Summary
- Olympic Steel is set to have a strong 2023, as steel demand continues to increase.
- Olympic Steel is one of the largest steel service centers, which makes it have low capex requirements.
- Olympic Steel is priced around 4x EBITDA. A very cheap multiple.
Investment Thesis
Olympic Steel ( ZEUS ) has seen the company's fundamentals dramatically improve in the past several years.
What you see in the graphic that follows is what appears to be a company that's over-earning right now.
And the old adage that says you don't buy steel stocks going into a potential recession has worked wonders in fully compressing ZEUS's multiple down to 4x EBITDA. However, I believe that line of thinking isn't fully aligned with what's actually on offer.
Here's why ZEUS stock offers investors a compelling risk-reward and why I'm bullish on this stock.
What Recession?
In the graphic above, I've selected a few steel names. I've not cherry-picked the names, I've simply gone with U.S. Steel ( X ) that I own, plus a few other steel stocks.
Essentially, I've picked a few names to show that you only needed to figure out that steel was going to be a good investment, and you'd have beaten the S&P 500 ( SPX ) in the past 6 months.
Understanding Steel's Prospects
The graphic above reminds investors of two trends.
Firstly, steel prices since the start of 2022 have been trending lower. In fact, not shown in the graphic above but steel prices have moved substantially lower from the highs it set back in 2021.
But as another adage says, the cure for low prices is low prices. Steel prices tumbled so hard in October, that prices immediately bounced back from the lows.
Now, as we look ahead, steel prices are coming back higher, even if the path isn't likely to be in a straight line.
So, What's Driving Steel Prices Higher?
There are two different drivers for steel prices.
There's China's great economic reopening. And within that driver, there's China's real estate market.
Essentially, investors believe that the demand for steel has reached a bottom thanks to the Chinese government's decision to support its slumped and heavily leveraged real estate sector.
To put some figures to it, if we were to state that somewhere close to 50% of all global steel consumption ends up in China, about 40% of that figure can be directly or indirectly tied to China's real estate market. Consequently, this means that 20% of all steel is consumed by the Chinese real estate market.
What that means is that, outside of China, there's a massive demand for steel. And this can be directly or indirectly tied to several elements.
There's deglobalization of supply chains, reshoring of factories, and the push to grow renewable energy, i.e., wind turbines and solar panels.
My point is that steel's prospects in 2023 are going to be less cyclical than many investors are presently pricing in.
ZEUS Stock Valuation - 4x EBITDA
Olympic Steel is one of the largest steel service centers in the US.
The business is meaningfully less capex intensive than steel manufacturers, as the business's cash flows are tied to a network of metal processing facilities, rather than involved in the construction of steel itself.
This distinction is important. Because Olympic Steel's cash flows are tied to its inventory build. Meaning that if steel prices go higher, the amount of working capital tied up in the business also increases, and by extension, ZEUS's free cash flows will go down.
As a point of reference, click on the graphic that follows and see the red arrows.
You can see massive swings in working capital from one year to the next. All that being said, as a point of reference, ZEUS's EBITDA ended 2022 at $152 million.
And given that the business has minimal capex, I believe that it's sensible to think of ZEUS as priced at somewhere around 4x EBITDA. A multiple that is really very low.
The Bottom Line
The biggest danger of investing in a commodity company is that management will squander capital. Sometimes down to hubris. Sometimes down to mismanagement. But in most cases, it's mostly because management and shareholders are not aligned.
That's not the case with Olympic Steel, as management holds about 15% of the company's stock .
To put it more concretely, management is highly motivated to do what's right for long-term shareholders in this company. And I believe that their actions in 2022 reflect that assertion, as they were extremely savvy to maximize free cash flow and bring down their debt by 49% y/y.
For further details see:
Olympic Steel: Yet Another Sizzling Steel Stock