Olympic Steel Inc. - A Solid Value Play

Jul. 05, 2019 9:10 AM ETOlympic Steel, Inc. (ZEUS)3 Comments1 Like
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Summary

  • Olympic Steel Inc. has short-term headwinds that make it a good buy now for a long-term patient investor.
  • The firm is making a number of smart acquisitions and investments designed to increase margins and EPS.
  • We see over 35% upside over the next 18 months, making this company a market outperform.

Investment Thesis

Olympic Steel Inc. (NASDAQ:ZEUS) is a solid company to own at current prices. The firm has a number of attractive catalysts moving forward. This is in the form of acquisitions and focus on areas of the business with higher returns and margins. This will lead to better EPS and share price moving forward.

Catalysts

Acquisitions

ZEUS has grown as a company through smart strategic acquisitions. This included the acquisition of McCullough Industries in January 2019. The takeover has contributed to earnings already, with the business off to a strong start. This is the first manufacturer that the company has of metal-intensive branded products and ZEUS is looking to buy similar companies in the future. We believe that the acquisitions will be positive for EPS moving forward and generate a lot of synergies.

An example of this is through ZEUS using its existing service centre capabilities to benefit McCullough’s manufacturing process. The growth that is going to come from the two companies merging together, will be a positive catalyst for both earnings and the share price moving forward. It is worth noting as well that the profit multiples that ZEUS will see from the acquisition are much higher than its existing service centre returns.

High Return Focus

The acquisition of McCullough shows how the firm is focused on high-margin businesses, such as from the high multiples on offer compared to its existing service centre returns. This focus on identifying areas with higher returns will lead to better margins and EPS moving forward. This is another catalyst for the firm moving forward.

ZEUS has a new slitting line in Ohio, a new cut to length line in Illinois and fixed axis laser in CTI. These lines are focused on growing business in areas with higher returns and improving operating efficiencies. The benefits of these efforts could be seen in the solid Q1 results.

Solid Earnings Due To Focus

This is with net sales of $446 million in the recent quarter, up 20% YoY. This came from higher selling prices on average due to the focus on more profitable areas. This also came from higher volumes in the Specialty Metals and Pipe & Tube segments. This is due to recent capital investments and successful execution of growth initiatives. The firm invested heavily in the Specialty Metals area over the past 24 months and now everything is up and running, contributing to profitability. This is good for shareholders moving forward. The investments made in the Pipe & Tube area over the past few years are starting to pay dividends as well. The Pipe & Tube segment reported record first quarter sales and earnings as a result.

Dividend

ZEUS isn’t a company worth buying for its dividend. With that said the firm offers a 0.59% dividend at current levels, which will contribute to total annual results. This is the firm's 56th consecutive quarter dividend in a row. This means the company has paid a dividend for at least the past 4 and a half years.

Valuation

How is ZEUS rewarded for focusing on these profitable areas? With a P/E ratio of 5.41. The solid acquisitions and strategic focus in particular parts of the business will lead to an EPS estimate of 1.21 in Dec 2020. This gives the company a Forward P/E of 11. Historically, over the past 10 years, the firm on average has had a P/E ratio of 15.24.

This is conservative though if we apply a multiple of 15 to the EPS estimate in Dec 2020 we get a price target of $18.15. This implies a return of 36% moving forward over the next 18 months. We believe this is a return that will outperform the market moving forward. The sell-side agree that the firm is undervalued with an average price target of $16.

Risks

ZEUS relies on the commodity price of Steel for its earnings. At the moment, the company is not performing as profitably as it could be due to the lower prices for steel, which are hindering margins. There is always a risk to earnings from the link to the commodity prices, which increases potential risk. ZEUS is also reliant on tariffs, and this is a potential risk with the trade wars currently going on. This is another reason why ZEUS is trading at such an attractive valuation. On the other hand, we see this as a reason to ‘buy when others are fearful.’ An exciting long-term opportunity has opened up for the patient long-term investor.

Conclusion

ZEUS is an exciting investment for a long-term patient investor, who is willing to look over short-term headwinds in the commodity price of steel and the current trade wars. The firm is investing cleverly in growth through acquisitions and focusing on profitable margin-increasing areas of the business. We see over 35% growth in the next 18 months from current levels.

This article was written by

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Articles from now on will be:Value & Growth Ideas in the Consumer Goods SectorExperience:- Building an eCommerce Consumer Goods Company (Cosmetics - Direct to Consumer)- Previous BIG 4 Audit Experience- Bsc in Accounting & Finance at the Number 1 Business School in Europe
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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