ZEUS - Olympic Steel: Starting 2023 With A Big Deal

Summary

• Olympic Steel saw a profit boom in 2022, which appears to have ended.
• Strong earnings were funneled into working capital requirements as softer operating conditions should translate into a cash flow boom.
• In anticipation of this, Olympic announced a relatively larger deal at the start of 2023, providing few details in the process.
• Given the interesting developments, I am happy to pick up coverage, just not yet willing to initiate a position.

I have never covered Olympic Steel ( ZEUS ) on this platform before, but as the steelmaker is announcing a substantial deal (certainly in relation to the size of the company) this might be an opportune time to pick up coverage.

A Quick Intro

Olympic Steel is a North American metal service center, which was founded in the 1950s. Over the past nearly 70 years, the company has grown to generate $2.3 billion in revenues, driven by an employee base of 1,600 workers with activities organized across three segments.

The company is active in the Central and Eastern states of the US, where half of revenues are generated from carbon flat products, complemented by a substantial specialty metals flat products and a smaller tubular & pipe products business.

With exception to a small momentum run in 2008, shares have mostly traded in a $10-$30 range over the past fifteen years, albeit that shares have traded at higher levels since the outbreak of the pandemic. The company hopes to drive more consistent outperformance through differentiated product offerings and distinctive processing capabilities. Another distinguishing feature is that the leadership team holds nearly a fifth of the shares and that the company has hiked dividends for 17 years in a row, although a current $0.36 per share dividend payout is relatively low.

Thanks to some targeted acquisitions, the company has grown its footprint and margins since the 2009 recession. A $1.4 billion business in 2012 was actually seeing quite stable revenue results until the outset of the pandemic, after which strong (price) growth followed.

A Valuation Base

Let's pick up coverage early in 2021 when the company posted its 2020 results. Revenues fell from $1.6 billion to $1.2 billion as the company was hit hard by the pandemic, with operating earnings of $17 million in 2019 turning into a flattish number in 2020.

A year made a huge difference as 2021 sales nearly doubled to $2.3 billion as operating earnings exploded to $172 million, with profitability coming in ten times as high as 2019, which was a pretty normal year by the looks of it. Net debt rose to $218 million as the company has seen huge working capital requirements yet with EBITDA of $211 million that was hardly an issue. Somewhat ironic, volumes actually fell in 2021 as the growth was entirely driven by higher selling prices, driving the profit boom as well.

Momentum continued in 2022 with first quarter sales coming in as high as $696 million on which fat operating profits of $53 million were reported. Second quarter sales even came in at $709 million, with operating profits approaching $54 million. The boom appeared to have ended in the third quarter , a period in which sales came in at just $634 million, yet operating profits imploded to $19 million. Despite the big fall in profits, the company earned more than $7.50 per share already in the nine-month period, creating a huge earnings yield in relation to the share price.

With working capital requirements coming down a bit, net debt is stable at $234 million. That seems no issue with EBITDA posted at $140 million so far this year, albeit that the third quarter number only came in at $25 million, for a $100 million run rate. Similar to 2021, volume trends were again down so far in 2022. The company expected more headwinds for the fourth quarter, but as the operating performance drops, cash flow generation is typically stronger for such kind of business.

The 11.5 million shares started the year 2022 around the $20 mark, to have traded in a $20-$40 range in 2022, now exchanging hands at $34. This gives the company a market value just below the $400 million mark, although some debt is still apparent, of course.

Big Start to 2023

Despite the small concerns related to softer performance in relation to the debt held by the business, Olympic Steel started 2023 with a relatively big deal. The company reached a deal to acquire Wichita-based Metal-Fab in a $131 million deal, set to increase net debt to $365 million overnight, albeit that strong cash flow generation is expected in the fourth quarter.

Metal-Fab focuses on carbon-coated and stainless steel, as few details have been announced on the deal, which is a shame as the deal is substantial, equal to a third of the current market valuation of Olympic Steel.

The reality is that shares have not really moved in response to the big deal, but it is hard to react while no real information is provided on the business, for that we probably have to wait until the fourth quarter earnings results.

Concluding Thought

What we see now is that a $10 earnings per share run rate has probably fallen to $4 per share, more or less, and that Olympic Steel has proven to be quite volatile with its operating performance over the past years, albeit that some kind of improvement was seen.

Being very wary of debt and the cyclicality of the steel industry, let alone the declining volumes over the past two years, I feel more comfortable to be involved with larger and better-capitalized names, like Nucor ( NUE ) , although the latest deal is enough of a reason to keep coverage on Olympic Steel into 2023.

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