Commodity

Steel Dynamics To Benefit From Commodity Cycle (NASDAQ:STLD)

Rolls of metal sheet. Zinc, aluminium or steel sheet rolls on warehouse in factory.

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Steel Dynamics (NASDAQ:STLD) is a $13 billion American steel producer and metal recycler. The company has a long history of strong operations and has increased profits in recent quarters, to great effect for shareholders.

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Data by YCharts

STLD equity shares have appreciated substantially in recent years.

Investors should consider allocating to Steel Dynamics Equity shares as the company stands to benefit from a constructive commodity cycle.

Fundamentals

STLD is headquartered in Fort Wayne, Indiana. The company is highly cyclical, and its performance from both the top line revenue and bottom-line profit perspective depends significantly on the commodity environment.

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Data by YCharts

Strong execution at STLD and attractive financial structuring has allowed the company to increase equity value even in a volatile commodity price environment.

Over the last several years, the company has generated strong earnings for shareholders, driven primarily by strong revenue generation at the top line. The best few years over the last decade for the company were 2017 and 2018, with annual revenue in the $10 billion range.

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Data by YCharts

Since then, the company’s top line revenue performance has decreased somewhat, but the last year has seen record sales for the company and I expect revenue generation to continue to remain strong as the COVID-19 driven inflationary pressures on commodities favor the company’s business.

On an earnings basis, the company trades <6x trailing earnings, and closer to 5x earnings on a forward basis.

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Data by YCharts

On a price-to-sales basis, the company trades at ~0.7x. The company sports an unlevered free cash flow yield of >3%, and 10-year median returns on assets, equity, and invested capital metrics have been quite strong in the high single digits to low double-digit percentage range.

Source: Q3 Presentation

Management has been operating the business at high levels of utilization, and notably are able to achieve higher steel mill production utilization than the rest of the domestic steel industry. This should enable return on assets to continue to remain attractive relative to the industry, which is favorable for shareholders.

I also note management has been executing aggressively on a share buyback plan, repurchasing $338 million in stock in the third quarter of 2021. Continued share buybacks should offer substantial value to equity holders if executed well.

STLD generates cash and is highly free cash flow focused. This is a key differentiator relative to a lot of companies in this market environment, where the promise of cash flows in the future is what is primarily driving valuation. As a prospective shareholder, I am attracted to STLD management’s focus on free cash flow generation:

Source: Q3 Presentation

STLD has been able to achieve ~10% EBIT margins over the last decade, and I would expect this to continue or for there to be 50-100 basis points of upside to this in a favorable commodity cycle.

Risks

There’s significant market environment risk when it comes to establishing a long Equity position in STLD. If, in a recessionary condition, aggregate demand for the company’s products drops off, top line revenue would suffer significantly. Given the company’s high degree of operating leverage, this would have a disproportionate negative impact on the bottom line, and investors could see dilutive years where earnings-per-share are negative.

Another operational risk relates to management execution capabilities. If there is significant management turnover or instability in this labor market, there may be impacts to STLD’s business from a quality of execution standpoint. However, given the company’s long history of successful execution, I would consider this risk largely mitigated.

Conclusion

In the final analysis, STLD at a $13 billion dollar market capitalization is undervalued relative to what the next several years hold in terms of the potential for a highly favorable commodity cycle.

The market environment over the coming years should significantly favor Steel Dynamics, and investors should consider a long equity position as part of their portfolios. Good luck to all.


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