Ternium S.A.

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

Ternium is a leading steel producer in the Americas, providing advanced steel products to a wide range of manufacturing industries, and also operates in the mining of iron ore.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview and Competitive Landscape

Ternium S.A. (TX) operates within the global steel industry, a sector characterized by cyclical demand and competition from both domestic and international players. Here’s a breakdown:

  • Geographic Reach: Ternium primarily serves the Americas, with a strong presence in Mexico and South America. Mexico contributed around 48% to the consolidated sales, followed by Southern region and Brazil.

The focus on the Americas allows the company to capitalize on regional demand and minimizes global volatility. However it leaves it very reliant on the economies in those regions

  • Product Diversity: The company produces a wide range of steel products from flat steel to long steel used for infrastructure to automotive industry, and also has significant operations for production of iron ore in mines.

Offering a variety of steel products helps protect Ternium from the impact of fluctuations in demand for any particular kind of steel. The recent increased focus in value-added products should give a boost to revenues and margin.

  • Integrated Operations: Ternium is vertically integrated through its steel and iron ore operations, which gives them more control on prices for raw materials. It has significant focus on low carbon practices in its steel production facilities.
  • Competitive Landscape: The steel industry is highly competitive. Competition is coming from global producers and from domestic steelmakers in the different markets. The industry also is seeing a consolidation of players.

The steel market is cyclical and competition intensifies in downturns. The rising interest rates, inflation and any volatility in the market due to political or economical issues, can affect prices which in turn affects profits and performance of Ternium.

  • What Sets Ternium Apart? Ternium benefits from low cost operations and integrated business model. Its presence in Mexico with low labor costs, also offers considerable advantage. It also is focusing more on long term sustainable practices to lower emissions and cost which will provide a big advantage in the long run.

Ternium also continues to be a large producer of value-added products, rather than commodity steel, meaning margins can be a little more predictable than those who solely focus on commodity steel.

  • Major Trend: There is increasing usage of scrap metal in steel production as companies are focusing on lowering carbon footprint. The company is currently implementing processes for a transition to a more sustainable way of steel making.
  • Industry Issues: Global steel prices are currently volatile, due to fluctuations in input costs (such as energy and scrap), and demand issues.

Supply chain issues could create instability as demand shifts rapidly during short time periods. Trade barriers are also a concern.

Moat Analysis

Ternium’s moat, while present, isn’t exceptionally wide, earning it a 3/5 rating. Here’s the rationale:

  • Limited Intangible Assets: While Ternium has a strong regional brand, it lacks significant global brand recognition and its business has a reliance on contracts with a set of customers. This implies it does not create a deep connection with customers.
  • Switching Costs: Switching costs in the steel industry are not very high as there isn’t any special lock-in feature to switching a supplier which makes it hard for companies to demand higher prices compared to their peers.

Customer loyalty can weaken if other competitors can offer similarly good products at better prices.

  • Moderate Cost Advantages: While integrated operations and large plants in Mexico could lead to some cost advantages, especially when compared to American companies, these are not unique enough to create large, durable moats, because these can be replicated. However, access to low cost energy, skilled workforce in the Latin American market and better energy mix can contribute to lower costs in the long run.

These scale advantages are susceptible to new companies coming into the sector who have similar setup.

  • Some Barriers to Entry: The regulatory processes that are needed to be followed for setting up of new iron ore mining and steel production plant, makes it harder for new competitors to enter the market. Also, the large investment in heavy assets such as mining equipment and steel facilities, creates a barrier to entry.

Regulations and changes in government policies especially related to China, could significantly affect the moat.

  • A Trend Towards Mini Mills: Mini mills are becoming increasingly common as they offer more flexibility to changing demand. The company needs to look at more investments on higher value steel or processes to mitigate this risk.
  • Overall: While Ternium does have some competitive advantages from its operations, it isn’t enough to guarantee a wide and defensible moat. The industry is cyclical and commodity oriented.

The focus on sustainability and low carbon practices can provide a boost to it’s moat in the coming years.

### Risks to the Moat and Business Resilience Ternium faces several legitimate risks that could erode its moat and impact its resilience: *   **Commodity Price Volatility:** Steel prices are highly volatile and dependent on supply, demand, and geopolitical factors. Fluctuations can harm Ternium’s profitability, because the company might not be able to pass the increased input prices to customers.

Input costs for steel like iron ore, and energy are also highly volatile and can have a negative impact on the earnings if the market price for the finished goods decline.

  • Cyclicality of Steel Demand: The steel industry is tied to economic cycles and is heavily dependent on economic conditions, such as industrial production, construction, and infrastructure investments. Any slowdown in growth could reduce the demand of steel and consequently affect the earnings and cash flow of the business.
  • Competition: The steel industry is very competitive with major players and regional ones operating across the globe. Increased competition could lead to price wars, eroding margins, and impacting profitability. The rise of Chinese and other cheap steel producers will create additional headwinds.
  • Technological Disruption: While the company is slowly adopting low carbon and other technologies for improved sustainability, there is risk of competitors implementing those processes before them or implementing processes that have more positive outcomes for the company and the environment.

The transition to new technology takes time and is costly. If the price for new technology and production process becomes higher it could harm profitability.

  • Global Economic Uncertainty: Geopolitical unrest or macro-economic downturns could affect demand for steel products, especially in a globalized world and the Latin American regions where the company primarily operates. High inflation could also affect growth projections.
  • Regulatory and Trade Barriers: Changes in trade policies, increased tariffs, or regulatory changes regarding environment could affect imports and exports, and affect the costs of production as a result, reducing prices, reducing profit margins.

The Argentinian operations were hugely affected in the past and may be again, due to foreign currency restrictions.

  • Cost Inflation: The company faces pressure from increase in production costs for its steel and mining business, such as raw materials, fuel, logistics, labor, and other expenses, putting pressure on profit margins, in case they can’t be passed on.

Despite these risks, the company has shown some resilience:

  • Diversification A significant benefit of Ternium lies in its geographic diversification, limiting the exposure to the economic issues within a certain area. The recent increased focus in value-added products should allow it to manage downturns better compared to pure commodity steel companies.
  • Financial Prudence: It has reduced its net debt levels over the last year, and has sufficient cash on hand to be able to manoeuvre through difficult market times.

Financial Analysis

Here’s an analysis of Ternium’s financials, focusing on recent performance:

  • Q3 2024 Highlights
    • Shipments up 4.1 million tons (up 3% sequentially and up 7% year over year)
    • Adjusted EBITDA was 368 million with 8% margin (decreased from 13% in Q2)
    • Adjusted Net Income 93 Million dollars
    • Cash generated by operating activities $303 Million
    • Free cash flow was $1.7 million (decreased from $514 million sequentially)
    • Interim Dividend Payment of $0.80 per ADS.

The company is seeing higher shipments volumes, but the decrease in profits and margins shows that the volatility in the industry is playing a significant role, specially due to low market prices of steel and higher input costs.

  • Revenue: Net sales in Q3 2024 increased 7% year-over-year to 4.1 Billion USD, but decreased from 4.5 Billion in Q2. Revenues are mainly driven by shipments of steel products, and a minor percentage by iron ore shipments. Steel prices have been extremely volatile recently and a large reduction in prices led to the fall in the revenue figures.

The trend of selling higher value products instead of commodity products, could lead to better profit margins.

  • Profitability: The company had an adjusted EBITDA of 368 million for Q3 with a margin of 8%, a big fall from Q2 where EBITDA stood at 602 million. The margins have taken a hit recently due to falling steel prices and elevated input costs. The decrease in average selling prices and increasing unit costs of production in Mexico and Southern Region have been the primary drivers for the decreased profits.

Operating expenses tend to be relatively stable while the prices are volatile, putting significant pressure on margins in difficult economic times.

  • Free Cash Flow: Cash generated from operating activities in Q3 2024 was $303 million, with free cash flow of $1.7 million. The company intends to keep a strong balance sheet by maintaining its liquidity position and expects to finance major strategic projects without impacting its creditworthiness.
  • Debt: Ternium has a comfortable debt profile. Net debt was 1.2 Billion USD with a leverage ratio (net financial debt to adjusted EBITDA) at 0.77. Debt is primarily in USD and is held by a number of different entities. Its debt is not considered a key concern, because the leverage is manageable and is under control.
  • Financials (General): * The company has a well-established accounting procedure that is in line with the IFRS, making it reliable for valuations.

The management tries to focus on long-term investments and profitability, but are pragmatic in taking steps to ensure they perform well in the near term. * The company has shown an ability to recover quickly from large downturns that have previously been seen in the industry. The company tends to quickly cut production costs and optimize its processes when facing downturns.

  • Capital allocation: Ternium plans to invest in low-emission steel making technologies to meet its sustainability goals, and maintain a strong balance sheet. The company also is focusing on new investments in the steel industry, as they expect it to grow strongly in the coming years.

Understandability

Ternium’s business, while operating in a well-established sector, has nuances that make it somewhat complicated, giving it a rating of 3/5 for understandability:

  • Industry Complexity: The steel industry is subject to a variety of external factors. Fluctuations in the global economy, commodity price volatility, changes in government policies, trade barriers and so on, affects the price, production and profitability. Investors need to be aware of all these aspects, and it takes some time and study to grasp the dynamics of the steel industry.
  • Geographic Scope: With the company having production facilities all across the Americas, the political and economic situations in different regions makes it complex to manage from afar. It becomes difficult to assess the impact of political risk on the different locations.
  • Vertical Integration: The company is involved in both mining and steel production, which requires understanding different aspects of the industry and puts it in a unique position where some aspects are independent and some are not, making it a complex situation.
  • Financial complexity: the financial statements have a lot of items that are added and removed during different processes to arrive at a meaningful number for profit or earnings. This might be a little hard for new investors to grasp, especially since the IFRS standards applied by the company can be difficult.

Balance Sheet Health

Ternium’s balance sheet is reasonably healthy, earning it a 4/5 rating:

  • Cash Balance: The company has a solid cash balance and enough liquidity. It has almost 1.7 billion in cash.
  • Debt: Total debt is low and easily manageable, with a leverage ratio of 0.77. The net debt has also been on a declining trend for the last few quarters and was 1.2 billion dollars in Q3 2024. The credit rating is at investment grade.
  • Assets: There is significant investment in the recent past into mining operations, new technology, expansion and modernization, these investments may be able to pay for themselves in the future.
  • Liabilities: Liabilities are managed efficiently with most liabilities being short term payables. The long term liabilities, are in line with what is expected. There are minimal long term commitments in off balance items.

Recent Concerns/Controversies and Management Response

The recent concerns are mainly around:

  • Falling Steel prices: The steel prices and prices for raw materials like iron ore are volatile at the moment and they fell significantly during the last few months, which in turn has reduced the company’s revenues. The company has also seen its operational expenses increase, putting more pressure on its profit margins.

Management states that they are carefully watching the market to make the best use of their capital. They are focused on maintaining a strong financial position. They also expect to see steel prices rebound as the inventory levels drop and construction activities ramp up.

  • Regional uncertainties: The company’s performance is tied closely with the economies in which it operates such as Argentina. The recent political turmoil and uncertainty in Argentine and other South American countries creates potential risks for the company’s financials and operations.

The management has stated that they expect these headwinds to die out, and they are focused on managing what is controllable and focus on their long term strategy.

  • High Capital Expenditure : The company has invested a high amount of capital in new facilities and modernisation. It is important to monitor the outcome of these investments, and if the returns from those investments are sufficient to cover for the huge costs.

Management expects these investments to be crucial in improving efficiency and production capacity for the company, thus driving value for shareholders in the long run.

  • Environmental Regulations: Governments in many countries are becoming increasingly focused on reducing emissions. Meeting those regulations will require investments. Also any trade restrictions imposed for companies based on their environmental record can affect the ability of the company to trade in that market.

Management views their investment in new technologies such as carbon capture, and a new energy matrix as important steps to reducing their environmental impact and staying compliant.

In general the management is doing what it can to mitigate all the risks, and is working on strengthening its operational efficiencies and financial health.

Conclusion

Ternium is a company that operates in a cyclical and intensely competitive market, and it is actively working to grow and streamline operations. Investors should monitor how the company manages costs, its growth plans, its strategic acquisitions, the economic health of the South American region, and the effects of the new technologies it is putting into practice to enhance its economic moat.