Specialty steel processor Steel Technologies (NASDAQ:STTX) rolled out a good quarter for December. Sales were up 94% to $254 million, and EPS of $1.11 beat the estimate of $1.10. It should be noted that the company preannounced a great December quarter back in early January and that the original estimate for the quarter was about $0.96 a share.
Steel Technologies occupies a borderland between the big steel producers such as Nucor (NYSE:NUE) or Posco (NYSE:PKX) and big steel users such as General Motors (NYSE:GM) or Toro (NYSE:TTC). Large steel mills can't adjust their production runs to produce customized steel for each customer. Yet customers need steel that meets certain specialized tolerances, and they don't want to make it themselves. Steel Technologies steps into that gap and buys steel from the mills, crafting it into specialized products for end users.
By staying in the middle, the company profits from the difference in what it has to pay for raw steel (and what it costs to process that steel) and what it can charge the end user. As such, this is a company with some serious operating leverage. Looking at historical results, the company seems to be able to make a "baseline" gross margin of about 11% when steel is at about $550/ton. When steel is above that price (as it has been lately), Steel Technologies can do even better.
The trick with operating leverage is that when prices fall below a certain point, earnings drop off sharply. Still, this is a company that understands its business and has always managed to remain profitable in the 20 or so years that the company has been public. What's more, Steel Technologies tries to lock in both its supply of steel and its end-user demand with contracts. In so doing, the company can "lock in" a profitable spread.
Sales were boosted in December by a one-two punch of higher volume and that profitable spread. Growth looks to be staying strong, with the company expecting to ship 10% more steel in the next quarter. Although spot-market pricing for steel has backed off a bit from a peak in September 2004, the company is still seeing upward price movement in its contracts.
While Fools shouldn't expect dramatic steel price hikes from here, so too is it unlikely that steel is going to crash. Investors with faith that Steel Technologies will continue to exploit that profitable niche between the big mills and the big customers might want to take a look at these shares. After all, at a trailing P/E of less than 8, there's not a lot of rust here.
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Fool contributor Stephen Simpson holds a CFA. He has no ownership interest in any stocks mentioned.
