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Weekly Play in Steel Minimill Leader

|Includes: AKS, CMC, NUE, Schnitzer Steel Industries, Inc. (SCHN), STLD

Weekly Play: Schnitzer Steel Industries Inc.

Analysis: One of the commodity industries that has had quite a successful year is the steel industry. I rarely get involved with steel, but that is due to my affinity with oil commodity plays. Yet, steel has quietly been making great advances. In the past year steel has increased from around $12 to $19. The increase in steel prices of over 50% is allowing for steel companies to report profits and making them very attractive plays.

The steel industry, though, has started to change shape lately. The mini-mill process of taking scrap and small metalpieces and forming them into reprocessed steel that has the strength and quality of ferrous metal produced by steel giants like AK Steel and ArcelorMittal are no longer the only leaders. One such company that has seen a turnaround from one year ago is Schnitzer Steel Industries (NASDAQ:SCHN). This company operates a successful reprocessing arm of its company that has helped the company turn to profit since Q3 of 2009. For Q2 of 2010, SCHN is projected to report its best earnings since 2008 and report a swing to profits from its Q2 of 2010 that saw the company hit a profit per share at -0.05. This quarter, the company is projected to report a 0.83 EPS.

The company, in addition to its steel recycling industry that sells to brokers, operates an auto parts sector. The company gets significant amounts of scrap metal from junk cars. Before recycling the steel, the company strips the cars of auto parts and sells the used auto parts to a number of companies and brokers through 37 locations in the USA. The increase of demand in the used and new auto sector is another plus for Schnitzer.

The company will be reporting earnings in a different reporting season than most steel companies, so the latest results are not really out there. SCHN will sort of set the stage for what we can expect in Q2 for other steel companies. A very similar steel player in Commercial Metals (NYSE:CMC) just reported earnings at 10% earnings surprise last week, but that is all for earnings in the last month. Q1 was very strong for steel as major players reported great growth in sales. AK Steel (NYSE:AKS), for example, reported a solid 53% increase in sales for Q1 and nearly every major player saw significant beats. Since the beginning of May, eleven out of thirteen reporting steel companies have had earnings beats, which is great news for the steel industry and SCHN’s prospects.

Schnitzer’s latest quarter saw its acquisition of Golden Steel and Recycling in Billing, Montana. The acquisition continues to show the company’s ability to expand and continued growth, which is restarting after tanking in 2009. This is a great sign for the future of the company and shows they are ready to get over the recession and get back to expansion.

Don Hamaker reported on the acquisition: 

Schnitzer’s long term vision remains focused on our growth strategy. The purchase of Golden Steel & Recycling gives us a presence in the Montana market and positions us for further growth in the region. Golden Steel & Recycling’s demolition services business nicely complements our core competency of metals recycling and allows us to expand our service and product offerings. We are delighted to have Jim Gallup and his team join us, and we look forward to being active participants in the Billings community. We will continue to look for other recycling opportunities in the region and to grow our business in order to better serve our customers and the communities in which we operate.

Steel processing remains tough, but the companies auto parts and recycling parts operate 80% of the company’s business. The recycling of steel is very attractive moving forward as the company is able to operate an environmental friendly industry with lower carbon emissions, which is starting to become much more eminent for overseas companies that face caps on pollution as well as domestic companies.

Finally, SCHN has a number of financial indicators that I like to see. Despite the downturn, the company kept relatively high levels of free cash flow, which is a sign of a healthy company that is continuing to look to expand. In the company’s TTM, the company is seeing gross margins improve in 2010 to close to 12% from 6% in 2009. Return on assets and return on equity has also turned positive in 2010 thus far. Finally, the company has seen inventory turnover expand at alarming rates, signaling great demand, from 5.8 to 8.0 for the 2010 TTM.

I am expecting a big report from SCHN, and the company is in a great position to move upwards. The stock is down today, which is always a plus and the market is starting to pick up. The stock dropped about 8% last week, and it should make its way back up prior to earnings and out of them. 

Entry: We are looking to get involved from 42.55 - 42.80.

Exit: We are looking to gain 4-6% prior to earnings or hold to Thursday morning.

Stop Loss: 4% on bottom.


Good Investing,

David Ristau

Disclosure: none