Steel Dynamics Pitted, But Not Rusting

So, how is the economy doing, exactly? Alcoa (NYSE:AA) or CSX (NYSE:CSX) earnings may have you feeling optimistic, while earnings from major banks cast a pall over that scenario. In that context, maybe Steel Dynamics (Nasdaq:STLD) earnings are a perfect metaphor - they were good, but not great, and guidance was a little murky.

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The Quarter That Was
Steel Dynamics reported 5% sequential growth in revenue (to $1.63 billion) and earnings per share of $0.22. Both of these metrics were slightly below the average Wall Street analyst estimate; enough to be a mild disappointment, but nothing to panic about.

Looking deeper, the company saw a 10% sequential decline in steel shipments, with flat-rolled steel showing particular weakness. Structural steel and engineered bar steel shipments were also higher on a sequential basis. Company management also mentioned lower scrap prices and transformer outages as factors in the company's performance and the sequential decline in operating margins. (For related reading, see Alcoa Gives A Good Start To Earnings.)

What Is Next?
Steel Dynamics said the outlook for flat-rolled steel was "uncertain", and that certainly has implications for companies like U.S. Steel (NYSE:X), Nucor (NYSE:NUE) and AK Steel (NYSE:AKS). That outlook also has implications for the broader economy, as flat-rolled steel is the steel typically used in new cars and appliances - big-ticket consumer items, in other words. Corroborate that with an earnings report from Whirlpool (NYSE:WHR) that showed a lot of good news on operating metrics but no real sense of breakaway top-line growth, and we have a dicey picture for the economy in the second half of the year.

Although capacity utilization is getting a little better at mills like Steel Dynamics, the recent movements in steel prices are not all that optimistic. On top of that, there clearly has not been any revival in commercial construction (another big consumer of steel) yet.

What To Do About The Stock?
The good news for Steel Dynamics bulls is that this company is one of the low-cost producers in the steel industry. Moreover, since the company has integrated scrap operations into the company, they have input cost advantages analogous (but not identical) to steel operators like Arcelor Mittal (NYSE:MT) that can control their iron and coal costs by virtue of owning mines.

On the flip side, Steel Dynamics' operations are heavily weighted towards the auto industry, consumer appliances and commercial construction -- all of which are markets that are not yet firmly on the road to recovery (or, in some cases, even on the on ramp). What that ultimately says to me is that Steel Dynamics may well be one of the best names in steel to own, but the whole idea of owning steel right now is a bit iffy.

Most steel stocks have rebounded a bit in the last month, stopping a slide that began in April as people began worrying about the economy once again. Whether iffy second-half guidance derails this rally or whether the rally was predicated on a realization that the second half was going to be "probably okay, but not strong", only time will tell.

Bottom Line
The bottom line is this - I believe you can buy Steel Dynamics here with the expectation of profiting on the eventual recovery in the U.S. economy. That said, you have to have patience and a threshold for near-term underperformance as any fears about a double-dip recession will thump this stock. (For more, see Indicators Suggest Strong Steel Performance.)

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