2023-03-14 11:13:24 ET
Summary
- Hedgeye released a short report against Steel Dynamics, Inc.
- I underline some key common-sense features of when you should and should not short a stock.
- Also, I recognize some aspects of Hedgeye's short thesis where I agree.
Investment Thesis
Steel Dynamics, Inc. (STLD) was on the receiving end of a Hedgeye short report yesterday. While there are some merits to the concerns raised by Hedgeye, I believe that the short report as a whole is unjustified.
Furthermore, despite Hedgeye's prominence on the short side, I believe that on this occasion, there's little merit behind this short thesis.
If Hedgeye hasn't unloaded the (presumed) short position in the coming few weeks, I believe they could rapidly mount significant losses.
On balance, although I recognize that I am biased on STLD since I have been declaring that the stock is cheap for nearly a year, I simply struggle to see the validity of this short report.
The Assertions in the Short Report
The short report makes 3 assertions.
- Steel cycle will turn lower, as it does, sooner or later.
- Construction will weaken
- Credit is tightening.
All three come together to drive the downfall of STLD. Now, before we go further, allow me to lay out 3 assertions of my own about when you don't short-sell a stock.
Firstly, you don't short a stock that has a lot of momentum behind it.
In the past year, STLD has massively outperformed the S&P500 ( SPX ). That insight alone tells you that there's something positive happening, and without going further, to short into strength is a tough game.
Secondly, you don't short a stock where the sell side is upwards revising their revenue consensus targets with time.
To successfully short a stock, you need to be either exceptional and have a strong reputation as a successful short. Or have other investors and analysts share your general view. Common sense shows that on this occasion, shorts have none of these 3 critical ingredients.
Next, my third argument of when you don't short a stock is when the balance sheet is strong.
What you see here is that STLD's debt profile holds no significant maturities in the next few years.
In fact, its total maturities over the next 2 years amount to $800 million compared to more than $2 billion of cash on the balance sheet.
On the other hand, w here I do agree with the shorts is that right now financial conditions are tightening. That is, of course, of concern, and I don't have a strong enough rebuttal on that front.
But to go ahead and build a short thesis on that consideration alone? Surely, there are many substantially better opportunities to short on that basis?
Another reason why I don't believe that shorts have a compelling argument is that the need for steel isn't going to meaningfully diminish in the next 3 to 5 years. Here's why.
Yet Further Considerations, Demand for Steel is More Secular than in Previous Cycles
Before we go much further, note this. In 2022, the cost structure for North American steel producers was atrocious. In addition to natural gas prices skyrocketing, which were one of the major input costs in the production of steel, there was also raging inflation that was permeating the whole steel industry.
As we now look ahead to 2023, I think that the majority of sensible predictions call for considerably reduced natural gas prices together with more moderate inflation.
And lastly, the driver of steel demand is the energy transition . This is not a buzzword. It's a real demand driver. We are navigating through a challenging time, where we recognize the massive need to decarbonize our energy infrastructure.
We desperately need to ramp up our renewable infrastructure. We need more solar panels, and wind turbines, as well as modernizing our energy grid, so we can electrify our world. For all these aspects, we are going to need substantially more steel over the next few years.
On what basis can we today make the case that steel demand is at a peak and bound to fall?
The Bottom Line
There are countless signals talking about the economy headed for a recession. This is one element where I wholeheartedly agree with Hedgeye. However, the rest of the short thesis doesn't appear to hold much water.
For further details see:
Steel Dynamics: Hedgeye Short Report, I Don't Agree