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 (
) 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
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
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.
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
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
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
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,"
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
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
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,
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 (
),Arcelor Mittal (
),Gerdau (GGB) andCompanhia Siderurgica (SID), and beforeUnited
States Steel (X). The group is currently ranked No. 18 of 197