Although I don't own it, I nevertheless feel like I've spent a lot of 2012 supporting or coming to the defense of steel companies like ArcelorMittal (NYSE:MT), Nucor (NYSE:NUE) and Steel Dynamics (Nasdaq:STLD). Maybe there's some logic there, as buying into beaten-down commodity stocks can be a good way to earn short-to-intermediate capital gains, or maybe I'm just stubborn. Whatever the case, it's getting harder and harder to stay optimistic on Steel Dynamics even though (yep, you guessed it) the shares don't look especially pricey today.

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

Decent Volume, but Weaker Pricing and Higher Costs
As broadly similar companies, a lot of what Nucor had already said prefigured Steel Dynamics' performance. That tempers, but doesn't erase, some of the disappointment, as does the fact that Steel Dynamics updated (lowered) guidance earlier in the quarter.

Revenue fell 8% from last year and 4% from the first quarter, as external steel revenue fell 5% and rose 2%, respectively. Steel revenue was fueled by a 5% annual and sequential shipment increase, tempered by a 10% and 2% reduction in annual and sequential realized pricing. The company's recycling ops (which actually sells more to external customers than to Steel Dynamics) were worse off; low scrap prices pushed revenue down 19 and 16% annually and sequentially.

Although scrap costs were lower, margins still suffered. Gross margin fell almost four points from last year and almost a full point from the first quarter. All in all, operating profit fell 13% from the first quarter, with the per-ton operating profit down 5%. As the revenue numbers may have suggested, the operating margin was worse in recycling than in steel ops - down 66% versus a 12% sequential drop from 2011.

SEE: Understanding The Income Statement

Lower Costs, but Lower Demand and Lower Prices?
Steel prices really haven't firmed at all this year, as the attempted price hikes of Nucor, Steel Dynamics, U.S. Steel (NYSE:X), AK Steel (NYSE:AKS) and so on have largely gone for naught. In fact, not only have hot-rolled prices recently hit new lows for the year, they're back down to the late 2010 levels.

While low scrap costs will help costs, demand erosion may be a bigger threat. Steel Dynamics management talked about flagging demand strength in markets like agriculture and transportation, and I don't think we're going to see enough growth in autos, non-residential construction and so on to offset it. What's more, I worry that the scrap price declines are demand-driven, as the lower manufacturing activity of recent years should be reducing supply somewhat.

Mesabi Still a Problem Child
Steel Dynamics has long received praise for being one of the best operators in the steel industry, and certainly the company's performance by metrics like labor cost per ton bear that out. Still, the ongoing mess that is Mesabi Nugget may be denting that prestige a bit. Management continues to fiddle with ways to improve operating availability and production this quarter was the lowest it has been in some time.

SEE: Earning Forecasts: A Primer

The Bottom Line
Although current conditions are not great for Steel Dynamics, I don't think the company is in any particular danger. That said, if the gloomier predictions of economists like Roubini prove accurate, next year may be just as bad or worse than 2012.

Taking a 10% discount to Steel Dynamics' usual forward EBITDA multiple suggests a fair value of $17, but investors cannot ignore the risk that the EBITDA estimates continue to erode. While present valuations may lead some to ask how much worse can it get, the fact that the company still trades at over two times tangible book value implies that the answer could be "much worse."

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

Related Articles
  1. Fundamental Analysis

    5 Must-Have Metrics For Value Investors

    Focusing on certain fundamental metrics is the best way for value investors to cash in gains. Here are the most important metrics to know.
  2. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  3. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  4. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  5. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  6. Stock Analysis

    The Top 5 Micro Cap Alternative Energy Stocks for 2016 (AMSC, SLTD)

    Follow a cautious approach when purchasing micro-cap stocks in the alternative energy sector. Learn about five alternative energy micro-caps worth considering.
  7. Stock Analysis

    Analyzing Porter's Five Forces on Under Armour (UA)

    Learn about Under Armour and how it differentiates itself in the competitive athletic apparel industry in light of the Porter's Five Forces Model.
  8. Stock Analysis

    The Biggest Risks of Investing in Qualcomm Stock (QCOM, BRCM)

    Understand the long-term fundamental risks related to investing in Qualcomm stock, and how financial ratios also play into the investment consideration.
  9. Stock Analysis

    The Biggest Risks of Investing in Johnson & Johnson Stock (JNJ)

    Learn the largest risks to investing in Johnson & Johnson through fundamental analysis and other potential risks. Also discover how JNJ compares to its peers.
  10. Investing News

    Chipotle Served with Criminal Probe

    Chipotle's beat muted expectations and got a clear bill from the CDC, but it now appears that an investigation into its E.coli breakout has expanded.
  1. What is the formula for calculating EBITDA?

    When analyzing financial fitness, corporate accountants and investors alike closely examine a company's financial statements ... Read Full Answer >>
  2. How do I calculate the P/E ratio of a company?

    The price-earnings ratio (P/E ratio) is a valuation measure that compares the level of stock prices to the level of corporate ... Read Full Answer >>
  3. How do you calculate return on equity (ROE)?

    Return on equity (ROE) is a ratio that provides investors insight into how efficiently a company (or more specifically, its ... Read Full Answer >>
  4. How do you calculate working capital?

    Working capital represents the difference between a firm’s current assets and current liabilities. The challenge can be determining ... Read Full Answer >>
  5. What is the formula for calculating the current ratio?

    The current ratio is a financial ratio that investors and analysts use to examine the liquidity of a company and its ability ... Read Full Answer >>
  6. What is the formula for calculating earnings per share (EPS)?

    Earnings per share (EPS) is the portion of a company’s profit that is allocated to each outstanding share of common stock, ... Read Full Answer >>
Trading Center