Schnitzer Feels the Squeeze

You don't need a Stanford MBA or a Harvard Ph.D. in economics to understand what happens to a company's bottom line when costs rise and sale prices fall. That's pretty much what happened to SchnitzerSteel (Nasdaq: SCHN) this quarter.

Second-quarter results just weren't very good. Net income fell 42% while operating income fell 44%. Rubbing a little salt in the wound, that drop in net income came despite a nearly 87% increase in reported revenue. Now it's certainly true that straight-up comparisons to the year-ago level aren't entirely fair -- in the intervening year, the company made some acquisitions and unwound a significant joint venture -- but it's equally true that it was still a tough quarter.

It's always seductive to look for easy explanations to problems, so I don't mean to oversimplify what's going on at Schnitzer. That said, in both the metals recycling and auto parts businesses, the company is getting squeezed between higher buying prices and lower selling prices -- though volume seems to be alright in both businesses. On a happier note, the company's steel business had what looks like a strong quarter; volumes were up meaningfully and pricing also ticked up a bit.

I haven't always had the easiest time finding a comfort level with this stock. On one hand, I like the company's position as a large scrap exporter in a fragmented industry, with good locations near ports. I also think the auto parts business can be a good one once it matures a bit. On the flip side, there's not much pricing power here. What's more, I'm a little nervous about stories tied into overseas demand -- China is growing gangbusters now, but they will have recessions and setbacks sooner or later.

For now at least, debt is low, return on capital is high, and the P/E is near the lower end of the historical range. Unfortunately, that often marks the top for companies in cyclical lines of business. Perhaps this will prove to be a so-called "supercycle," or maybe Schnitzer will continue growing despite broader cyclical moves. Either way, I'm not too keen to find out with my own money. In the meantime, investors wanting some exposure to the metal markets might still want to consider the likes of Nucor (NYSE: NUE) or SteelDynamics (Nasdaq: STLD)

Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).