ZEUS - Olympic Steel: Not Really A Steal Here

2023-10-04 09:53:04 ET

Summary

• Olympic Steel, Inc. has seen a profit boom in 2022, but softer results in 2023 have led to a cash flow boom.
• The company has announced a substantial deal for Metal Fab, and the impact of the deal is hard to gauge.
• Shares have seen further gains, but the performance of the shares make me cautious about investing in Olympic Steel.

At the start of this year, I concluded that Olympic Steel, Inc. ( ZEUS ) was starting 2023 with a big deal. This came after the company saw a profit boom in 2022 which appeared to have ended at the time.

Strong earnings in 2022 were funneled into working capital requirements as ironically, softer results should translate into a cash flow boom, as the company announced a larger deal while providing few details. Amidst all this, I was happy to pick up coverage, but was not yet willing to initiate a position.

Unfortunately, I have been too cautious, with shares up another 50% year to date, as the company has largely delivered on its promises. The re-rating to about 10 times earnings leaves me not compelled to chase the shares here, even as Olympic has announced another bolt-on deal.

A Recap

Olympic Steel is a North American metal service center with origins which date back to the 1950s. Over time, the company has grown to a $2.3 billion revenue base, generated by 1,600 workers with activities organized across three segments: carbon flat products, specialty metals flat products and a smaller tubular & pipe products business.

Over the past decade, shares of Olympic Steel have traded in a $10-$30 range (except for a brief rally in 2008). The strategy of the company is to report more consistent outperformance through differentiated product offerings and more specialized processing capabilities. Some of these claims are backed up by an emerging track record, which leadership team holding about a fifth of the shares, as dividends have been hiked nearly two decades in a row, although a $0.36 per share dividend (at the start of this year) was still quite low.

The pandemic had a huge impact on the results. A $1.6 billion business in 2019 (which posted paltry operating profits of $19 million) saw sales fall to $1.2 billion a year later, after which a flattish earnings number were reported. The business saw a huge turnaround in 2021, with sales essentially doubling to $2.3 billion on which operating profits of $172 million were reported, with growth entirely driven by higher prices (as volumes actually fell).

The momentum appeared to have peaked in the first half of 2022. Revenues for the first two quarters came in at $696 million and $709 million, respectively, with operating profits reported at $53 and $54 million. Third quarter sales fell to $634 million as operating profits fell to $19 million, as the company earned $7.50 per share so far in the first three quarters of the year.

Net debt was reported at $234 million, amidst higher working capital requirements, as EBITDA came in at $140 million in the first three quarters of the year, making leverage no major concern. With 11.5 million shares trading at $34 at the start of 2023, the market value of about $400 million looked very modest in relation to the earnings power, as leverage seemed manageable.

With a $650 million enterprise valuation, Olympic Steel announced a substantial $131 million deal for Wichita-based Metal Fab, in a deal set to increase net debt towards $365 million. As the deal tag was equivalent to a third of the equity valuation, the deal was substantial, but few details were announced. A peak $10 earnings per share run rate has likely fallen to just $4 per share and given the cyclicality and debt, I was fearful to get involved, opting for larger and better-capitalized names Nucor ( NUE ) .

Doing Well

After my take in January, shares have seen further gains, as they have generally traded in a $40-$60 range for most of the year, now trading at the middle of the range at $52 per share.

In February, Olympic Steel hiked the dividend to a run rate of $0.50 per share, a huge 38% increase from the previous dividend, with the yield coming in around 1% here. Later that month, Olympic posted fourth quarter sales of $520 million, although that operating profits fell to just $7 million and change.

Net debt fell to just about $150 million, for the reason that softer results made that inventory and working capital requirements fell, reducing leverage in the meantime. The issue is that fourth quarter adjusted earnings of $0.28 per share look dismal compared to the annual results of $7.77 per share in 2022 (which compares to an $11.69 per share number in 2021).

First quarter sales for 2023 came in at $573 million, recovering on a sequential basis, as operating profits rose to nearly $18 million. Net debt came in around a quarter of a billion, due to the Metal Fab deal as first quarter adjusted EBITDA came in around $28 million, with adjusted earnings reported at $1.15 per share. No details on the contribution of Metal Fab were split out.

In August, second quarter sales were reported flattish at $569 million as operating profits came in at nearly $26 million with adjusted EBITDA reported at $31 million. Net debt fell to $223 million already, which makes that leverage concerns are no major issue. The company posted earnings of $1.30 per share, with earnings trending at a run rate around $5 per share.

A Bolt-On Deal

Early in October, Olympic Steel announced the bolt-on purchase of Central Tube & Bar, a provider of fabricated tube and bar products, serving a wide range of industries. No purchase price has been announced, but with a $40 million sales contribution, the consideration is likely manageable.

This revenue number is equivalent to about 1-2% of sales, which trend around $2.3 billion per annum here. With Olympic Steel commanding an enterprise valuation at just around 0.3 times sales, the purchase price of Central Tube & Bar will likely run in the (tens of) millions of dollars.

The reality is that 2023 so far has turned out to be as expected, although I am surprised to see shares up some 50% year to date. The company has seen leverage come down amidst slower demand and earnings have stabilized around $5 per share here.

This is generally positive, and while debt has come down a long way, there still is some debt. Olympic Steel, Inc. shares have seen some multiple inflation, making me cautious to get involved here, as I am not impressed by the performance, including the Metal Fab deal.

Hence, this remains a show-me story here, as I am not keen on getting onboard Olympic Steel, Inc. here.

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