Macro Issues Loom Over Commercial Metals' Ongoing Self-Help Story

In the days before COVID-19, I liked Commercial Metals (CMC) as a mispriced steel asset leveraged to better underlying pricing power, a still-healthy non-residential construction market, and ongoing self-help potential as the company continued to leverage production and distribution optimization opportunities. While the stock outperformed its steel peers for most of 2020, it underperformed the S&P 500, and recently, Steel Dynamics (STLD) and Cleveland-Cliffs (CLF) have pulled ahead in terms of returns since that prior article.

Although the valuation still looks out of whack, it’s harder to recommend Commercial Metals when the outlook for non-residential construction is deteriorating. A federal infrastructure stimulus bill would be a big help, but that is most likely a 2021 event (if then...), and I’m concerned that pricing could be weaker on softer demand. I do see this as one of the more interesting price/value opportunities, but those macro worries do hold back some of my enthusiasm.

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Macro Issues Loom Over Commercial Metals' Ongoing Self-Help Story

Commercial Metals Looks Mispriced Given Generally Favorable Market Trends

I'm probably closer to bearish on steel than bullish, but I do see some select opportunities that are worth a look, and Commercial Metals (CMC) seems to be one of them. Unlike the market for flat-rolled steel, I see a better supply/demand balance in CMC's core long markets, particularly given how consolidated the U.S. rebar market is now after the CMC-Gerdau (GGB) deal in 2018. Add in some growth from infrastructure projects, decent non-resi trends, improving fabrication results, and some opportunities for network optimization, and I think CMC has some potential.

I think CMC shares could be more than 10% undervalued now, with long-term annualized return potential in the double digits. Certainly a lot rides on whether above-trend metal spreads can be maintained, but CMC management has made several smart moves and seems underappreciated relative to flat producers facing more structural challenges.

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Commercial Metals Looks Mispriced Given Generally Favorable Market Trends

Weaker Shipments Sap Insteel's First Quarter, And Margin Threats Remain

It didn’t take long at all for Insteel (IIIN) to show some divergence from my expectations for fiscal 2019, as the company’s first quarter came in meaningfully lower than I expected on weather-related shipment weakness in the quarter. Even so, the conditions in the market remain quite challenging, and it sounds as though the company will be sacrificing margins to maintain volume with customers in 2019 and hoping for some tariff relief.

I’m still comparatively less bullish on non-residential construction in 2019 than many, and I think that presents some risks to volumes and overall earning expectations for Insteel. While I believe this company is fundamentally well-run, the reality of competing against cheaper imported product is a difficult one, and the possibility of weaker-than-expected demand doesn’t help. I saw the possibility of 25% or more downside in my last update, and the shares are down about 15% from there. I do believe that has de-risked the investment case somewhat, but my confidence in the acumen of Insteel’s management is tempered by the ongoing risks presented by macro factors outside of their control.

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Weaker Shipments Sap Insteel's First Quarter, And Margin Threats Remain

Insteel Navigating A Host Of Uncertainties, With Metal Spreads High On The List

It’s a challenging environment right now for Insteel (IIIN). Although this leading manufacturer of steel wire reinforcing products has an uncommonly good long-term track record for margins and returns on assets, equity, and capital given the cyclical nature of its business, pricing leverage has gotten tricky and non-residential construction spending finally seems to be slowing.

Down about a quarter from when I last wrote about the company, Insteel really hasn’t done any worse than large steel companies like Nucor (NUE) and Steel Dynamics (STLD) or other building material companies like Vulcan (VMC) and Martin Marietta Materials (MLM). Although the share price looks undemanding even if revenue and EBITDA do see some contraction from here, a retesting of past low multiples would represent about 25% to 33% downside risk.

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Insteel Navigating A Host Of Uncertainties, With Metal Spreads High On The List

Insteel Seems To Be Shrugging Off Serious Margin Pressures

There are a lot of things about Insteel's (IIIN) business model that make it a challenging company to model. Although the company has had success in coaxing construction companies to use its welded wire reinforcement products instead of rebar, demand is driven by non-residential construction (and public construction, to a lesser degree) and there's not much Insteel can do to drive that. What's more, the company competes with rebar manufacturers like Nucor (NUE) and Commercial Metals (CMC), but also turns to companies like Nucor to buy the wire rod it needs, putting it in a sometimes-challenging spot between competing with rebar on price and trying to maintain a healthy spread between its rod costs and end-user pricing.

Margin pressures have hit Insteel hard recently on higher wire rod pricing, and the tariff actions taken by the U.S. government aren't going to help Insteel's supply situation (though they should help somewhat on protecting it from imported competing products). Insteel has managed volatile pricing before, and while there will be lags and turbulence, I believe the company's own pricing actions will help restore margins later this year. A bigger question remains the ongoing health of the non-residential construction market and whether these high input prices finally bring an end to a long recovery and expansion. Although I feel far less confident in my Insteel model than I'd like, I'm not sure I see a lot of upside from here.

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Insteel Seems To Be Shrugging Off Serious Margin Pressures

Expectations Seem To Have Caught Up To Gerdau

Brazil's Gerdau (GGB) has remained one of the strongest performers in the steel sector, as the company is benefiting from a healthy combination of end-market recoveries in Brazil and North America and better management discipline. Gerdau's management team still believes that they can drive North American margins into the double digits and that the recoveries in Brazil's construction and infrastructure sectors are only getting started.

All of that sounds great, but price/value remains a hang up for me. Unlike many North American and European producers, I don't think Gerdau is going to see a near-term EBITDA peak in 2018 or 2019. I'm willing to give Gerdau a higher EBITDA multiple than I would for most steel companies, but it takes a 12-month EBITDA estimate of over R$6B and a multiple of over 7x to drive a compelling fair value from here.

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Expectations Seem To Have Caught Up To Gerdau

Long Products Should Drive A Good 2018 For Nucor

These are good days to be a steel company. Even with the negative impact of higher scrap costs and import competition, revenue and margins are better than they’ve been in some time. For Nucor (NUE), it’s not just about riding the cycle (although the cycle is important), as the company has been continually invested in value-added capacity and executing tuck-in acquisitions to broaden its portfolio. With relatively healthy industrial markets and the prospect of protection from imports, 2018 is looking pretty good for Nucor and peers/rivals like Steel Dynamics (STLD), Gerdau (GGB), and Commercial Metals (CMC).

Price/valuation is a hang-up for me. While an 8x multiple on my 2018 EBITDA estimate would offer some upside (about 5%), that’s about as high as I’d go for the company. There are certainly opportunities for Nucor to outperform in 2018 and drive a higher fair value by virtue of a higher EBITDA estimate, but this isn’t my favorite steel name right now and that’s not surprising as up-cycles tend to favor lesser operators and Nucor remains among the best-run companies in the industry.

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Long Products Should Drive A Good 2018 For Nucor

Volume Remains The Critical Driver For Insteel

Insteel (IIIN), the country's largest independent manufacturer of steel reinforcing products, is a challenging company to evaluate as an investment. On one hand, I believe this company is run along very sound lines, with management looking to drive higher value-added sales and consolidate the industry, while also distributing cash to shareholders through dividends, special dividends, and buybacks. On the other hand, this company is basically a "commodity-plus" type of business, where demand is largely outside of management's influence, where pricing spreads have significant influence, and where capacity utilization is critical to margins.

I wasn't thrilled with the valuation when I last wrote about Insteel (in September of 2016), and the stock chopped lower until starting to rebound this fall. At this point, I am cautiously optimistic/bullish on the company's prospects. Demand should improve to a level that can drive attractive capacity utilization and pricing should continue to help spreads - both of which are good for margins. Valuation remains tricky, though, as I think the company needs to get over a $110M/quarter run-rate in sales to really offer attractive upside.

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Gerdau On A Better Path, But Higher Utilization Is Essential

With Brazil looking healthier and the U.S. government taking a stronger position with respect to protecting domestic steel production from imports, Gerdau’s (GGB) outlook has improved in many respects. Even so, the share price performance since my last update in late 2016 hasn’t been all that special – the 30% move isn’t bad, but you’d have done only slightly worse with the S&P 500 (without the attendant risk and volatility), and other steel companies like Steel Dynamics (STLD), Nucor (NUE), and Ternium (TX) would have delivered even better returns.

I expect that Brazil will continue to recover, and I’m cautiously optimistic that the U.S. market will support better margins for Gerdau’s long steel products. I continue to believe that Gerdau can generate long-term FCF growth in the mid-single digits, with double-digit growth in both FCF and EBITDA from 2018 out through 2021. The valuation picture is mixed; the shares are no longer a bargain on a DCF basis (not surprising for a cyclical company in a recovery cycle), but EV/EBITDA suggests some potential upside is still in play.

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Gerdau On A Better Path, But Higher Utilization Is Essential

Seeking Alpha: Buoyed By Better Sentiment, Can Commercial Metals Keep It Going?

The past couple of years have been rough ones for the steel sector, but stock prices have improved pretty noticeably in recent months on optimism that improving conditions in the market aren't yet another false start for the long-predicted recovery. Relatively speaking, Commercial Metals (NYSE:CMC) has held up all right - the shares haven't been as strong as those of Steel Dynamics (NASDAQ:STLD), but they've done quite a bit better than those of Gerdau (NYSE:GGB) and U.S. Steel (NYSE:X), while also outperforming AK Steel (NYSE:AKS) and Nucor (NYSE:NUE) over the past year.

Can they keep it going? This fiscal year should be the low point of the current cycle and the outlook for non-residential construction is still positive, but there's a lot of capacity out there, the dollar is still pretty strong, and competition from imports (Turkey in particular in the case of Commercial Metals) is still a risk. Although the rally in the shares makes it harder to call them a bargain today, it's worth remembering that cyclical recoveries are a lot like the declines - they tend to go further, faster, than you might initially think.

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Buoyed By Better Sentiment, Can Commercial Metals Keep It Going?

Investopedia: Schnitzer's Results Are Better, But The Challenges Are Still Significant

All parts of the steel cycle have been volatile lately, as investors fret over demand for steel from ArcelorMittal (NYSE:MT) and Nucor (NYSE:NUE) and the demand for inputs like met coal, iron ore, and scrap steel. While improving economic conditions and a possible revival in North American commercial construction may seem to augur well for Schnitzer Steel (Nasdaq:SCHN), investors shouldn't ignore the significant long-term challenges of this leading scrap processor.

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http://www.investopedia.com/stock-analysis/040413/schnitzers-results-are-better-challenges-are-still-significant-schn-sms-stld-nue-cmc.aspx

Investopedia: Investors Seem To Believe The Recovery Is Coming For CMC

Steel stocks rode up into the start of 2012 on optimism in the fall of 2011 that there would be an improvement in non-residential construction and industrial demand to deliver sustainably higher prices and good shipment growth. That didn't really materialize as hoped, and the stocks of minimill operators Commercial Metals (NYSE:CMC), Steel Dynamics (Nasdaq:STLD) and Nucor (NYSE:NUE) all underperformed the S&P 500.

Now it's a new year and there's new optimism that the industry is past the worst. Will that optimism pay off a little better this year?

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Investopedia: Another Quarter, Another Warning From Steel Dynamics

Tuesday evening marked a continuation of a pretty unfortunate trend for Steel Dynamics (Nasdaq:STLD), as the company once again revised its quarterly guidance lower. Although Steel Dynamics' situation may not be identical to other domestic steelmakers, it would seem that investors would continue to do well in approaching these stocks with caution for the time being.

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Seeking Alpha: Can Steel Dynamics Keep Up Its Momentum

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'.


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Can Steel Dynamics Keep Up Its Momentum?

Investopedia: The Market May Have Already Given Steel Dynamics Its Due

I have made little secret of my admiration for Steel Dynamics (Nasdaq:STLD). I think it's one of the best-run steel companies in the world, and offers an excellent growth profile in an industry that seldom gets much credit for quality management or strategy. Unfortunately, I didn't follow my own advice to buy this stock about a quarter ago and now it looks like it may be too late. (For more, see Earning Forecasts: A Primer.)

Another Quarter, Another Warning  
One of the best signs that momentum is with a stock is that bad news doesn't really knock it off stride. To that end, Steel Dynamics warned the Street in December 2011 that the fourth quarter results weren't going to be as good as they hoped. As is often the case, what is true for Steel Dynamics is broadly true for Nucor (NYSE:NUE), and this larger mini-mill operator likewise announced a weaker fourth quarter would be coming.

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Investopedia: Icahn Tilts At Commercial Metals

To give credit where due, Carl Icahn rolls with the punches and always seems to have at least a couple of ideas percolating on the back burner. After an ill-fated attempt to acquire Clorox (NYSE: CLX), Icahn (through Icahn Enterprises (NYSE: IEP)) is at it again, this time attempting to acquire mini-mill and recycling operator Commercial Metals (NYSE: CMC), in a cash deal. While this is a relatively rare ray of sunshine in the primary metals industry, investors shouldn't rush to assume this is the beginning of a new merger wave.

The Deal

Icahn has publicly offered $15 a share for Commercial Metals, an offer that totals about $1.73 billion and represents a 31% premium to Nov. 25, 2011's, close. That said, it's not an especially generous offer. Commercial Metals has been in a slump lately, but was trading above $15 as recently as May, despite what has been a bad operating environment for better-regarded mini-mill competitors, like Nucor (NYSE: NUE) and Steel Dynamics (Nasdaq: STLD).

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http://stocks.investopedia.com/stock-analysis/2011/Icahn-Tilts-At-Commercial-Metals-CMC-STLD-IEP-CLX-NUE-AA-MT-FCX1130.aspx

Investopedia: Will The Street Believe In Steel Dynamics?

This has been a tough year for steel companies. Squeezed between rising costs and iffy demand, the sector has largely been treading water. With better than expected results for the second quarter, maybe the turn is at hand for Steel Dynamics (Nasdaq:STLD). Then again, considering a glut of sheet steel and the company's spot pricing exposure, the Street may be slow to fully climb on board this name. 

A Better Quarter ... Sort of  
There are two ways to think about Steel Dynamics' quarter - it was much worse than initially expected, but at least better than the company's pre-announced guidance. Revenue rose more than 27% this quarter, with tons shipped rising 15% and all steel products up a little more than 14%. Shipments were especially strong in categories like structural, rail and steel bar.


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Will The Street Believe In Steel Dynamics? (STLD, MT, NUE, CMC, GGB, ATI, BTU)

Investopedia: Play Steel Dynamics For The Next Materials Story

Every commodity and resource boom is a little different, but it is not uncommon to see divergent trends between materials. Materials like copper and iron ore can have their runs only to be followed later by the likes of steel and aluminum. With steel prices starting to firm up, and industrial conditions staying strong, now might be a good time to consider the likes of Steel Dynamics (Nasdaq:STLD).


A Solid Open to the Year
Due in part to strong pricing, Steel Dynamics surpassed the average revenue estimate for the quarter. Investors should note, though, that there was a very wide range of published estimates ($1.1 billion to $2.2 billion). In any case, revenue rose nearly 30% from last year and almost 32% sequentially. Average selling prices rose 21% from the year-ago level, and more than 18% sequentially, while shipments rose about 10% on a sequential basis. (For more, see Steel Cycle Looks Good.)

The company's cost and profit performance was also stronger this time around. Scrap costs were higher, but operating efficiency handily surpassed that increase. Gross margin jumped more than a full point from last year, and nearly six full points from the fourth quarter. Operating margin improved even more - up more than 160 basis points from last year and more than tripling from the fourth quarter.


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http://stocks.investopedia.com/stock-analysis/2011/Play-Steel-Dynamics-For-The-Next-Materials-Story-STLD-NUE-AKS-PKX-CMC0420.aspx

Commercial Metals - A Tough Market May Be Getting Better

Although the sector has had a rough 2010, the stocks of many players have been doing a lot better of late, as investors take a more encouraging view of steel prices and demand in 2011. As Commercial Metals (NYSE:CMC) earnings reflect, though, there are still a lot of pressures in the industry and a great 2011 is no guarantee. 

Fiscal First Quarter Results - Some Good, Some Bad
In many respects, CMC's earnings this quarter are a microcosm of the industry; some good and some bad, with reasons for cautious optimism. On a simple top line basis, for instance, revenue was up 27% from last year as units like recycling and American mini-mills did well (each up about 41%) and no units had year-on-year declines. Within that top line number, the company saw total mill tons shipped increase 9%, with fabrication tons shipped up a similar 8%. Selling prices were also strong, with domestic prices up almost 20% and foreign mill prices up more than 30%.

Profitability also improved from the year-ago level. Although scrap costs were quite a bit higher (up 17% domestically and 23% overseas), per-ton operating profits still grew almost 22% and 45% at home and abroad, respectively. Interestingly, the purchase prices for scrap (as opposed to the cost of scrap used) were even higher, and that could be an issue. Still, the company reversed a year-ago operating loss and was profitable on an as-reported basis. 


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The Steel Sector: No Jam Today, But Maybe Tomorrow

Investors might feel like the White Queen is running the economy these days. There was good growth in the past, and a lot of people seem to be expecting it again in the not-so-distant future, but it is pretty hard to find in the present. With a series of pre-announcements over the last few days, the steel sector is definitely shaping up as a "jam yesterday, jam tomorrow, sorry ... none today" sort of sector right now. 

Steel Dynamics
To a certain extent, maybe Steel Dynamics' (Nasdaq:STLD) downward revision for the third quarter was not a big surprise. After all, analysts have taken down the numbers on this major mini-mill operator multiple times over the last three months and estimates are now about a third lower.

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http://stocks.investopedia.com/stock-analysis/2010/The-Steel-Sector-No-Jam-Today-But-Maybe-Tomorrow-STLD-NUE-AKS-X-CMC-VALE-CLF0917.aspx