Another Challenging Quarter At Steel Dynamics

By Stephen D. Simpson, CFA | April 16, 2012 AAA

Unfortunately, another quarter is in the books and the song pretty much remains the same for the steel industry. Customers are pushing back fairly successfully on price hikes, and demand in traditional steel-heavy applications just hasn't recovered as expected. Steel Dynamics (Nasdaq:STLD) still looks undervalued, but it's tough to be patient with a lagging stock in an otherwise reasonably good market.

Investopedia Broker Guides

: Enhance your trading with the tools from today's top online brokers.

Q1 Results Come in at the Better End of Disappointing
Along with Nucor (NYSE:NUE) and AK Steel (NYSE:AKS), Steel Dynamics had once again warned the Street that first quarter results were going to be weaker than analysts had initially expected. And once again, Steel Dynamics managed to deliver results that were on the high end of the lowered range.

Reported revenue fell 2% from last year, but did climb almost 7% sequentially. Steel production rose 3% sequentially, while shipments fell 1%. Although shipments are usually seasonally better, market issues and an unexpected outage at a bar facility hurt results. ASPs were mixed - up almost 3% sequentially, but down about 2% from last year to $875/ton.

Operating performance was likewise mixed. Operating income plunged from last year's level (down 42%), but did pickup on a sequential basis (up 45%). Operating profit per down dropped almost 28% from last year, but rose about 20% sequentially and came in stronger than expected.

SEE:

Understanding The Income Statement

Newer Products Seem to Be Picking up
One little nugget I saw in Steel Dynamics' report was a meaningful jump in the contribution of rail shipments. Steel Dynamics has been looking at this as a growth opportunity since getting clearance to sell to Class 1 rails, and there should be a solid market out there for this application.

Will Mesabi Pay Off?
Recent developments external to Steel Dynamics also have me wondering about the future of its Mesabi Nugget venture. As a refresher, this is a majority-owned iron project in Minnesota that uses technology from Kobe Steel to produce iron nuggets (while Steel Dynamics and Nucor use mostly scrap steel in their mills, they need supplementary iron), and one in which Steel Dynamics has invested a lot of capital.

About two months ago, Cliffs Natural Resources (NYSE:CLF) announced that it was dissolving a JV with Kobe Steel that used that same technology for the same intended use. Cliffs didn't explicitly state that the project looked to be commercially non-viable, but that seems to be the implication. Admittedly, the economics are different for Cliffs and Steel Dynamics, as STLD uses Mesabi Nugget production internally and Cliffs was looking to sell this to third parties. Still, it's worth asking whether Mesabi Nugget is producing the sort of cost-advantaged nuggets that management intended.

SEE:

Earning Forecasts: A Primer

The Bottom Line
I am still cautiously optimistic that the steel sector can see a turnaround this year, as demand picks up in markets like autos and construction. I also prefer the mini-mills (Nucor and Steel Dynamics) to the traditional mill operators (AK Steel and U.S. Steel (NYSE:X)), but acknowledge that there's more upside to the traditional steel companies if the steel market really gets going again.

Like Alcoa (NYSE:AA) and Freeport McMoRan (NYSE:FCX), this is something of a hope trade - prices just look too low right now and that's usually a good time to buy these stocks. That said, these troughs can be longer and deeper than investors expect, so there's definitely risk in this trade. I still like Steel Dynamics into the high teens, but it wouldn't be my first trade with new money.

Use the

Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

You May Also Like

Related Analysis
  1. Stock Analysis

    Yet Another ETF to Follow Stock Market Legends Debuts - ETF News And Commentary

  2. Stock Analysis

    SunCoke Energy Plans to Cut Coal Mining in Weak Market - Analyst Blog

  3. Stock Analysis

    L.B. Foster Runs Risks on Expense Worries, Scopes Exist - Analyst Blog

  4. Stock Analysis

    Nucor (NUE) Unveils Fourth Quarter Earnings Guidance - Analyst Blog

  5. Stock Analysis

    L-3 Communications to Sell Marine Systems International - Analyst Blog

Trading Center