Specialty metals and materials don't often end up looking so special, as they are often just as cyclical as other industrial metals like copper or zinc. That said, Materion (NYSE:MTRN) has consistently looked to find new value-added uses for beryllium and related alloys, ceramics and specialty products. Admittedly, the company's long-term cash flow production and returns on capital are not stellar, but recoveries in consumer electronics and telecom equipment could push this company into another cyclical upswing.
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These Aren't the Best of Times
Materion's first quarter earnings certainly don't argue for any particular urgency on the part of investors. Sales dropped 6% on a reported basis and were even weaker, netting out metal price pass-throughs. With weak sales came weak margins; operating income dropped nearly 50% from last year's level.
SEE: Zooming In On Net Operating Income
A lot of beryllium goes into the tech sector and comes out in data storage equipment, computers and telecom equipment. Looking at the volume and shipment numbers we've seen lately from Cisco (Nasdaq:CSCO), Juniper (Nasdaq:JNPR), Hewlett-Packard (NYSE:HPQ) and so forth, it's pretty clear that demand is still quite soft. Making matters worse, other applications like defense applications are fading with government budget cuts.
Going up the Value Chain
One of the major goals for companies like Materion, OM Group (NYSE:OMG) and Johnson Matthey (OTC:JMPLY) is to get as far away as possible from commodity raw material sales and instead pursue higher-value applications for the metals and minerals in question.
SEE: Investing In The Metals Markets
In the case of beryllium, there are certainly plenty of applications. Not only is it useful in somewhat esoteric applications like radiation windows, but it can harden other materials and it is useful in both harsh environments (including down-hole electronics for the energy industry) and applications where consistency and precision are critical (like glucose testing strips).
Of course, there are limits on how much Materion can charge for these benefits. Other materials like aluminum or magnesium can be used as substitutes in some cases. So Materion finds itself in the same situation as rare earth producers like Molycorp (NYSE:MCP) or Lynas (OTC:LYSDY) - returns are capped over the long-term by the ability for companies to engineer around expensive components and substitute cheaper materials.
The Bottom Line
Investors have to have a baseline confidence in the thesis that demand for telecom equipment, consumer electronics and advanced electronics will recover, or Materion isn't going to make much sense as an investment. I happen to have that confidence, as many analysts have made themselves look foolish by pinning a date to the recovery in carrier or consumer spending, but I don't think that level of precision is essential.
SEE: Earnings Forecasts: A Primer
More to the point, even with the unimpressive projections that are in place for 2012, these shares look interesting. Materion has generally traded at an average multiple to forward EBTIDA of over seven, but currently trades at around 4.5 times sell-side estimates for 2012 EBITDA. Even allowing for the possibility of further cuts (the average 2012 EPS estimate has fallen about 10% in the last three months), that seems like too much of a discount.
At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.