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Tickers in this Article: STLD, X, MT, NUE, CLF, AA, UNP
Once again, investors are being asked to look ahead to the future with Steel Dynamics (Nasdaq:STLD). Tepid construction activity and iffy auto sales have kept a lid on this very efficient American steel company, but investors write this one off at their own risk. While a roaring recovery across STLD's markets is not likely in the near-term, the current stock price does not seem to account for this company's competitive position nor its full cycle earnings potential.

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Q3 - Not Good, But Better than Feared
Like its larger rival Nucor (NYSE:NUE), Steel Dynamics warned investors earlier that this quarter was not going to be as strong as the original projections suggested. Perhaps counter-intuitively, the stocks in the steel space were actually fairly strong that week as investors seemed to be relieved that conditions were better than their worst-case fears.

In any case, Steel Dynamics reported that revenue rose 29% from last year and fell 2% from the prior quarter. Pricing was problematic as per-ton prices fell $50 overall and even more ($95) for flat-rolled steel. That compares to shipment growth of 12% versus last year and 1% on a sequential basis. It's also worth noting that shipments in structural and rail steel were especially strong.

Steel Dynamics has a reputation as a low-cost operator, and the company continues to deliver on that. Gross margin picked up about a point from last year, though falling more than three points sequentially. Likewise, operating income jumped 57% from last year and fell 42% sequentially, though results were impacted by a one-time bonus payment to employees.

2012 Looking Like Another Challenging Year
For some time now, the refrain on steel stocks ranging from Steel Dynamics to U.S. Steel (NYSE:X) to international giant Arcelor Mittal (NYSE:MT) has been that conditions will get better ... eventually. To that end, management does seem to believe that pricing in the core flat-rolled business has gotten about as bad as it will be for this part of the cycle.

It's worth noting, too, that Steel Dynamics has gotten this far despite some major headwinds. Construction is normally about one-third of the company's business, but building activity has been weak outside of the petrochemical and energy sectors. Likewise, auto customers like Ford (NYSE:F) and General Motors (NYSE:GM) have seen softer demand, and there seems to be an ongoing trend toward substituting aluminum for steel.

Making matters a bit more challenging, the company's Mesabi Nugget project is still in its loss-making startup phase, and a favorable supply deal with Cliffs Natural Resources (NYSE:CLF) rolls off soon. Still, STLD does source about half of its scrap needs internally, so that expense item seems under control.

The Bottom Line
Steel Dynamics is a low-cost manufacturer in a critical industrial supply market. While the market for steel stocks is sharing many of the same economic worries that have weighed on aluminum company Alcoa (NYSE:AA) and copper giant Freeport-McMoRan (NYSE:FCX), it is hard to argue against buying a well-run cost leader near its lows. Don't forget, too, that this is a company with some growth tricks still up its sleeves - selling steel rails to railroads like Norfolk Southern (NYSE:NSC) and Union Pacific (NYSE:UNP) should be a long-term growth opportunity.

Steel Dynamics is not a stock that will pay off tomorrow. It is a risky commodity play that needs a stronger economy to really meet its potential. As said before, though, it is a cost leader and well-positioned to benefit when markets like construction, autos and appliances recover. For patient value investors, then, this is a name well worth considering. (For additional reading, see The Ups And Downs Of Investing In Cyclical Stocks.)

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