Algoma Steel Group Inc. (ASTL)
Summary of both the warrants and common stock valuation of Algoma Steel Group Inc.
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Today’s write up will cover the investment merits of Algoma Steel Group common stock and warrants. To begin let’s review the company's history as presented by Wikipedia.
Algoma Steel Inc. (formelry Algoma Steel; Essar Steel Algoma) is an integrated primary steel producer located on the St. Mary’s River in Sault Ste. Marie, Ontario, Canada. Its product is sold in Canada and the United States as well as overseas. Algoma Steel was founded in 1902 by Francis Clergue, an American entrepreneur who had settled in Sault Ste. Marie. The company emerged from bankruptcy protection in 2004. In April 2007, Algoma Steel was purchased by India’s Essar Group for US $1.63 billion, continuing operations as a subsidiary known as Essar Steel Algoma Inc. It was purchased again in 2017, by a group of US investors.
In May 2021, it was announced that Algoma “was to become a public company again” as it had agreed to a merger with New York-based acquisition firm Legato Merger Corp, which is a NASDAQ-listed special purpose acquisition company. The deal would give Algoma just over $1.1 billion worth of new shares in Legato.
Now delving into the balance sheet we find the following. As of June 30th 2022 Algoma had just over $1.1 billion of cash against a market cap of only $1 billion. Bank indebtedness is a mere 3 mm with long term government loans totaling another 85 mm. Of course steel production being a very capital intensive business, the company's total liabilities come to $1.6 billion after including accounts payable, pension liabilities, environmental liabilities and other expenses. Combined, both the assets and liabilities bring Algoma’s enterprise value to about $3 billion.
Regarding bank indebtedness, Algoma secured a revolving credit facility for $250 mm of which only $3 mm had been drawn at the time of this writing. This gives the company an extensive ability to draw cash should the need arise.
For all of the company's balance sheet strength, its income statement is very difficult to predict from quarter to quarter. From the time of the 2021 SPAC through today, the company has seen record high profits owing to record high steel prices and manageable input costs. Over the last decade, hot rolled coil steel prices have ranged from $500 on the low end, up to the mid $800’s at market highs. Post COVID, prices exploded upwards to exceed $1,900 and have now drifted back into the, still historically high, $700 range. With key inputs such as iron ore, natural gas, and others at elevated and unpredictable levels, I’d place the company's future profits somewhere between unpredictable and unknowable, leaving us to consider how well management will navigate these volatile markets and how they’ll return cash to shareholders.
As it stands today, Algoma trades at just over one times earning with earnings of nearly $1 billion against a market cap just over that number. Again, however, unpredictable input prices and finished steel prices make the future anybody’s guess. Market consensus would lead you to believe that the steel industry as a whole is a falling knife with many of the world's major producers trading at low single digit multiples which is typical of a cyclical industry peak.
To date, management's track record is solid but short lived with the CEO having been in the seat for about one year. On March 3, 2022 the company commenced a normal course issuer bid (NCIB), or what seems to be Canada’s version of a Dutch Tender Offer. The final result of the bid saw the company repurchase a staggering 31% of its stock bringing the common share count down from 147 mm to 100 mm shares. The company's huge cash position stated earlier is post share repurchase, making the balance even more impressive. Currently, the company is authorized to repurchase another 7 mm shares of its common stock which would shrink the total share base by another 7% once completed.
Beyond what appears to be quality management, Algoma has another tailwind. The plant currently consists of aging high emission and costly blast furnace steel production, but the company has plans to convert to modernized electric arc furnace (EAF) steel production over the next several years. The first benefit of this plan is in the form of Canadian government subsidies which will finance a significant portion of the upgrade so long as Algoma hits its reduced carbon emission targets in the coming years.
A second benefit of the EAF conversion comes in the form of reduced carbon penalties charged to Algoma Steel. EAF steel production is less carbon intensive and will therefore incur fewer carbon penalty taxes as the company transitions from outdated blast furnaces to modernized EAF production. Most North American steel companies have already converted to EAF production, meaning they don’t have the same cost savings benefit ahead of them in the coming years.
Now with that background out of the way, how can an investor best position themselves in Algoma Steel? For starters, the company already offers the benefits mentioned above, namely cash equal to market cap, a 30-40% share repurchase in 2022 alone, and no debt to speak of. As with any IPO, SPAC, or other going public event however some unique considerations apply.
For starters there is a share overhang that could put a cap on the stock price for some time, Bain Capitol, Goldentree, Contrarian Capital, and others all hold significant positions in the company as a result of the restructuring and SPAC. The institutional shareholders have a lockup price by which they can’t sell their pre-SPAC shares until they trade above $12.50 for a set period of time. That said if and when the shares reach that level, the selling pressure from those institutions may keep the price in the $12-$13 dollar range for some time.
A second technical quirk surrounding the stock price is the call price of ASTL warrants. As part of the SPAC, the company issued warrants with a strike price of $11.50. The publicly traded warrants are good for five years post SPAC and expire on 19 Oct 2026. The warrants are callable when the common stock of the company trades at $18.00. The private warrants, issued pre-SPAC, are also have an $11.50 strike price but can’t be called and are good for as long as they’re held by the original owner.
Given the information just covered, I suspect that one way or another the institutional investors will get a return on their investment. This will happen either through dividends, special dividends, or the sale of common stock above the $12.50 lockup price. Sales of privately held warrants at or above $12.50 would also yield a profit for institutional investors.
Given the large institutional shareholder base, warrant strike price, and pre-spac share lockup price what is the best way for the average investor to take advantage of this super cheap stock? At todays price of $9.63 on the common and $1.92 on the warrants, I’d rather own the common.
At these prices, the common stock is more appealing for several reasons. First, it has no expiration date, so that even if you’re wrong on the value of the company today, you can wait as long as you want to recover your capital. Second, you can collect dividends on the stock for as long as you hold it while warrant holders do not receive dividends. Third, your upside in the stock is not capped at $18.00 per share as it is with the warrants. And finally, your upside from the mid nines up to a mid twelve dollar range offers more upside than do the warrants at the current price.
On the other hand, if the warrants sold cheaply enough they could be a more compelling investment than the common shares. This would be the case if the warrants sold for less than $1 per share. In my opinion, the warrant price is less likely to decline to any such low given that the person selling the warrant is probably more informed than whoever is selling the common stock and you’re less likely to get panic selling or irrational selling from a sophisticated investor.
In any case, the warrants at less than $1 would be attractive because you could still exercise at $11.50 and sell at a profit around $12.50 where the institutional shareholder overhang kicks in. Two additional factors make the warrants appealing with the first being their duration. At five years the warrants are good for much longer than even the longest dated LEAPS and a lot can happen in five years. Second, even with an $18 call provision on the warrants the holder of the warrant can make several multiples of his investment even at the current sub $2 price.
Well that’s all I have for today's write up. I hope we’ve made you aware of one of the cheaper companies available today along with a rare warrant opportunity that will broaden your investment possibilities. Hopefully the gap between episodes won’t be as long this time as it was last week as I was up against multiple unforeseen events that kept me from publishing a new episode. Once again, thank you for listening and we’ll see you again soon.