One hallmark of the middle class anywhere in the world is the hankering for automobiles. Growing affluence allows for the purchase of a car, which represents both status and convenience.

As the middle classes have grown across much of Asia, particularly in China, the region has become the largest automotive market in the world, accounting for 44 percent of global vehicle sales, with Europe and North American accounting for just 22 percent of sales each.

The Chinese began purchasing vehicles in earnest about four years ago, with sales still going strong. Units sold in October in China reached 1.61 million, a year-over-year increase of 24 percent, according to the China Association of Automobile Manufacturers. So many cars have been sold in China in recent years that a used car market has finally exploded onto the scene, with sales growth of used cars outpacing those of new vehicles last year.

Income growth in South America largely lagged Asia for many years, which is why the Latin auto market is still relatively nascent, accounting for just 7 percent of global sales.

But economic growth Down South has rapidly boosted incomes. In Brazil alone, wages for the poorest workers grew by nearly 30 percent between 2009 and 2011, while those of the general labor force were up by more than 8 percent. Wages in other South and Central American countries such as Argentina, Peru, Colombia and Mexico underwent similarly meteoric increases over that period as well.

As a result, South American auto sales broke 5 million annual units in 2012, with more than 3 million vehicles sold in Brazil alone. According to HIS Automotive, sales in the region could grow by as much as 2.5 million additional units annually by 2025.

Both homegrown and international automobile manufacturers are focusing on the region, particularly as trade agreements such as the Mercosur trade pact among Brazil, Paraguay and Uruguay have imposed import duties—35 percent in this case. These factors incentivize local production.

Largely thanks to that rapidly growing automotive market, Latin America has one of the highest steel use growth rates in the world. While global steel use grew by just 1.2 percent in 2012 and is expected to grow by just less than 3 percent this year, Latin American steel use shot up by 4.7 percent last year and in excess of an estimated 5.1 percent this year (see chart below). That puts the region second only to the US and Canada, which have been undergoing an automotive renaissance of their own.



Ternium (NYSE: TX) is one of the largest Latin American steel producers, with operations primarily in Mexico and Argentina. Much of the company’s raw materials are produced at three iron ore mines and an ore processing facility located in Mexico, which supplies the company’s mills which are capable of producing 10 million tons of finished flat and long steel products per year. About 85 percent of the company’s production is flat rolled steel, primarily used in the automotive market.

Given its vertically integrated nature, the company enjoys a high degree of insulation from global ore prices, since it produces more than half of the ore it uses. The company also has the capability to recycle scrap metal with natural gas as the primarily fuel source, giving it considerable flexibility as the pricing environment changes.

The company is subject to volatile global steel prices, but Ternium primarily serves Latin America with relatively little exposure to the export markets, so it’s somewhat protected against falling global prices. It also helps that it’s the only local producer of flat rolled steel in Argentina.

Right now, despite the rapid growth in the Latin American automotive market, Ternium offers an extremely attractive valuation.

The company’s revenue and operating income have averaged 20.2 percent and 45.7 percent growth respectively over the past three years, but net income and earnings were down by 42 percent over the same period. That’s largely due to the legacy effect of acquisitions and heavy capital spending during the recession years, which caught the company off guard.

That said, Ternium’s acquisitive nature has eased, as the company pauses to digest its purchases of years past, resulting in a nearly 30 percent drop in capital spending over the next few years. In particular, several production lines in Argentina will be completed next year and a recently developed ore mine in Mexico will finally be up and running.

At the same time, falling iron ore prices are expected to help drive down production costs even as finished product prices are expected to hold steady over the next few years, thanks to demand growth.

Ternium will focus much of its production growth efforts in Mexico, where automotive galvanized steel demand is expected to grow from 1.1 million tons this year to 1.4 million tons in 2016. Currently, about 70 percent of demand is being met with imports, so a growing local producer will enjoy a strong competitive advantage. That’s why Ternium installed a new hot-dip galvanizing line in the country with a capacity of 400,000 tons per year, with operations that began in July.

The company has also built four new distribution centers in key Mexican markets over the past few years, already creating a 36 percent increase in active customers over the last two years.

Still, shares currently trade at par with book value and just 0.6 times trailing 12-month sales. The company’s price-to-earnings-growth ratio is also currently just 0.3, suggesting the company is extremely undervalued relative to expected future growth. The company carries little debt, with a debt-to-equity ratio of just 0.1.

Wall Street estimates for the company have become increasing optimistic over the past few months, with analysts forecasting full-year earnings of $1.54 per ADR, up from just 95 cents three months ago and representing year-over-year growth of 120 percent. Despite that strong shift in analyst sentiment, shares are up only 3 percent over the same period.

With strong growth prospects in a growing market, Ternium is a great buy up to 34 and a new addition to the portfolio.