Although the last couple of quarters have been difficult ones for mini-mill operators Steel Dynamics (STLD) and Nucor (NUE), investors have actually been pretty enthusiastic on the stocks. Whether it's expectations of strength in markets like automobiles, energy, and construction or just a response to cyclical low valuations, Steel Dynamics is up more than 60% since early October lows. That's a big gain for non-owners to miss, but the question is how much is yet left to go.
A Surprisingly Strong End To The Year
Steel Dynamics warned the Street that numbers were too high back in December, but the company managed to do better than those revised expectations. Revenue fell 9% from the third quarter and operating income was cut by almost one-quarter, but the earnings per share came in at $0.14 - two cents above the high end of management's guidance range and three to four cents higher than most analysts'.
Certainly there were challenges and disappointments in the quarter. Average price per ton fell 5% and operating income per ton fell about 19% as the company saw lower margins from sheet steel. Steel Dynamics also had to absorb higher scrap costs and costs tied to a maintenance shut down at Iron Dynamics. That latter event cost the company $0.05 a share in operating income, though I would argue that it's better to have the maintenance downtime in quarters that aren't going to be so strong anyway.
New Projects Aimed At Growth And Margins
Steel Dynamics has been spending a fair bit of capital lately on projects that should have some solid long-term payoffs for investors. Mesabi Nugget (a joint venture between Steel Dynamics and Kobe Steel) helps the company control its iron costs (mini-mills like Steel Dynamics, Nucor, and Commercial Metals (CMC) need to supplement input scrap with iron), even though Steel Dynamics already runs some of the most cost-effective mills in the county.
A relatively new rail production capability has allowed the company to compete with the likes of Arcelor Mittal (MT) in this 1 million ton per year market (of which Steel Dynamics has less than 10%), while a separate venture is underway to produce copper wire as well.
Prices Firming And Demand Looking Better
Steel pricing has been firming up of late, particularly in the flat roll products that make up nearly two-thirds of Steel Dynamics' sales base. Pricing's a tricky thing, though. Steel companies are happy to announce price hikes on their output, but they rarely make announcements when customers push back and succeed in weakening or reversing those hikes.
It's worth noting, though, that even though heavy construction is still pretty weak (about one-third of the company's historic market), beams and rails are still profitable. At the same time, there are signs of life with automobile builders and heavy equipment manufacturers are still seeing solid demand in North America.
The Bottom Line
Unfortunately, that 60% rise from the fall of 2011 has taken Steel Dynamics off the "ridiculously undervalued" list. Based on some positive revisions in 2012's EBTIDA outlook and applying its historical average forward EV/EBITDA multiple, these shares should trade around $18 to $21. That's roughly 30% undervalued on today's price and arguably not enough for cyclical commodity company - even a great one with an excellent cost structure and some above-average growth prospects.
Remember, though, that expectations for 2012 are still pretty modest. If Steel Dynamics can take this end-of-year momentum and run with it (though steel market demand and pricing are clearly out of their control), the EBITDA numbers may be too low, and these shares may yet prove to be a good buy.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
