Steel Dynamics Reinforces To Grow As Markets Pick Up


Steel Dynamics is on a roll, thanks to renewed demand for steel and its plan for a transformational acquisition that would expand its presence in the southern U.S., bolster its production capacity and broaden its exposure to growth industries.

The Fort Wayne, Ind.-based steel maker and metal recycler on July 21 said it would buy Mississippi-based Severstal Columbus from OAO Severstal in a $1.63 billion deal. If the cash acquisition closes late this year as planned,Steel Dynamics ( STLD ) says, its annual steel shipping capacity will increase by 40% in 2015, to 11 million tons. The acquisition is expected to be immediately accretive to earnings.

The deal would provide Steel Dynamics a bigger presence in the lucrative energy and automotive industries, as the Severstal Columbus mill produces steel in demand by those sectors. Domestic oil and natural gas production has been strong in Texas and neighboring states in the South, analysts say, boosting demand for steel used to build equipment for that sector.

Auto sales nationwide, meanwhile, have been solid in 2014. The annualized selling rate of 16.48 million autos in July represented a notable jump from 15.76 million a year earlier, according to Autodata, lifting demand for steel used to build cars and trucks.

"Those two industries have been the main drivers of demand for domestic steel, so that should continue to drive growth" for Steel Dynamics, said Andrew Lane, a Morningstar analyst who covers several steel producers.

Steel Dynamics' stock is up about 25% since the trading day before the acquisition announcement. "Investors welcomed the deal," Lane said, "and I think it makes a lot of sense for them."

The acquisition aside, Steel Dynamics is on solid footing, Lane says. The company in July reported strong second-quarter results that reflected a broad recovery in domestic demand for steel and lower costs for raw materials used to produce steel, he says, both of which are favorable trends that are expected to continue.

Steel Dynamics reported second-quarter net income of $72 million, or 31 cents per diluted share. It marked a rise in net income of $34 million from the first quarter, when results were hampered by harsh winter weather, and a jump of $43 million from a year earlier. Second-quarter net sales of $2.1 billion were up 13% and 15%, respectively, from the first quarter and from a year earlier. Raw material prices decreased, the company said, boosting operating income by $51 million from the first quarter, to $132 million.

Demand Recovers

Commercial demand for steel dried up in the wake of the 2007-08 financial crisis, as major construction and development projects were put on hold. This drove down prices for steel producers. At the same time, a surge in major construction projects in China, the world's largest consumer of steel, put upward pressure on the cost of raw materials globally, analysts say. This, in turn, hurt operating margins for U.S. steel producers, including Steel Dynamics.

But as the U.S. economy has healed over the past couple years, the construction industry has gradually recovered, adding to demand for steel, Raymond James Chief Economist Scott Brown said in an interview. He said the domestic steel industry "for the most part tracks alongside the overall economy, which has been growing, modestly, but growing."

Meanwhile, the Chinese economy has begun to slow and construction has started to shift from big commercial endeavors to smaller residential projects that require less steel there, lessening demand for raw materials in China and lowering costs for U.S. producers, Brown says.

"So there is not that upward pressure on (costs) and I don't think there's an expectation for that to change soon," he said.

Analysts on average forecast third-quarter earnings of 37 cents per share for Steel Dynamics, according to Thomson Reuters. The Street expects sales to again top $2 billion.

During a call to discuss second-quarter results in July, Steel Dynamics CEO Mark Millett told analysts that the Severstal Columbus acquisition would not only ramp up production capacity and broaden exposure to surging industries, but the expansion into the South should also deepen Steel Dynamics' ties to industrial markets in Mexico, where he expects "significant growth."

Millett also said the broad U.S. economic recovery is expected to continue, as is strength in the oil and auto sectors, driving continued steel consumption growth. In the second quarter, Millett said, "all our reporting segments achieved meaningfully higher profitability compared to the first quarter, improving well beyond the bad weather impact experienced in that quarter. The meaningful improvement ... supports our continued optimism, as does the positive sentiment from our customers."

'Strengthening Trends' Seen

The company's director of investor relations, Marlene Owen, told IBD this week that Steel Dynamics' view of market conditions remains upbeat nearly two months into the third quarter. She said macro indicators of steel industry health, from construction spending to indexes that track planning of new projects, show "strengthening trends."

Lane said the company's optimism is warranted, but he also said Steel Dynamics is burdened by one lingering headwind: a multiyear project at its Minnesota iron production facility that, to date, has failed to generate returns. The company has invested about $500 million in the facility, Lane estimates, in an effort to develop a cutting-edge production operation. But the quantity of the refined iron ore generated by the Minnesota project has "fallen short of expectations" and the product quality is "poor," he said.

Steel Dynamics said the negative impact of the Minnesota operation on earnings totaled about $18 million in the first half of 2014. Lane said the company hinted earlier in 2014 that it might scrap the project, but now plans to continue investing in it in hopes of fine-tuning operations and benefiting future earnings. Lane said he and many on Wall Street remain skeptical.

The company said it anticipates losing money in Minnesota in the third quarter, though at a slower rate than in the first half of the year.

"There remains this concern that they will continue to funnel money to this with no real results," Lane said. "It's been a drain on earnings for many quarters. It's a major misstep for them."

That noted, the analyst added, Steel Dynamics has an "excellent management team" with a long track record of wise investments. The Minnesota project "is really management's one black eye." He called it a "one-off" problem that, while significant, is not enough to undercut the firm's strong overall growth and favorable outlook.

Lane said Steel Dynamics posted an operating margin of 6.4% in the second quarter. By 2018, he expects it to expand to 11%, as steel sales and prices continue to rise and as Steel Dynamics integrates and capitalizes on its planned acquisition. With the much larger base it can spread out its fixed costs over greater production volumes to boost the margin and, by extension, profitability.

It's "a good story overall," he said.

Steel Dynamics is the seventh-largest company by market cap among 20 in IBD's Steel-Producers industry group, afterPOSCO ( PKX ),Tenaris ( TS ),Arcelor Mittal ( MT ),Nucor ( NUE ),Gerdau (GGB) andCompanhia Siderurgica (SID), and beforeUnited States Steel (X). The group is currently ranked No. 18 of 197 tracked.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ, Inc.

This article appears in: Investing , Investing Ideas

Referenced Stocks: STLD , PKX , TS , MT , NUE

Investor's Business Daily

Investor's Business Daily

More from Investor's Business Daily:

Related Videos




Most Active by Volume

  • $15.4957 ▼ 0.16%
  • $27.86 ▼ 1.73%
  • $29.98 ▲ 4.28%
  • $4.89 ▼ 4.12%
  • $28.135 ▲ 0.16%
  • $5.24 ▼ 3.32%
  • $12.95 ▲ 0.47%
  • $111.97 ▲ 0.33%
As of 10/13/2015, 12:28 PM

Find a Credit Card

Select a credit card product by:
Select an offer:
Data Provided by