This post has been excerpted from a letter by Chip Rewey, Lead Portfolio Manager of the Third Avenue Value Fund.
Founded in the late 1930s, Reliance Steel & Aluminum (“Reliance”) has grown to become the largest metals service center in North America. Given the name of the company, one could be forgiven for thinking the company produces steel and aluminum. In actuality, as an operator of service centers, Reliance’s business is providing essential value-added services and distribution for these metals, as well as brass, copper, titanium and other alloys, with more than 100,000 products offered. A few examples of the value-added services Reliance provides are slitting, laser cutting and electropolishing. The company operates a network of more than 300 locations across almost 40 states in the U.S. and a dozen countries.
Reliance has been on our radar for years during which time we’ve had the chance to meet with management and tour its operations. After a decline in its stock price this year, we took advantage of the opportunity to initiate an investment with a belief that the company is very well-positioned to continue its profitable growth, both organically and inorganically. As the domestic and global economy grows over the long term, the need for metal products is ever-increasing, and Reliance has carved out a defendable niche for itself serving this demand. Specifically, Reliance focuses on smaller customers with relatively small orders that need the company’s high-quality products quickly (40% of orders are delivered the next day). Taken together, this affords Reliance sticky customer relationships (97% repeat business) with superior margins and pricing, regardless of underlying metal prices. As Reliance’s share of its market is still only in the single-digits, the company should continue growing both with the industry and also through ongoing share gains. Reliance has been able to steadily capture market share over its history given the breadth of its products and services, its buying power and operational efficiency, and the exceptional quality of its products and customer service. Another notable competitive advantage is Reliance’s strong balance sheet, with net debt of approximately 30% of capital, 2.2x EBITDA, and strong cash flows for deleveraging. In an industry with a number of poorly capitalized peers, Reliance’s financial position has given rise to lasting partnerships with its suppliers and customers and is tied to the quality of its products as it has allowed Reliance the ability to make industry-leading investments in state-of-the-art equipment.
The balance sheet is also a reflection of the high quality of Reliance’s management team. In addition to being judicious financiers, the long-tenured team has proven to be exceptional operators and capital allocators, having completed more than 60 acquisitions since taking the company public in 1994. This has brought about the Reliance “Family of Companies,” as management insists on acquisition targets with strong leadership teams and brands that it can keep in place. Reliance is now becoming the recognized acquirer of choice in the industry and this has helped management deliver an outstanding long-term track record, with the company’s retained earnings and dividends compounding at 12%, 16%, and 20% per share over the last 5, 10 and 15 years, respectively. Given the still very fragmented nature of the industry, we expect resource conversion will remain a persistent source of value creation for management over the longer term.
We were able to purchase Reliance common stock at a discount of roughly 30% to our estimate of NAV. Over the medium term we see the improving economy and renewed push for investments in infrastructure within the US as potentially offering a tailwind to demand for Reliance’s products and services. Over the long term as Reliance continues growing, we expect ongoing compounding in the value of the company and a closing of the discount to our NAV estimate.
This publication does not constitute an offer or solicitation of any transaction in any securities. Any recommendation contained herein may not be suitable for all investors. Information contained in this publication has been obtained from sources we believe to be reliable, but cannot be guaranteed.
The information in this portfolio manager letter represents the opinions of the portfolio manager(s) and is not intended to be a forecast of future events, a guarantee of future results or investment advice. Views expressed are those of the portfolio manager(s) and may differ from those of other portfolio managers or of the firm as a whole. Also, please note that any discussion of the Fund’s holdings, the Fund’s performance, and the portfolio manager(s) views are as of June 30, 2017 (except as otherwise stated), and are subject to change without notice. Certain information contained in this letter constitutes “forward-looking statements,” which can be identified by the use of forward-looking terminology such as “may,” “will,” “should,” “expect,” “anticipate,” “project,” “estimate,” “intend,” “continue” or “believe,” or the negatives thereof (such as “may not,” “should not,” “are not expected to,” etc.) or other variations thereon or comparable terminology. Due to various risks and uncertainties, actual events or results or the actual performance of any fund may differ materially from those reflected or contemplated in any such forward-looking statement. Current performance results may be lower or higher than performance numbers quoted in certain letters to shareholders.
Date of first use of portfolio manager commentary: July 17, 2017
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Current performance results may be lower or higher than performance numbers quoted in certain letters to shareholders.