Please ensure Javascript is enabled for purposes of website accessibility

Can This Steelmaker Keep Delivering Record Results?

By Reuben Gregg Brewer - Nov 17, 2018 at 5:13PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Steel Dynamics has been posting record results. That may continue for a little while, but don't forget that the industry it's in is highly cyclical.

U.S. steelmaker Steel Dynamics, Inc. (STLD -1.02%) has been hitting on all cylinders lately. In fact, during the third-quarter earnings conference call CEO Mark Millett noted that the company is very different today than it was roughly a decade ago. The changes the company has made, like increasing diversification and moving up the steel value chain, will serve investors well over time, of course. But it's important to understand exactly what's going on at Steel Dynamics before its record results draw you in.   

Impressive numbers

Steel Dynamics' third-quarter net income of $1.69 per share was a record, and up materially from $0.64 in the prior year. It also posted records for earnings from operations, adjusted EBITDA, cash flow from operations, and steel shipments. That last item there being the real driving force of all of the other records, of course. 

A man drawing a rising line over a rising bar chart

Image source: Getty Images.

A number of very distinct factors are supporting these records. For starters, steel is an economically driven commodity, and the United States has been growing relatively quickly lately. That's led to robust demand. Looking forward, the CEO noted during the earnings call that "it's important to remember domestic steel inventory levels appear to be balanced and virtually every domestic steel consuming sector is already in good shape or continues to improve." He hinted that 2019 should be a pretty good year as well, if the current industry dynamics continue. In fact, according to the CEO, some of the company's steel fabrication operations had to turn business away because of the already large backlog of orders on the books.   

This is a great position to be in, of course, but one that is tightly tied to the economic environment. If the United States should fall into a slump -- or, worse, a full-on recession -- demand for steel will fall and Steel Dynamics' record results will be a thing of the past. Investors will react accordingly and push the shares materially lower. That, however, would likely be a buying opportunity for long-term investors because of the other aspects supporting Steel Dynamics' recent results.

Changing the model

The last downturn in steel started around the time of the deep 2007-to-2009 recession. For those with a short memory, that downturn was particularly bad. Steel Dynamics' bottom line was pushed into the red in 2009, which shouldn't be a surprise given that the construction industry, a key end market for steelmakers, was particularly hard hit during that downturn.   

STLD Chart

STLD data by YCharts

Steel Dynamics, however, didn't sit and lick its wounds during what turned into a long industry malaise. Between 2007 and 2017 the company made five acquisitions. It also undertook four major expansions or upgrades. Management's goal was twofold: to increase diversification and to move up the value chain by increasing its production of higher-margin products. The company's not done, either, with the recent completion of yet another acquisition and another set of expansions and upgrades on the books. It has projects slated out to 2020.     

The big picture is summed up in CEO Mark Millett's comment that "our growth-expanded product diversification and market positioning will continue to achieve higher highs and, just as importantly, higher lows driving considerably higher through-cycle cash flow generation capability." Today, the company serves nine major sectors, with roughly 60% of its production considered value added, providing higher margins than commodity products. Essentially, Steel Dynamics has strategically shifted its business so it can better handle the ups and downs of the cyclical steel industry.   

The company's $400 million June 2018 acquisition of Heartland Steel Processing is a case in point. Historically the mill has focused on producing just one type of steel, and it had been running at low utilization levels. Steel Dynamics intends to broaden the product lineup and is already shifting demand from other mills it owns nearby to Heartland to increase use. Shifting production around among the mills, meanwhile, should allow for lower costs and higher productivity for the company's four regional facilities as it gives the company the flexibility to make broader changes at all the mills. The end result is expected to be annual synergies of between $10 million and $15 million. This acquisition wasn't about getting bigger for the sake of getting bigger; it was about making the best use of assets so the company would get bigger and better.   

A good company, wait for a better price

At the end of the day, Steel Dynamics is a very well-run steel mill with a leadership team that thinks long term. If you are looking to buy a steel company today, you should take a close look, because it is doing quite well. However, the current set of record results suggests that the cyclical industry is soundly in an upturn. While management has been preparing for this period by diversifying and moving up the value chain, the next economic downturn is when the company will really shine by producing "higher lows." But there's a good chance most investors will be so caught up in the downturn that they will likely miss that subtle but important fact. And that should present a much better opportunity for value-conscious investors who are willing to think long term along with Steel Dynamics' management team.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Steel Dynamics, Inc. Stock Quote
Steel Dynamics, Inc.
STLD
$66.15 (-1.02%) $0.68

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
317%
 
S&P 500 Returns
112%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 07/01/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.