CA - Stelco: Less Followed Steel Company Will Sizzle

Summary

• Stelco is a Canadian-based steel company. What the business lacks in investors following it makes up for with its high profitability.
• Stelco's balance sheet is squeaky clean. Furthermore, as of Q3 2022, approximately a third of its market cap was made up of cash. And it's debt-free too.
• Also, Stelco has a 3.2% dividend yield and is aggressively repurchasing its shares.

Investment Thesis

Stelco ( STLC:CA ) (STZHF) is a dividend-paying steel stock. Not only a dividend-paying stock, but one that has recently raised its base dividend. And on top of that, it's aggressively repurchasing its shares.

No investment is without risk. And investing in a small cyclical steel company can be particularly risky. Indeed, I highlight some noteworthy risks readers should be mindful of.

Nonetheless, I'm bullish on Stelco.

What's Happening in Steel?

Steel companies have reported very strong results in the past few days. Here's my report on Steel Dynamics ( STLD ). While the results out of Nucor ( NUE ) echo this sentiment too.

The message is clear, while many investors thought that the oncoming recession would kill steel demand, but that's not happening.

The reason why that's happening is that steel demand has recently increased, due to the reopening of China. China, particularly its real estate market, is the biggest consumer of steel.

The move by the Chinese government to support its overleveraged and slumped real estate market has signified to investors that demand for steel has found a bottom.

Why Stelco?

The reason why I believe that Stelco makes for a strong investment is that it has a 3.2% base dividend yield. This base dividend has recently been raised in Q3 2022 by a whopping 40% y/y.

This consideration in and of itself should carry its weight in gold (or steel, if you prefer).

Next, Stelco holds no debt. Well, no debt for practical purposes, something immaterial. And about CAD$1.3 billion of cash and equivalents (approximately $1 billion). This means that roughly a third of its market cap is made up of cash.

And on top of that, I should note that Stelco had repurchased 29% of its market cap in 2022, as of the time of its Q3 results.

However, keep in mind that 2022 was brutal for the steel industry. And even in this case, not only did Stelco buyback nearly 30% of its shares, but it also had a one-off special dividend of CAD$3 per share. Obviously, this special dividend can't be banked on going forward.

But that insight missed the point. It shows that this company is more determined to return capital to shareholders than it is set on empire building.

Consequently, given what we've discussed above about the whole sector now turning around, I'm of the opinion that a similar special dividend could be on the cards in 2023.

Risk Factors Worth Considering

Steel is cyclical. That means that even though steel prospects are hot right now, excessively high prices will lead to a massive ramp-up in steel production from marginal producers.

The market is always looking ahead six months. That means that if there are rumors of increased steel production starting to surface, smaller companies such as Stelco will be negatively impacted.

Furthermore, steel is a commodity product. That means that Stelco is mostly competing on price. And given its small size, it will struggle to undercut some of its peers, particularly in China where the cost of its workforce can be materially lower than that of Stelco, based in Ontario.

The Bottom Line

The way I'll sum up Stelco is as a debt-free steel producer that is highly profitable and resolute on returning capital to shareholders.

The business clearly operates with a structural cost advantage compared with its peers, as Q3 made Steelco's performance the seventh consecutive quarter where it had the highest adjusted EBITDA margin of any U.S. or Canadian reporting steelmaker.

Yes, there are issues with investing in a cyclical steel company, so investors should appropriately size this position on that consideration. But overall, there's a lot to be bullish about here.

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