A.M. Castle (CTAM) Stock Analysis

Investment Thesis

I would not invest in A.M. Castle at this time due to high debt, recent bankruptcy, a lack of liquidity, and troubling inability to turn inventory into cash.

What is A.M. Castle?

A.M. Castle (CTAM) is an Oak Brook, Illinois based specialty metals distribution company that serves customers around the world. Founded in 1890, the company has 930 employees and serves customers in the industrial and aerospace sectors. CTAM is currently trading at $3.25 and features an incredibly low average volume of 637. This relatively unfollowed stock has dropped nearly 19% year-to-date.

Industry Outlook

A.M. Castle is in the trading companies and distributors industry. This industry is highly reliant on the industrial production, construction, and the prices of metals such as steel and aluminum. The outlook for industrial production is very positive. The Industrial Production Index is expected to grow at a rate of 1.2% over the next five years. This is good news for CTAM specifically as the industrial sector is one of the company’s core customers. The value of private construction is expected to grow at a rate of 1.7% over the next five years. Consumer confidence is at an eighteen-year high and although it hasn’t benefited new home sales yet it is expected to benefit the industry moving forward. An increase in new homes means more demand for the metals that a company like A.M. Castle distributes.

A macro-economic event that could affect the distribution industry is the tariffs on imports of steel and aluminum. These tariffs will affect the price of metals being imported into the United States and increase the expenses of the metals distributors.

A.M. Castle’s Strengths

As a company that has been around for 130 years it is not surprising that A.M. Castle has many strengths. These strengths start with the CEO, Steve Scheinkman, who started with A.M. Castle in 2015. Since his arrival, the company has gone from negative $209.8 million in net income to making a profit in 2017 with earnings of $22.9 million. Scheinkman has been in the specialty metals industry since 1986 and he has been an executive at five different companies. This experience certainly gives Scheinkman an edge in tackling some of CTAM’s biggest problems which will be discussed later. Since taking over as CEO, Scheinkman has ended A.M. Castle’s dealings in the energy sector. This aligns with his strategy of simplifying operations at CTAM in order to be more efficient. Another example of this simplification of operations is the number of employees at A.M. Castle. When Scheinkman took over there were nearly 1,700 employees and now that number has decreased down to 930. This is yet another example of an attempt to decrease costs and increase efficiency. This efficiency is proven effective in the company’s financial statement which shows decreasing revenue over the last three years but increasing earnings.

Another strength of A.M. Castle is their strong national and global reach. The company features 23 distribution offices around the world including 17 in North America. In the specialty metals distribution business, most of a company’s customers are located within a 200-mile radius of the wholesaler who is supplying them. By having many offices across the entirety of the United States, CTAM is able to reach a broad range of customers and minimize turnaround time when fulfilling an order.

A.M. Castle also has very strong relationships with U.S. steel producers while many other distributors rely on imports of steel and aluminum. These relationships could prove very beneficial for CTAM moving forward if the trade war with China persists. While other distributors are importing steel and paying higher prices, A.M. Castle will be minimizing costs by purchasing steel from within the U.S. due to its strong relationships with domestic steel suppliers.

A.M. Castle’s Weaknesses

It can be seen in the 2017 annual report that A.M. Castle is facing litigation concerning contract disputes, personal injury, environmental health and safety, employee benefits, and taxes. Litigation can be extremely detrimental to a company, especially one like A.M. Castle whose best chance of growth is through acquisition. Ongoing litigation is a big negative to any company that is considering acquiring A.M. Castle.

In 2017 A.M. Castle filed for bankruptcy. This in of itself scares me away from the stock as it proves the lack of stability in the company. It also attributes to the fact that 80% of the company’s shares are held by management or large institutional positions. This is most likely the case because the company received shares as a part of the bankruptcy settlement.

Another weakness of this stock is its lack of liquidity. It is traded on the OTC and it has extremely low average volume. This is another factor that makes the stock extremely risky because it can change significantly off one large trade. It also limits the possibilities of stock buy backs that would boost the stock’s value because the amount a company can buy back is based on its recent volume.

There is also a red flag when looking at the company’s current assets. Yes, A.M. Castle has a very strong current ratio (current assets/current liabilities) when compared to its peers, but upon further review the level of current assets may not be as positive as one may think. The June 30, 2018 balance sheet shows that inventory and receivables have both increased while cash has decreased. This signals that there may be an issue regarding collection or an instance of obsolete inventory.

The biggest weakness of all, however, is the enormous amount of debt that A.M. Castle is facing. The company currently faces long-term debt of $199.9 million and this leads to a debt ratio of 6.06 which is well over the industry average of 2.0. The high level of long-term debt is a struggle that is very difficult to overcome as this debt features high interest rates which use up the majority of the company’s cash. The silver lining to A.M. Castle’s debt problem is that it has been decreasing steadily ever since Scheinkman has taken over as CEO.

Acquisition Opportunities

A.M. Castle certainly has some strengths such as its broad global reach, strong CEO, and good relationship with U.S. steel suppliers that make it attractive to M&A. However, these strengths are currently outweighed by its significant weaknesses which are what is in the way of A.M. Castle being acquired by a larger player in the metals distribution industry. High debt and litigation risk are very unattractive to any company considering acquiring A.M. Castle. In order to be considered as a candidate for M&A, A.M. Castle will need to solve its debt problem and get past the current litigation. If they are able to do this there are many suitable candidates who could potentially acquire the company. An example is Reliance Steel (RS) who has strong financial standing and limited global or even national reach. As a company that only does business in California they could benefit from A.M. Castle’s global presence. Another good acquirer could be Ryerson Holding Corporation (RYI). Ryerson has great coverage of North America and China but has no distribution centers in Europe. By acquiring A.M. Castle they would be adding three new distribution centers in Europe.

Conclusion 

If A.M. Castle can significantly decrease their debt, continue to recover from the recent bankruptcy, and come out of the current litigation threats relatively unscathed the company has many strengths that would appear very attractive to acquirers. These strengths are currently being covered up by extremely high debt but CEO Steve Scheinkman is trying to dig the company out of the hole it is in. I believe that Scheinkman will fix the company’s debt problem as he has already erased more than a third of the debt that he inherited in 2015. However, until this problem is solved and A.M. Castle’s debt ratio gets closer to the industry average of 2.0 I do not believe that this will be a good investment. Once the debt ratio is closer to 2.0 I feel that A.M. Castle will be a very interesting acquisition option for many of the players in the metal distribution industry and I think the company could see significant growth. Until then I will be sitting on the sideline and keeping a close eye on the company’s debt ratio.

CTAM

 

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