For four quarters running, Canadian steel processor Novamerican Steel (NASDAQ:TONS) has trounced the earnings estimates posited for it by Wall Street's best and brightest. But tomorrow, analysts have set a high hurdle for the company, predicting it will more than double the profits it produced in last year's third quarter. Will Novamerican clear the bar, or will TONS sink under the weight of Wall Street's over-lofty expectations?

What analysts say:

  • Buy, sell, or waffle? Only two analysts follow Novamerican. Both vote "hold."
  • Revenues. On average, the two analysts expect sales to be up just 1% versus last year at $193 million.
  • Earnings. But are looking for $0.94 per share in profits on Wednesday -- 129% better than last year.

What management says:
Actions speak louder than words, right? If that's true, then shareholders can take heart at the news (released in July) that Novamerican has authorized a 450,000-share buyback. If implemented in full, that could reduce the firm's share count by as much as 4.3%, boosting earnings per share in the process.

Personally, I suspect that come Wednesday, we'll see that Novamerican has already begun to implement the buyback. When the plan was announced in late July (when, presumably, management thought the shares were already undervalued), the company's shares were trading for just over $35. Today, they're in the mid-$33s, which is a good 4% cheaper. What's more, although the company is trading at less than the midpoint of its historical P/E range, Novamerican believes that the recent trend toward consolidation among the big steelmakers has set up a paradigm shift that will allow even downstream steel players like Novamerican to earn more profits than in years past.

What management does:
Over the last six months, Novamerican has experienced flat sales but declining cost of goods (down 1%) over the previous year's period. As a result, the decline in year-over-year gross margins slowed in the February quarter and reversed in May. Although operating costs continued to rise (up 8% year over year), the savings in gross profits sufficed to offset the firm's higher selling, general, and administrative costs, with the result that operating and net margins also rose on a rolling basis.

Margins %

2/05

5/05

8/05

11/05

2/06

5/06

Gross

22.9%

20.3%

17.2%

15.3%

15.2%

15.7%

Op.

14.9%

12.4%

9.1%

7.3%

7%

7.4%

Net

9.2%

7.6%

5.6%

4.4%

4.3%

4.7%
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.

The Fool says:
Over on the balance sheet, Novamerican made great strides in the management of its working capital in recent quarters. As sales flattened but did not fall over the last two quarters, the firm reduced accounts receivable by 1%, and drew down its inventories an impressive 15% year over year.

As a result, free cash flow improved (or rather, negative free cash flow declined) markedly. The last six months saw only $8 million flow out the door, which was about a two-thirds reduction compared to the negative $24 million free cash outflow we saw one year ago. Nor, by the way, is the negative free cash flow in Q1 2006 particularly alarming. Novamerican almost never runs free cash flow-positive in Q1, and generally makes all of its cash in Q2 through Q4. We'll be looking to see similar improvement in Wednesday's news, as the firm reports on one of its seasonally strongest quarters.

Competitors:

  • Gibraltar (NASDAQ:ROCK)
  • Olympic Steel (NASDAQ:ZEUS)

Customers:

  • Ford (NYSE:F)
  • GM (NYSE:GM)
  • DaimlerChrysler (NYSE:DCX)

Still not sure whether you should invest in Novamerican? Get the president's own views on the firm's future in our recent interview with Scott Jones.

If you're looking for companies selling at great prices, check out the Motley Fool Inside Value newsletter. Subscribers have access to many features, including the full interview with Scott Jones. Try a free 30-day trial here.

Fool contributor Rich Smith does not own shares of any company named above. The Motley Fool's disclosure policy is as strong as steel.