2023-04-20 03:51:13 ET
Summary
- Steel Dynamics misses on the top line. Why that is a non-issue.
- The great energy transition will not happen without steel.
- Steel Dynamics is cheaply valued at 7x EPS, with record liquidity, and returning capital to shareholders.
Investment Thesis
Steel Dynamics ( STLD ) missed on the topline and this led investors to sell this stock. I argue that selling STLD stock while it's priced at about 7x EPS is not the right course of action.
In fact, I believe that the remainder of 2023 is well set up to shine positively and deliver an attractive upside for Steel Dynamics. Here's why.
Grid Electrification Requires Steel
Steel's prospects are often intimated as being tied to China's real estate market. And clearly, China's real estate is a meaningful consumer of steel, which I estimate to account for about 20% to 25% of the total global steel consumption if we assume that 50% of the global steel consumption ends up in China.
However, my critical contention is that outside of China, demand for steel in the near term looks strong and is equally important. Why?
Because steel is a vital metal needed for our great energy transition. Everything to do with our Future Energy, meaning wind turbines, solar panels, deglobalization trends, building LNG terminals, and reshoring of our semiconductor fabrication facilities (see CHIPS and Science Act), requires tons of steel.
Let me put it more concretely, the great energy transition will not move beyond aspirations to action without steel. This led Steel Dynamics' management to declare,
The automotive, non-residential construction, energy, and industrial sectors continue to lead demand.
[...] the continued onshoring of manufacturing, coupled with the robust U.S. infrastructure program and industrial build-outs, supports strong demand for 2023 and beyond.
In sum, there's plenty of demand for steel, particularly outside of China.
Revenue Growth Rates Should Improve
STLD revenue growth rates
Steel Dynamics' Q1 2023 revenues were down 12% y/y. Given the strong Q1 of last year, it would always be a challenging period to compare against.
But with each passing quarter of 2023, the comparable periods rapidly become easier, so that just over 90 days from now, starting Q3 2023, the quarterly comparison becomes dramatically easier, leaving Steel Dynamics well-positioned to impress investors in 6 months' time.
As you know, Steel Dynamics has substantial fixed costs. This means that operating leverage works both ways. When revenues grow, the bottom line sizzles. But when revenues are negative, its bottom line EPS figures meaningfully drop. This all translated into Steel Dynamics' EPS figures on an adjusted basis, being down 32% y/y to $4.01.
Increased Capital Allocation
Recall, back in February, Steel Dynamics announced a 25% dividend raise.
In fact, as I've made the case previously, Steel Dynamics' laddered debt profile, with no meaningful near-term maturities, allows the company to continue returning excess capital to shareholders.
STLD Q1 2023
Not only does Steel Dynamics offer a dividend, albeit small, of 1.6%, during Q1 2023, Steel Dynamics also repurchased about 1.7% of its shares during this "weak " quarter.
STLD Q1 2023
However, I argue that with Steel Dynamics' prospects for the remainder of 2023 looking even better than Q1 2023, I believe that there could be even more share repurchases coming throughout 2023.
In fact, keep in mind that not only Steel Dynamics ended Q1 2023 with record liquidity , but despite its share repurchases and dividend payouts, the cash on its balance sheet went from $1.2 billion in Q1 of last year to $2.3 billion in Q1 2023.
STLD Q1 2023
In sum, Steel Dynamics is dynamically charged and swimming in cash.
STLD Stock Valuation -- Approximately 7x EPS
While investors continue to fear and anticipate a recession, Steel Dynamics continues to report strong bottom-line free cash flows.
It's practically impossible to predict what Steel Dynamics' EPS figures will come out in 2023 since everything is contingent on steel pricing.
But if we were to assume that steel prices would not retrace lower and take out the October lows, I believe there's a very fair chance that Steel Dynamics could report at least $14.54 of EPS, in line with the current Street estimates.
After all, Q1 2023 is typically the low season for Steel Dynamics, and Steel Dynamics already reported more than a quarter of its full-year EPS expectations.
The Bottom Line
At the most surface level, it was rather a lackluster quarter. But once we consider where investors' expectations have been for Steel Dynamics as we headed into this quarter, with the share price already down more than 20% in the last two months, I believe investors have not got much to be concerned about.
In fact, I believe that the risk-reward here looks mightily attractive.
My final request is this. If anyone knows whether Hedgeye is still short on this stock , please let me know in the comments section.
For further details see:
Steel Dynamics Earnings: Domestic Outlook Is Strong, Stock Is Cheap