* All data are as of the close of Tuesday, January 27, 2015. Emphasis is on company fundamentals and financial data rather than commentary.
Economic slowdowns in Europe, China, and the global energy sector have nearly doused the fires in the furnaces of the Steel & Iron industry, as per the graph below. Over the past three months, shares of the three largest U.S. companies in the space - Nucor Corporation (NYSE: NUE) [beige], Steel Dynamics Inc. (NASDAQ: STLD) [purple], and Reliance Steel & Aluminum Co. (NYSE: RS) [orange] - have all fallen dramatically, losing 16%, 22% and 20% respectively.
Much of the slowdown is being attributed to a shrinking demand for steel and iron by resource companies, such as miners and oil and gas producers. Surplus stockpiles in commodities such as copper, oil and gas have slowed production and eliminated the need for facility expansions.
The need for expanding transport networks through new rail lines, new railcars and new ships - which had been unable to keep up with transportation demands up until a year ago - has also been reduced, lowering the demand for steel and iron all the more.
While falling energy prices generally boost economies over time, such rapid plunges over a short period of time as we have seen lately - with oil falling nearly 58% from $107 a barrel at the end of June of 2014 to near $45 recently - has produced more harm than good over the immediate term, with a rapid shutting-off of projects, laying-off of workers, and putting-off of expansion plans.
But indications are that basic materials companies should rebound rather quickly and sooner than most other industries, given the position of basic materials at the base of nearly every production tree. Monetary stimulus recently announced by the European Central Bank last week should begin to stimulate the European economy much as the U.S. Federal Reserve's programs helped pull America out of its slump in 2009. And even though the strong U.S. dollar is dampening foreign demand for U.S.-made materials and goods, the U.S. Fed will still be keeping interest rates low for a while, keeping the cost of doing business in America down.
For these reasons, the forecast is for U.S. industrial production to grow quite impressively at its fastest pace since 2010, as per the graph below. Where industrial production has ranged from +2.5% to +5% annually over the past five years, the forecast going forward is for even stronger growth by an annualized +5.26% (Q1-15), +5.45% (Q2-15), +5.44% (Q3-15), and +5.24% (Q4-15), with an annual average of +5.02% out to 2020.
This means the demand for basic industrial materials such as steel and iron should increase soon. Analysts are already anticipating strong earnings growth for the Steel & Iron industry as tabled below, where green indicates outperformance while yellow denotes underperformance.
Over the next two quarters and for the next reporting year (2015), the industry's earnings are expected to grow at some 2.50 to 9.13 times the S&P's average earnings growth rate.
Longer term, however, analysts expect a slight slowdown in the Steel & Iron industry, with earnings growth projected to underperform the broader market's by 5 percentage points annualized over the next five years.
This slowing over time is likely due to current forecasts not yet factoring-in ECB stimulus in Europe, which was announced only a week ago. Once the more than €1 trillion over 18 months at a rate of €60 billion per month starts making its way into the economy, we could expect all basic materials industries' earnings estimates over the longer term to rise as well.
Zooming-in a little closer, the three largest U.S. companies in the space are expected to split perform rather starkly, as tabled below.
Where Dynamics and Nucor are projected to follow the industry's course rather closely, with strong growth near term slowing slightly longer term, Reliance is expected to bend under pressure near term as it under-grows all including the broader market, before outgrowing the market longer term - though still lagging behind its competitors.
Over the immediate term, the strongest growth is expected to come from Dynamics, which is expected to outgrow the broader market at some 3.77 to 10.82 times its growth rate. Over the longer term, the prize goes to Nucor which is anticipated to grow at 3.77 times the S&P's average rate annually over the next five years.
Yet there is more than earnings growth to consider when sizing up a company as a potential investment. How do the three compare against one another in other metrics, and which makes the best investment?
Let's answer that by comparing their company fundamentals using the following format: a) financial comparisons, b) estimates and analyst recommendations, and c) rankings with accompanying data table. As we compare each metric, the best performing company will be shaded green while the worst performing will be shaded yellow, which will later be tallied for the final ranking.
A) Financial Comparisons
• Market Capitalization: While company size does not necessarily imply an advantage and is thus not ranked, it is important as a denominator against which other financial data will be compared for ranking.
• Growth: Since revenues and expenses can vary greatly from one season to another, growth is measured on a year-over-year quarterly basis, where Q1 of this year is compared to Q1 of the previous year, for example.
In the most recently reported quarter, Dynamics delivered the greatest trailing revenue growth year-over-year, Nucor delivered the greatest trailing earnings growth, while Reliance delivered the least in both.
• Profitability: A company's margins are important in determining how much profit the company generates from its sales. Operating margin indicates the percentage earned after operating costs, such as labor, materials, and overhead. Profit margin indicates the profit left over after operating costs plus all other costs, including debt, interest, taxes and depreciation.
Of our three contestants, Reliance operated with the widest profit margins, where Dynamics operated with the widest operating margins. At the narrow end of the scale, Dynamics and Nucor split the narrowest margins between them.
• Management Effectiveness: Shareholders are keenly interested in management's ability to do more with what has been given to it. Management's effectiveness is measured by the returns generated from the assets under its control, and from the equity invested into the company by shareholders.
For their managerial performance, Nucor's management team delivered the greatest returns on assets and equity, while Dynamics' team delivered the least.
• Earnings Per Share: Of all the metrics measuring a company's income, earnings per share is probably the most meaningful to shareholders, as this represents the value that the company is adding to each share outstanding. Since the number of shares outstanding varies from company to company, I prefer to convert EPS into a percentage of the current stock price to better determine where an investment could gain the most value.
Of the three companies here compared, Reliance provides common stock holders with the greatest diluted earnings per share gain as a percentage of its current share price, while Nucor's DEPS over current stock price is lowest.
• Share Price Value: Even if a company outperforms its peers on all the above metrics, however, investors may still shy away from its stock if its price is already trading too high. This is where the stock price relative to forward earnings and company book value come under scrutiny, as well as the stock price relative to earnings relative to earnings growth, known as the PEG ratio. Lower ratios indicate the stock price is currently trading at a cheaper price than its peers, and might thus be a bargain.
Among our three combatants, Dynamic's stock is the cheapest relative to forward earnings and 5-year PEG, where Reliance's stock is cheapest relative to company book value. At the overpriced end of the scale, Nucor's stock is the most overvalued relative to earnings and company book, while Reliance's stock is the most expensive relative to PEG.
B) Estimates and Analyst Recommendations
Of course, no matter how skilled we perceive ourselves to be at gauging a stock's prospects as an investment, we'd be wise to at least consider what professional analysts and the companies themselves are projecting - including estimated future earnings per share and the growth rate of those earnings, stock price targets, and buy/sell recommendations.
• Earnings Estimates: To properly compare estimated future earnings per share across multiple companies, we would need to convert them into a percentage of their stocks' current prices.
Of our three specimens, Dynamics offers the highest percentage of earnings over current stock price for the current quarter and the next reporting year (2015), while Reliance offers it for the next quarter and the current reporting year (2014). At the low end of the spectrum, Nucor offers the lowest percentage for all time periods.
• Earnings Growth: For long-term investors this metric is one of the most important to consider, as it denotes the percentage by which earnings are expected to grow or shrink as compared to earnings from corresponding periods a year prior.
For earnings growth, Dynamics offers the greatest growth in the current and next quarters and the current and next years, where Nucor offers it over the next five years. At the low end of the scale, Reliance offers the least growth in all time periods.
• Price Targets: Like earnings estimates above, a company's stock price targets must also be converted into a percentage of its current price to properly compare multiple companies.
For their high, mean and low price targets over the coming 12 months, analysts believe Reliance's stock offers the least upside potential and least downside risk, while Dynamic's offers the greatest upside and Nucor's offers the greatest downside.
It must be noted, however, that all three companies' stocks are already trading below their low targets. While this may mean increased potential for sharp moves upward, it may warrant reassessments of future expectations.
• Buy/Sell Recommendations: After all is said and done, perhaps the one gauge that sums it all up are analyst recommendations. These have been converted into the percentage of analysts recommending each level. However, I factor only the strong buy and buy recommendations into the ranking. Hold, underperform and sell recommendations are not ranked since they are determined after determining the winners of the strong buy and buy categories, and would only be negating those winners of their duly earned titles.
Of our three contenders, Dynamics is best recommended with 3 strong buys and 12 buys representing a combined 83.33% of its 18 analysts, followed by Reliance with 4 strong buy and 2 buy ratings representing a combined 50% of its 12 analysts, and lastly by Nucor with 2 strong buy and 6 buy recommendations representing 40% of its 20 analysts.
Having crunched all the numbers and compared all the projections, the time has come to tally up the wins and losses and rank our three competitors against one another.
In the table below you will find all of the data considered above plus a few others not reviewed. Here is where using a company's market cap as a denominator comes into play, as much of the data in the table has been converted into a percentage of market cap for a fair comparison.
The first and last placed companies are shaded. We then add together each company's finishes to determine its overall ranking, with first place finishes counting as merits while last place finishes count as demerits.
And the winner is… Dynamics with an ironclad victory, outperforming in 14 metrics and underperforming in 6 for a net score of +8, with Reliance proving less reliable, outperforming in 10 metrics and underperforming in 13 for a net score of -3, and Nucor melting in the heat of competition, outperforming in 7 metrics and underperforming in 13 for a net score of -6.
Where the Steel & Iron industry is expected to outperform the S&P broader market substantially this and next quarters, significantly in 2015, then underperform notably beyond, the three largest U.S. companies in the space are expected to split perform in earnings near term, with Dynamics and Nucor strongly beating the broader market while Reliance under-grows. All three are then expected to outgrow the S&P's average longer term, with Nucor leading the way.
Yet after taking all company fundamentals into account, Steel Dynamics Inc casts the strongest financial figures, given its lowest stock price to forward earnings and 5-year PEG, highest trailing revenue growth, widest operating margin, highest EBITDA over revenue, highest future earnings over current stock price this quarter and next year, highest future earnings growth overall, best high and mean price targets, and most analyst buy recommendations - decisively winning the Steel & Iron industry competition.