Steel Dynamics, Inc. (STLD): Is This Company as Solid as Steel?

Companies compete successfully by either differentiating their products or by providing almost identical products at lower costs. Low cost producers are typically market leaders, benefiting from economies of scale. Steel Dynamics, Inc. (NASDAQ:STLD) is an example of that. It is one of the largest steel producers in the U.S. It runs five steel mini-mills with capacity in excess of 6 million tonnes every year, producing an equal mix of flat products and long products.

Lowest cost domestic steel producer in the U.S.

Steel Dynamics, Inc. (NASDAQ:STLD) was co-founded in 1993 by three ex-employees of Nucor Corporation (NYSE:NUE), its closest competitor which was founded much earlier in 1969. However, the tables have turned two decades later, with Steel Dynamics being the lowest cost domestic steel producer. In fiscal 2012, Steel Dynamics delivered a gross margin of 9.9%, compared to a lower 7.8% gross margin for Nucor.

There are two key factors contributing to Steel Dynamics, Inc. (NASDAQ:STLD)’ cost advantages. Firstly, Steel Dynamics’ mini-mill model is much more labor- and energy-efficient, compared with other integrated steel companies. Secondly, Steel Dynamics’ steel making facilities are strategically located in the proximity of its supply sources and customer base, which results in significant transportation cost savings.

Improved balance sheet is a plus

The high operating leverage inherent in the industry suggests that having a strong balance sheet is critical in offsetting the adverse impact of cyclicality on Steel Dynamics, Inc. (NASDAQ:STLD)’ bottom line.

Its current gearing at 85% represents a huge improvement from a debt-to-equity ratio of 137% in fiscal 2008. This was the result of the repayment of more than $275 million in debt with available cash in the past two years. In addition, the reduction in borrowings will bring about annualized interest expense savings amounting to $30 million for Steel Dynamics, Inc. (NASDAQ:STLD) in fiscal 2013.

Besides the absolute level of indebtedness, it is also necessary to assess refinancing risk, especially in the current environment of low interest rates. Steel Dynamics, Inc. (NASDAQ:STLD) also restructured in excess of $1.4 billion of debt, helping to extend its debt maturity. In particular, about $1 billion of debt that was supposed to be due by 2016 has been refinanced, with key maturity dates extended to 2019 and beyond.

Outlook

Steel Dynamics, Inc. (NASDAQ:STLD) saw quarterly net sales and net income fall 5% and 34% year-on-year to $1.8 billion and $29 million, respectively, with slower economic growth in China and Europe contributing to lower product prices. Despite this, management is optimistic about the prospects in the residential construction and automotive markets.

Steel Dynamics, Inc. (NASDAQ:STLD) has also witnessed increased demand for high quality steel products. It ramped up annual production capacity of engineered special-bar-quality products from 625,000 tons to 950,000 tons to capitalize on that. Another key initiative is its expansion into other markets beyond construction, such as rail production, to increase utilization and generate more cost savings from economies of scale.

Peer comparison

Steel Dynamics, Inc. (NASDAQ:STLD)’ peers include Nucor Corporation (NYSE:NUE) and Insteel Industries Inc (NASDAQ:IIIN).

Nucor registered a 3% increase in quarterly sales to $4.7 billion in the second quarter of 2013, while net income remained flat year-on-year at $85.1 million. Nucor entered into a natural gas agreement in November 2012 to secure a long-term supply of natural gas for its steel mills and direct-reduced iron plants that is estimated to last for more than two decades. Going forward, Nucor should realize energy-related cost savings with this low cost natural gas supply.However, Nucor Corporation (NYSE:NUE)’s current margins are still inferior to that of Steel Dynamics. Despite that, Nucor trades at a premium to Steel Dynamics, Inc. (NASDAQ:STLD) with a forward P/E of 13.9, suggesting that it is overvalued.

Insteel Industries Inc (NASDAQ:IIIN) is the country’s largest manufacturer of steel wire reinforcing products for concrete construction applications. It benefits from anti-dumping provisions protecting the interests of domestic producers of prestressed concrete strand and Federal Highway Administration’s Buy America provisions favoring the use of domestic produced prestressed concrete strand for public construction.

In the third quarter of fiscal 2013, Insteel Industries Inc (NASDAQ:IIIN) grew its revenue 4% to $96.9 million, with capacity utilization increased to 48%, compared with 46% a quarter ago. M&A is a key driver of growth for Insteel; it recently acquired all of Tatano Wire and Steel’s concrete pipe and box culvert reinforcement production equipment in April to strengthen its presence in the area of welded wire reinforcement. With a meager 0.7% forward dividend yield, Insteel has less appeal than Steel Dynamics

Conclusion

I like Steel Dynamics for its low cost structure and strengthening balance sheet. In addition, it is currently attractively valued at 10.6 times forward P/E and 0.68 times PEG. With a forward 2.8% dividend yield as the icing on the cake, Steel Dynamics is a buy in my books.

The article Is This Company as Solid as Steel? originally appeared on Fool.com and is written by Mark Lin.

Mark Lin has no position in any stocks mentioned. The Motley Fool recommends Nucor. Mark is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.