CMC - Commercial Metals Company: Still Going Strong

2023-10-01 07:00:00 ET

Summary

• Commercial Metals Company (CMC) is a vertically integrated manufacturer of steel and reinforcing bars used in infrastructure projects.
• CMC's sales and earnings have been improving, with a recent bolt-on acquisition adding to its capabilities.
• Economic headwinds and slower demand in housing markets may lead to further earnings declines, making investors cautious.

In June, I believed that Commercial Metals Company ( CMC ) was a rock solid business, as peak profits in 2022 have retreated in just a modest fashion. I liked the business strategy, as Commercial Metals has found a nice combination of organic and inorganic investments over time.

With earnings power still being very strong and the near term outlook continuing to look sound, I was appealed to non-demanding valuations. Over the summer, the company announced a bolt-on deal and with shares recently having seen a pullback, value territory is approaching.

Made Out Of Steel

Commercial Metals Company is a manufacturer of steel and reinforcing bars (among others), used to make concrete solutions. This includes products like merchant bars, fencing, wire rods with typical applications including infrastructure (and related) projects. These include bridges, highways, skyscrapers and other applications.

The business is vertically integrated, including tens of sites in the US and Poland, including supply mills and downstream locations. These products are applied largely in the infrastructure segment (responsible for a third of sales) as well as a non-residential sector, residential sector, OEM and agriculture activities. By far, the vast majority of sales were generated at home in the US.

Pre-pandemic, this was a $5 billion business which posted EBITDA margins in the low double digits. By the end of 2020, CMC posted sales which fell from $5.8 billion to $5.5 billion, although that EBITDA improved from $423 million to $577 million. This resulted in net earnings of $279 million, equal to $2.32 per share, translating into a non-demanding multiple with shares trading around the $22 mark.

2021 sales rose in a convincing manner to $6.7 billion as EBITDA improved to $754 million, with earnings advancing to $3.43 per share, as shares rose in tandem to the $35 mark. The company used its financial strength and operating momentum to acquire Tensar Corporation in a $550 million, adding engineering construction ground reinforcement capabilities to its line-up of expertise.

Forwarding to June of this year, shares of CMC have seen further gains, trading in the lower fifties. This came after the company announced some bolt-on deals and operating momentum continued to come quite strong.

In June of this year, CMC posted third quarter results as revenues for the first three quarters of the year came in at $6.6 billion already, with the business reporting earnings of $5.69 per share for the same period, down nearly two dollars per share compared to the same period in the year before. Nonetheless, with earnings per share trending at $7-$8 per share per annum, valuations were non-demanding.

Net debt of $700 million was substantial, mostly due to dealmaking and capital spending, but this was a modest amount with EBITDA trending at $1.5 billion. With sales trending over $9 billion a year and earnings coming in close to $8 per share, it was needless to say that valuations were non-demanding at just 7-8 times earnings, with investors undoubtedly believing a further normalization of earnings was to come.

In fact, I was positively surprised to see a modest pace of normalization of these earnings (and strong margins) during the year, and while I fully expect a further normalization of earnings and margins, there is the long term potential for the business.

What Happened?

Since my last take at $51, share of Commercial Metals Company have recovered to levels in the high-fifties over the summer, before now selling off to $49 per share.

In July, Commercial Metals Company announced the bolt-on acquisition of EDSCO Fasteners. The company provides an engineered line of anchor cages, bolts and fasteners, primarily used to secure high voltage electrical transmission poles to concrete foundations. While CMC did not release any financial details on the transaction, public record shows that the revenue contribution of the business run in the low tens of millions.

This deal was announced just a few days after CMC announced its leadership succession plan, with CEO Barbara Smith retiring to become Chairman of the board.

With the company on the verge of posting its fourth quarter results in the coming weeks, I find myself in a bit of a tough situation as economic headwinds are appearing on the horizon. While this is not a great sign, expectations have come down as well, as I have a full intention of buying dips in the mid-forties, and learn more about the upcoming quarterly report.

While the current earnings multiple is very low, I fully anticipate further earnings declines, due to slower demand in housing markets, and perhaps in other parts of the business as well. Even as aging infrastructure desperately needs a revamp, and it is a broad consensus that this will happen, state and municipality budgets are under pressure.

This makes that I will take a balanced and gradual approach in trying to establish a position, but I am committing to the shares on dips here.

For further details see: