TMST - TimkenSteel: Key Macro And Business Implications To Monitor

Summary

• Within the steel industry, TimkenSteel Corporation has a Hold rating as the company's outlook remains unclear due to macroeconomic and corporate factors.
• Investors are awaiting signs that melt utilization will recover to early 2022 levels following the July 2022 explosion at TimkenSteel's Faircrest plant.
• The company expects demand for TimkenSteel steel products to be resilient in all end markets in 2023 amid the possibility of a mild recession.

Conflicting Factors Make It Difficult To Forecast How Steel Prices Will Develop

Today, more than ever, it is virtually impossible to predict the next evolution of the price of steel, one of the most widely used basic materials across industries worldwide, due to the numerous factors at play that work in the opposite direction.

Based on the current situation in the People's Republic of China, where the lifting of zero-tolerance measures against COVID-19 will lead to a strong recovery in housing, construction, mining and manufacturing activities, global demand for steel products may gain momentum, as China is the world's largest consumer of “apparent steel.”

Statista.com analysts clarify that the apparent steel metric is used to measure demand for steel products, as the metric is calculated by subtracting net exports of steel products from production plus net imports.

But with sanctions on Russia and the decline in U.S. industrial production and U.S. retail sales , not to mention job cuts at multinationals and the recession risk in the European Union due to the ECB's hawkish stance , the headwinds will not only further impact steel demand and weigh on various end markets, but could also depress steel product prices.

Therefore, it would be prudent not to go beyond a Hold stance on shares of publicly traded companies manufacturing steel products, as very uncertain timing means a very high risk of misjudgment.

TimkenSteel Corporation Stock Is A “Hold”

For example, TimkenSteel Corporation ( TMST ) is given a Hold rating, as the company's prospects remain unclear due to the following factors.

This is due, among other things, to lower shipments and market-driven reductions in per tonne surcharges impacting profitability, while demand for steel products is still rated by the company as strong in all end markets based on customer backlogs and 2023 production capacity commitments.

TimkenSteel Corporation In The Basic Materials Sector

Headquartered in Canton, Ohio, TimkenSteel Corporation produces high-performance carbon steel and alloy steel products from recycled scrap metal at its Canton manufacturing facility.

The company offers its products to a variety of end markets in the automotive, energy, industrial equipment, mining, construction, railroad, defense and agriculture industries.

The company's products consist primarily of alloy steel bars (diameter up to 16 inches), seamless mechanical tubing, and various fabricated components.

With more than 100 years of experience in manufacturing high-quality steel tubes, TimkenSteel Corporation is a leading manufacturer in the United States bar steel industry with total sales of $1.3 billion in 2021 and employs approximately 1,725 people.

The Situation Of The Operation As Of Q3 2022

The company recently reported an issue related to lower sales volumes, the main cause being the incident at TimkenSteel's Faircrest plant in July that impacted the availability of the inventory of steel products for shipment and resulted in lower shipments.

On July 26, 2022, three workers were seriously injured in the explosion at TimkenSteel's Faircrest plant. The reason for the incident was the fire that broke out in the area of the melting plant, in which a blast furnace was involved. Several other incidents occurred in the past and resulted in TimkenSteel being subpoenaed by OSHA, part of the U.S. Department of Labor, for safety violations.

The melt's utilization rate was halved as a result of the incident, and subsequently the operational shortcoming was reflected in uncovered fixed costs which, together with other costs from ramping up the production and higher maintenance and repair costs, reduced profitability.

In addition, there are currently factors such as inflation, for which the company has little leeway, but which nonetheless affect operating costs.

Relevant Financial Results From Q3 2022

So, for the third quarter of 2022, the company reported net sales of $316.8 million, down 7.8% year-on-year, and on an adjusted basis, the company reported a net loss of $4.1 million, or a diluted net loss of $0.09 per share. On an adjusted basis, the company also reported an EBITDA of $10.8 million, down 85% year over year, while the EBITDA Margin of 3.4% of total sales compared to 20.9% in the prior-year quarter.

TimkenSteel Corporation shipped 158,500 tons of steel products in Q3 2022, down 25% from Q3 2021 due to the melt incident in July 2022.

As of September 30, 2022, total cash and cash equivalents reached a record $262.5 million. Total liquidity, including the credit facility due September 30, 2022, was $487.2 million.

The financial position of TimkenSteel Corporation appears to be on solid footing. This rating is primarily driven by an Interest Coverage Ratio of 54.4, indicating that the US steelmaker has no difficulty paying interest charges due to its borrowings. The interest coverage ratio is calculated as a 12-month trailing operating income of $217.7 million divided by a 12-month trailing interest expense of $4 million . The Altman Z-Score, which measures the likelihood of the company going bankrupt, currently shows no risk as it indicates safe areas at 3.35 . If the ratio is less than or equal to 1.8, there is a high risk of bankruptcy within a few years, associated with financial distress. A ratio that fluctuates between 1.8 and 3 warns that the company may go bankrupt, but this is less likely than in areas of financial distress.

Operations Improve

However, melt utilization is gradually improving due to progress in monthly production ramp-ups, and if the utilization ratio has recovered to 60% in the last quarter of 2022, that means the asset has a high chance to return to pre-incident levels of around 85% in the first quarter of 2023.

The operating and financial results for the last quarter of 2022, which TimkenSteel Corporation is expected to publish on February 23, 2023, will provide a good indication of whether the melt's utilization rate is on track to achieve above recovery level.

If the fourth quarter 2022 earnings report indicates that the company is bullish on the recovery in melt utilization rate, the information could potentially have a positive impact on the stock price as the restored facility helps address issues that have hitherto impacted inventory levels and the profitability of the operation.

If the melt utilization recovery is on track, TimkenSteel Corporation would send a strong signal to its shareholders, who are waiting for their holding to catch up on a backlog of customer orders and exploit production capacity.

With the Q3 2022 earnings report, the U.S. steelmaker estimated that more than 300,000 tons of steel products had to be shipped, while production capacity was already almost fully deployed for customer orders in 2023.

Inflationary Pressures and the Likelihood of a Soft Landing for the Economy

There are inflationary or market factors that may affect the TimkenSteel Corporation's profitability through increased expenditure on inputs or unfavorable changes in the surcharge revenue per ton and in the prices of the steel products the company sells in the various markets.

The profitability of TimkenSteel Corporation and other competitors is being challenged by a highly uncertain environment that leaves shareholders with a clear question mark as to whether prices and other terms will be more or less favorable in 2023 than in 2022. In terms of annual price agreements with customers, TimkenSteel Corporation expects better prices in 2023 than in 2022.

While inflationary pressures should ease on an effectively aggressive rate hike by the US Federal Reserve, which may decide to implement lower rate hikes from now onward, but not the ECB, which is expected to proceed with 50 basis point hikes.

Should a mild or no recession materialize, with the first scenario being more likely than the second, the impact on steel demand could be much smaller than expected.

About the supply side, this is currently being impacted by a sharp drop in shipments from Brazil 's key producers and disruptions to stable exports from Australia, a leading steel-producing country in the world, due to Tropical Storm Ellie.

So, supply and demand could create a very attractive pricing environment for TimkenSteel Corporation.

Stock Valuation

Driven by an 18% rise in the price of steel, TimkenSteel Corporation shares have also recovered somewhat from the slump that occurred in the early June 2022 to late September 2022 period, and at the time of writing, they were trading at $18.85 per share.

The stock has a market cap of $825.80 million and a 52-week range of $12.67 to $26.23. Shares are almost on par with the long-term trend of the 200-day simple moving average line of $18.54. They are also below the middle point of $19.45 of the 52-week range.

As a result, TimkenSteel Corporation shares are trading at low levels compared to recent market valuations.

The near-term outlook for steel product demand and prices is encouraging and the company should be able to capitalize on the outlook when it resumes operations at its Faircrest, Ohio plant, which is recovering from the July accident in 2022.

With the fourth quarter 2022 earnings results to be released on February 23, investors will have a much clearer picture of the situation regarding the melt utilization of the Faircrest facility in Ohio.

The fourth-quarter 2022 earnings report should show another step forward that would position TimkenSteel well to capitalize on robust demand conditions in its end markets and expectation of better pricing in 2023 than in 2022.

Investors could then consider the idea of increasing the number of shares by paying a price that is unlikely to be much different from the current one, as the high level of uncertainty due to the coexistence of global macroeconomic and geopolitical factors is causing investors to just hold US-listed steelmakers.

In addition, investors will receive more signals from central bank policymakers about the probability of a recession and its extent for 2023. The signal from ECB member Francois Villeroy de Galhau that the EU should avoid a recession, increases the likelihood of a mild recession that would not create the feared bad impact on demand for steel products. Instead, the demand for steel products is likely to continue strengthening following the end of China's zero-tolerance policy on COVID-19, followed by major initiatives to boost construction and give stimuli to the housing demand, according to Trading Economics .

Of course, it's also possible that the above catalysts don't kick in, but the risk is macroeconomic rather than corporate. Therefore, it is prudent to hold shares of TimkenSteel Corporation and see if central banks continue to signal the possibility of a soft landing in the economy.

Conclusion

TimkenSteel Corporation appears to be on track to restore melt utilization in Ohio after an incident in July 2022 that injured three workers. Following this, the company should regain steel product supplies and improve profitability given the robust end-market outlook and expected supportive pricing environment in 2023.

However, the stock is not yet a Buy, but a Hold.

It is prudent to await confirmation of the fourth quarter earnings report to see if this quarter's melt utilization could already return to pre-incident levels.

In addition, despite some recession, demand for steel products could remain strong in 2023. More signs in this direction are likely to emerge in the coming weeks, prompting investors to consider increasing their position in TimkenSteel Corporation stock.

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