Stelco Holdings Trading At Just 2X Earnings Is Aggressively Buying Back Stock
- Stelco has come off its 52-week highs despite a reduced share count and a blowout earnings report in Q3.
- The company has just launched a C$250M Dutch Auction buyback program and shareholders are invited to tender their stock at a premium.
- Stelco is trading dirt cheap but likely has reached its peak and the downcycle in the steel industry starts now.
- Even if the EBITDA would decrease by 75% vs. 2021, the company is still trading at an EV/EBITDA of less than 5.
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In an October article, I was bullish on Stelco Holdings (OTCPK:STZHF), a Canadian steel producer. Stelco predominantly services the domestic market which represents 75% of its output, while the remainder is exported to the US. I was bullish because the steel producers were in a cyclical uptrend and Stelco was printing cash enabling it to rapidly improve its balance sheet and buy back big blocks of stock which should help the per-share performance going forward. Surprisingly, the share price is currently trading about 10% lower than in October, so I wanted to see if I needed to update my investment thesis.
As a Canadian company, Stelco’s most liquid listing is on the Toronto Stock Exchange where it’s trading with STLC as its ticker symbol. The average daily volume in Canada is just under 400,000 shares, making it the most liquid listing to trade in the company’s shares as its US listing has a lower average volume of just over 15,000 shares per day. As the company repurchased and canceled 11.4M of its own shares earlier this year, the net share count has decreased to 77.3M shares outstanding. This means the current market cap is almost exactly C$3B. As Stelco is a Canadian company with its most liquid listing in CAD and reporting its financial results in CAD, I will use the Canadian Dollar as base currency throughout this article.
The share price has softened, despite strong financial results
The third quarter was an amazing quarter for the company as it combined higher shipments with higher prices and margins. During the third quarter, Stelco shipped 710,000 tonnes of steel of which almost 80% was hot rolled steel. The average received price per tonne was approximately C$1,800 which is almost three times as high compared to the third quarter of 2020 and although the COGS increased as well, the EBITDA margin reached a level of 58%. The combination of all these elements caused the EBITDA to almost double compared to the second quarter of this year.
Source: Company presentation
As mentioned above, the total revenue in the third quarter came in at C$1.35B and as the total COGS were just C$571M, the company reported a net gross profit of approximately C$783M and an operating income of C$770M. That’s higher than the operating income in the first two quarters of the year combined.
Source: Financial statements
Meanwhile, the interest expenses are nosediving as Stelco has been rapidly reducing its debt, and the bottom line shows a net income of C$614M or C$7.42/share. Keep in mind the net income per share is based on the weighted average share count during the quarter. If we would divide the C$614M net income by the 77.3M shares that are currently outstanding, the EPS would be even higher at approximately C$7.94. There’s a similar explanation for the 9M 2021 EPS which officially came in at C$12.64 per share. That was based on the average share count of 86.7M shares during the first nine months of the year. If we would divide the C$1.1B net income by the current share count, the EPS in the first nine months of the year would have been in excess of C$14.
Looking at the free cash flow result in the first nine months of the year, we see the company generated almost exactly C$1.2B in operating cash flow and even after deducting the C$6M in lease payments and the C$175M in capex, the YTD free cash flow result exceeds C$1B.
Source: Financial statements
Considering the free cash flow result was just around C$450M on an adjusted basis in the first half of the year, Stelco generated in excess of half a billion Canadian Dollars in free cash flow in the third quarter and Q4 could be equally strong bringing the full-year free cash flow to C$1.5B (including growth capex), or in excess of C$20/share using the anticipated share count as of the end of January.
The company is getting ready for a Dutch Auction
The share count at the end of January will likely show an additional reduction compared to the 77.3M shares that are currently outstanding as the company announced last week it would be spending C$250M on buying back more stock using the modified Dutch Auction procedure.
The company has established a price range of C$31-37 whereby shareholders are invited to tender their shares, and Stelco will buy back up to C$250M of stock at an average price within that range. This means the company will repurchase 8.7%-10.4% of its share count and the new net share will likely be just around 70-71 million shares when the dust settles.
I believe this is an excellent way to immediately reward its shareholders while rapidly reducing the share count.
Stelco Holdings is currently trading at roughly twice the earnings it will post this year and that makes the company dirt cheap on any metric. Of course, Stelco is massively benefiting from the tailwinds in the steel industry and 2022 will likely be weaker. But as the company will have repurchased in excess of 20% of its shares within a year, the net residual value per share will have increased. Additionally, the balance sheet is in a much better shape with a net cash position of in excess of C$300M as of the end of September (excluding the pension deficit).
So while I don’t expect the tailwinds in the steel industry to last, Stelco has made excellent progress in restructuring its balance sheet and will head into the cyclical downturn with fewer shares outstanding and a substantial net cash position. Although we can reasonably expect the FY 2022 EBITDA to decrease versus the excellent performance in 2021, Stelco is ready for any downtrend.
I currently don’t have a long position in Stelco but I would be interested in going long, despite knowing very well 2021 will likely have been the peak year for Stelco.
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