ZEUS - Olympic Steel: A Hold Until Prices Stabilize

2023-07-11 11:10:05 ET

Summary

• Olympic Steel Inc, a company that processes and distributes metal products, is in a strong financial position with $350 million available for further growth opportunities.
• ZEUS has diversified its revenue streams, with carbon-flat products accounting for 53% of revenues, and is focused on further diversification through M&A.
• Despite a decline in revenues and EPS, the company's future looks promising, with the global steel market expected to grow by 3.8% CAGR between 2022 and 2027.

Investment Summary

Investing in the steel industry might not seem as exciting to most investors as EV or AI companies, but there is plenty of value to be had in the sector. Olympic Steel Inc (ZEUS) is a company that processes and distributes metal products in the United States but also internationally. The company primarily focuses on processed carbon steel, coated, aluminum, and lastly plate steel products. With that said, the revenues for ZEUS are highly dependent on the price of commodities, and with them fluctuating, so do the revenues and net income for ZEUS.

During its many years of operations, founded back in 1954, ZEUS has diversified its revenue streams very well and now makes around 53% of the revenues from carbon-flat products. It now boasts 44 different facilities across the US and employs around 2.000 people. The prices that ZEUS was able to charge in 2022 don't apply anymore as the average selling price per ton of carbon flat products has fallen by 23% YoY. This of course affected the final results for the quarter. ZEUS does remain however in a very strong financial position right now and has $350 million available to invest in further growth opportunities. But until I see some more stability in terms of the quarterly results I don't think ZEUS is a buy right now. Rating ZEUS a hold.

A Diversified Company Structure

Since its founding back in 1954 ZEUS has heavily relied on the revenues it generated from carbon-flat products, but has since shifted away from that and it now accounts for just a little over half of the total revenues. ZEUS has been very proactive in generating revenues from specialty metals flat products and tubular & pipe products as well.

These three different revenue streams are also what make up the three various segments in the company. The carbon flat products are a very high-volume business that has much of its revenues affected by what the market prices are which they can charge. For Q1 in 2023 that was $1.419 per ton, down from $1.819 a year prior. This is also the segment which a lot of the acquisitions the company is doing get integrated into. Most recently that was the acquisition of Metal-Fab for a deal that reached $131 million. This will integrate more residential products into the company's portfolio as Metal-Fab focuses on manufacturing comprehensive venting solutions. The segment is focused on higher margin products that did seem to face some difficulties in the last quarter as the operating expenses increased whilst the net sales decreased. A tough scenario to be in for ZEUS.

Looking ahead, a lot of the focus for the company will be around further diversifying its revenue mix through M&A. The company aims for the carbon-flat products to no longer make up a majority of the revenues, which I think could be a good thing. If there is less dependence there it seems the coming earnings reports will be more consistent. The new approach to prioritizing new streams of revenue streams has been very successful for ZEUS. The ROA between 2010 - 2019 was 0.8% but climbed to 8.9% between 2021 and Q1 2023. During that period, the shareholder return has been 296%.

Quarterly Result

The last report from ZEUS showed a noticeable decline in both the top and bottom lines of the business. The revenues decreased by 18% and the EPS by over 70%. This sort of volatility has in large amounts been caused by less favorable pricing environments. But looking at the income statement some leading causes that led to higher expenses were warehouse and processing climbing $6 million YoY and distribution costs rising too.

Looking ahead though, I think we are likely to see a better and more favorable market environment for ZEUS. The global steel market is continuing to grow, and estimates suggest it will grow by 3.8% CAGR between 2022 and 2027. Steel prices are also recovering and the coming quarters should be reflecting this with higher revenues in the various segments.

Risks

The risk with investing in ZEUS right now seems to circle back to them being very dependent on the price of steel and other commodities. This isn't necessarily a negative, but it can cause short-term pain for the company and investors in it. In my opinion, the long-term remains very strong, and seeing a steady uptrend in steel prices for example seems likely when demand for infrastructure and residential buildings is so strong in the US.

With steel companies, you often, or at least I expect them to have strong cashflows through the growth part of the cycles. For ZEUS that has held and 2022 netted them $153 million in levered FCF. But unfortunately, this hasn't translated into buying back shares and passing down value to shareholders. Instead over the last 5 years, the outstanding shares have increased. In the coming quarters, I would like to see an improvement from the management to at least stop dilution and set aside capital to buy back shares. In the long term, this will incentivize investors to stick with the company and it could earn them a higher multiple too.

Valuation & Wrap Up

Having some exposure to the materials sector, and particularly steel, I think is important for investors. Just like with the revenue mix of ZEUS being diversified, the same should hold for investors' portfolios. With ZEUS you are getting a company that benefited heavily from the euphoric market state that was 2022. But since a year ago, the results have fallen and the pricing environment is less favorable right now.

Demand still seems persistent and I think ZEUS will benefit greatly from the recent trend of companies moving manufacturing back to the US. Right now though I think it's not unlikely we see a pullback in the share price for ZEUS. It has run up quite impressively over the last 12 months and sits at an FWD P/E of 13, which is 13% above its historical 5-year average of 11.8. Compared to the sector, however, it seems just in line right now. My point is that ZEUS is right now, not a very undervalued play, but could potentially become one if we see a pullback to the historical p/e of 11. As of now, I am rating ZEUS a hold.

For further details see: