Not many of our readers are likely to be familiar with the market dynamics of the scrap metal recycling industry, so here's an analogy. In the insurance business, one can chase business by writing lots of premiums when pricing is weak, in order to gain or maintain market share. Or, one can target the elusive underwriting profit by being disciplined and sacrificing current business when profitability is not assured. Guess which strategy works better over the long term?
We see this same dynamic play out in many cyclical businesses, and Metal Management (NYSE: MM ) finds itself in a particularly cyclical niche: Not only is demand for scrap metal cyclical, but it's a function of the cyclicality facing minimill steel producers like Nucor (NYSE: NUE ) , Gerdau Ameristeel (NYSE: GNA ) , and Steel Dynamics (Nasdaq: STLD ) . Past leadership ran Metal Management right into the ground the last time the market turned down. While the new, post-bankruptcy leadership is still interested in consolidating the industry, management has demonstrated its resolve to maintain profitability and not "chase and choke," in the words of CEO Daniel Dienst.
This quarter's results disappointed some folks, but not for the typical reasons. Revenue of $624.4 million and earnings per share of $1.04 both came in above the average forecast of the few analysts covering the company. It appears to be the lower non-ferrous volumes and inventory turns that disappointed people Thursday. They must not care that much about profitability.
In Dienst's words on the conference call, "things got a little goofy." So I am quite happy to see that the company didn't chase business with no margin in it. It turned inventories three times (OK, 2.97 times), which is right at its target. (Inventory turns equal the cost of goods sold divided by average inventories.) I see no reason to be unhappy with these results.
Management speaks often of being the steward of shareholder capital. Dienst himself owns a fair-sized chunk of the company. I feel that his priorities and his incentives are both in the right place, and I expect the company to continue to return capital to shareholders in the form of dividends and buybacks if the operating environment fails to merit full participation. The company's clean balance sheet enables management to take exactly such measures if the situation warrants a scaling-back. Also, such a downturn, while painful, would also present a lot of distress acquisition opportunities for the company. Call me sadistic, but I can't wait to see how this company does in a recession.
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