CA - Stelco: Steel Company Fully Focused On Shareholder Returns

2023-03-21 18:49:05 ET

Summary

• Stelco Holdings Inc. has a habit. It announces buybacks and actually repurchases a massive amount of shares so that by the end of the year, the total number of shares drops significantly!
• Stelco's balance sheet is debt free. Also, 25% of its market cap is made up of cash.
• What's the catch? Steelco hasn't got a large following and is traded on the pink sheets.

Investment Thesis

Stelco Holdings Inc. (STZHF) is fully focused on returning capital to shareholders. Case in point, in 2022, Stelco repurchased 29% of the company. Although, note that this return of capital does not account for either its regular dividend or special dividend that was offered in 2022.

Meanwhile, despite its stock soaring on the back of its latest results, Q4 2022, the stock has now given back many of the gains from its Q4 results .

Consequently, this is my contention: take advantage of the weakness in this share price.

Because Stelco's story isn't over yet. There's a lot to be bullish about here.

Why Invest In A Steel Company?

Steel is the metal of the modern grid. Also, wind power and solar power (meaning photovoltaic systems ''PV'') are the two preferred technologies to embrace the renewable transition.

The rapid adoption of these two renewable energy sources requires massive infrastructure construction, which will drive massive demand for steel resources. Below is a simplified schematic of this.

In essence, everything that we need to progress in our electrification, from wind turbines to solar panels, storing energy and transmitting to the modern grid, can't achieve significant progress on the path to mass adoption of renewable energy without steel (and copper and aluminum).

Risk To Investing In Stelco?

Stelco is a small, under-followed company. Consequently, not many shares change hands each day.

And so, there's limited liquidity, which puts off large institutions from getting involved with this stock.

Why Invest in Stelco?

If you are a new or an experienced investor you know that the first and most important consideration of investing in any commodity business is to spend a few moments on the company's balance sheet . This doesn't take long.

But without spending that moment on the company's balance sheet, you are flying blind. And that's never going to get you where you need to be.

Accordingly, not only is Stelco's balance sheet holding plenty of cash, but to put its cash balance in perspective it amounts to 25% of its market cap!

Incidentally, during Stelco's recent earnings call, management said ,

We have built a strong business that was able to complete these investments only with cash generated from our operations while continuing to deliver industry-leading capital returns to our shareholders.

And we can see the reflection of the above quote in the fact that its balance sheet is debt free.

Furthermore during the Q&A portion of the call management commented,

[...] our CapEx will certainly be lower than last year. As you know, we've gotten through all of the major capital projects. We maintain, as we've talked about, really rigorous return requirements for looking at new projects.

And so we're going to be much closer to kind of our maintenance mode, possibly with some small things here and there, but nowhere near that CAD$200 million.

Having looked through its financial statements all the way back to 2018, I am not able to figure out what's maintenance capex actually is. But I must form a view on this consideration, so I'll assume that the total capex in 2023 will be approximately CAD$180 million until management provides a better figure.

STZSF Stock Valuation -- 9x FCF

The thing with investing in a capital-intensive business with a lot of fixed assets is that operating leverage can dramatically swing one way, or another, on the back of small changes to the company's revenue line.

Nevertheless, according to my rough estimates, I suspect that Stelco's free cash flow this year could probably be at least CAD$200 million. Here is my math, I've assumed that CAD$82 million of EBITDA is the weakest quarter of 2023. After all, steel prices have moved significantly higher since the lows set in November and now appear stable.

Hence, I've assumed that Stelco's total EBITDA in 2023 reaches CAD$500 million. Meanwhile, assuming that the capex figure reaches CAD$180 million, this means that Stelco's free cash flow this year reaches CAD$320million.

Incidentally, I should note that my estimate is substantially lower than what analysts presently expect.

Thus providing my estimate with a large margin of safety.

The Bottom Line

Stelco openly declares that it will repurchase up to 6.0% of its stock in 2023. Given that Stelco repurchased 29% of its stock last year, I believe that we can assume that Stelco isn't like tech businesses where they announce a large repurchase plan, but rarely complete them. And when tech companies do complete their repurchase programs, somehow at the end of the year, the number of shares outstanding somehow actually ends higher.

As you can see in the table that follows, that's clearly not the case with Stelco.

In sum, Stelco Holdings Inc. has a regular dividend of 3.2%. It is buying back 6% of its stock. It's priced at approximately 9x this year's free cash flows, although the multiple is most likely meaningfully cheaper than this, and 25% of its market cap is made up of cash.

The bearish aspect to consider here is that steel is incredibly cyclical and sensitive to the underlying economy. Whatever you decide, good luck.

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