Pipe manufacturing stock Russel Metals goes fiberglass

“Fools rush in where wise men never go.” Johnny Mercer wrote those original lyrics for the popular song in 1940. But Mr. Mercer had love in mind—not money. And while investors are fleeing the energy patch, pipe manufacturing stock Russel Metals moves in to make an acquisition in the sector.

While investors are fleeing the energy sector, Russel Metals Inc. (TSX─RUS) continues to invest in the oil patch. The company’s latest acquisition is Western Fiberglass Pipe Sales. Western is a leading distributor of fiberglass down hole tubing casing, facility pipe and line pipe within the oil and gas industry servicing Western Canada. The acquired company has had annual revenues of $30 million. Fiberglass is becoming a popular alternative to certain steel applications in the oil and gas industry because it requires less maintenance and it has low installation costs, improved capacity and a long service life.

Russel Metals is one of the largest metals distribution companies in North America. The company carries on business in three metals distribution segments: metals service centers, energy products and steel distributors under many names including Russel Metals, A.J. Forsyth and Acier Leroux. The metals service centers carry a broad line of metal products; the energy products segment distributes oil and gas industry tubular goods, line pipe, tubes, valves and fittings; and the steel distributors sell steel in large volumes.

Weakness in the metals service centers and energy products businesses caused profits to fall in the first quarter. For the three months ended March 31, 2015, Russel made $19 million, or $0.30 a share, compared with $29 million, or $0.47 a share, in the same period of 2014. Revenues fell 2.2 per cent to $904 million.

Earnings were adversely impacted by the drop in oil prices which resulted in a decrease in revenues in the energy products segment. Operating profits at the metals service centers, meanwhile, were adversely impacted by declining steel prices, which put pressure on gross margins.

The dividend payout ratio is likely to exceed 100 per cent in 2015. Nonetheless, we view the dividend as sustainable for now in view of Russel’s strong balance sheet. Debt is just 32 per cent of the company’s capital structure. That’s less than the rule of thumb that says total debt should not exceed one-third of total capital.

Difficult business conditions in the sectors in which Russel operates should continue in the near term. The company’s oil and gas industry customers have reduced capital spending in response to low oil prices. Plus, excess inventories in the industry, mainly related to imports, have put continued downward pressure on steel prices. The upside to this is that Russel’s strong balance sheet will let it take advantage of acquisition opportunities that arise. In the meantime, the company is ready for sustained low oil prices, and it should profit handsomely when a recovery begins.

The shares have recently traded around 16.8 times Russel’s projected 2015 earnings of $1.26 a share, which is not unreasonable especially since these earnings are at a depressed level. The current annual dividend of $1.52 yields 7.1 per cent. Russel Metals is a buy for growth and income.

 

Money Reporter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846

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