After three straight quarters of posting year-over-year declines in profits, steelmaker Steel Dynamics (NASDAQ:STLD) turned things around last quarter, and showed it still knows how to grow its earnings. Tomorrow comes the big test, though, when the company reports its Q2 2006 earnings; can Steel Dynamics demonstrate the start of an uptrend in profits, or was last quarter just a fluke?

What analysts say:

  • Buy, sell, or waffle? Ten analysts follow Steel Dynamics; six of them say it's a buy; four more a hold.
  • Revenues. So overall, they're a pretty optimistic bunch. One reason why: they expect to see a 37% rise in sales in tomorrow's results. $749.1 million is the target.
  • Earnings. Profits should be even better, with a 55% rise to $1.55 per share predicted.

What management says:
Actions speak louder than words, right? Then listen to what Steel Dynamics said when, late last month, it "continued" its policy of issuing "special" dividends of $0.10 per share, in addition to the "regular" dividend of $0.10 per share. Paying out twice what it's formally committed to doing tells shareholders that Steel Dynamics has a lot of confidence in its ability to earn the cash needed to support these dividend payments.

What management does:
Much as they love the dividends, investors had best hope Steel Dynamics management knows what it's doing. Because judging from the trends we've been seeing over the last 18 months, this company's headed in the wrong direction, profitability-wise. Rising raw materials and energy costs have driven gross margins down 550 basis points, ultimately resulting in a 350-basis point decline in net margins.

Margins %

12/04

3/05

6/05

9/05

12/05

3/06

Gross

28.1

28.1

26.8

23.2

22.2

22.6

Op.

23.6

23.8

22.6

18.9

18

18.4

Net

13.8

13.9

13.1

10.8

10.2

10.4
All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
Once upon a time -- oh, about 18 months or so ago -- I argued that the rise in steel companies' profits would eventually end, as all cyclical trends do, in a crash. I was way early with that call; it took a good nine months before profits began to slump at Steel Dynamics, for example. But slump they did. The question investors are now asking is whether the long slow slide in margins you see above is just the beginning of a downward slope in profitability (i.e., that last quarter's numbers were a fluke), or whether the mini-crash Steel Dynamics suffered over the last couple of quarters was itself the fluke.

For my own part, I'm agnostic. I know the crash will come, because it always does. Whether it's come already, or is still over the horizon, I don't and won't know until it's already happened. What I do know is that Steel Dynamics is well positioned to withstand the crash when it comes. It's got plenty of cash against not much debt on the balance sheet. Moreover, its sales rose only 6% in the last six-month period. But the company didn't keep building inventories -- they remained flat year over year. And it didn't cut its customers any slack on bill collection either. On the contrary, while sales rose, accounts receivable declined 4%. Steel Dynamics is running a tight ship in a stormy market, but with actions like these, I have little doubt that it can weather the storm.

Competitors:

  • Allegheny Technologies (NYSE:ATI)
  • Chaparral Steel (NASDAQ:CHAP)
  • Gerdau AmeriSteel (NYSE:GNA)
  • Mittal Steel (NYSE:MT)
  • Nucor (NYSE:NUE)
  • U.S. Steel (NYSE:X)

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Fool contributor Rich Smith does not own shares of any company named above.