode has a $675.85 million cash position as of the most recent quarter. This includes cash and cash equivalents, marketable securities, and short-term bank deposits. It also has $0 in debt. InMode's cash pile has been growing over the years as the firm rakes in profits, but management has decided to save this money for a potential acquisition instead of buying back shares.
Now that you know this key information, let's look at the two catalysts that can send InMode higher.
Catalyst #1: Potential Activist Investor Involvement, Share Buybacks
To be clear, we don't know or haven't heard of any activist investors who want to take a large stake in InMode. So, it's not as if the market is expecting activists to get involved. However, given its large cash position and low valuation, it's very possible that INMD stock will catch a large investor's attention.
If this happens and the investor convinces (or forces) the company to buy back its stock, shares will likely spike, as buybacks are what many shareholders are hoping for. For context, InMode's cash position makes up 35% of the company's market cap, meaning that plenty of shares can be repurchased without using debt. This would lower the share count, driving earnings per share (EPS) higher.
Catalyst #2: InMode Finally Makes an Acquisition
As mentioned above, InMode isn't keen on spending its cash unless it finds a company that's good enough to acquire. Acquisitions carry risks, as management teams may overestimate how good the other company is. However, InMode's management is very conservative, so if they do make a purchase eventually, it would likely be a great company that's highly profitable like InMode.
In fact, in May 2023, InMode's CEO stated, "Any company that we will acquire should not dilute the shareholders. It should be accretive and not dilutive. And it's not easy. It's not easy because of the profitability structure of InMode. So we're very careful in the analysis that we're doing on companies that we would like or that we're exploring a possibility to do M&A."
If the company makes an acquisition that's big enough to excite investors, the stock can spike.
Is INMD Stock a Buy, According to Analysts?
On TipRanks, INMD comes in as a Moderate Buy based on three Buys and three Sells assigned in the past three months. The
average INMD stock price target of $30.50 implies 31.2% upside potential.
If you’re wondering which analyst you should follow if you want to buy and sell INMD stock, the most profitable analyst covering the stock (on a one-year timeframe) is
Jeff Johnson of Robert W. Baird, with an average return of 19.6% per rating and a 57% success rate. Click on the image below to learn more.
The Takeaway
InMode is a profitable company trading at a low valuation. Apart from external factors that sent shares lower, investors have simply become frustrated with the company's cash balance, as it keeps growing without being put to use. However, this leaves investors with upside potential, as it's likely that sooner or later, the cash can be used for buybacks or an acquisition. Nevertheless, the stock can rise even if the company's cash balance keeps growing, as its 9.2x forward P/E multiple implies a 10.9% earnings yield.
Disclosure
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