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

Note: This post has been amended to clarify Steel Dynamics’ outlook.

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, Inc. (NASDAQ:STLD) delivered a gross margin of 9.9%, compared to a lower 7.8% gross margin for Nucor Corporation (NYSE:NUE).

There are two key factors contributing to Steel Dynamics’ cost advantages. Firstly, Steel Dynamics’ mini-mill model is much more labor- and energy-efficient, compared with other integrated steel companies. Secondly, Steel Dynamics, Inc. (NASDAQ:STLD)’ 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’ 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 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.