Thursday, July 18, 2013

Steel Dynamics Earnings: Profit Growth Goes Into Reverse

"We remain optimistic as the demand for high-quality steel products has not abated." So said Steel Dynamics' (NASDAQ: STLD  ) CEO Mark Millett in making yesterday's earnings announcement. But the facts beg to differ.

The $1.8 billion in sales that Steel Dynamics recorded in fiscal Q2 2013 were down about 5% from last year's Q2 sales of $1.9 billion. And with the average selling price for the company's steel dropping more than 8% per ton in comparison to last year's Q2, to $781, this hurt profits even worse. For comparison, rival mini-mill operator Nucor (NYSE: NUE  ) reported this morning that its average selling prices for steel were only down 7%. With prices and sales both down on a diluted earnings-per-share basis, Steel Dynamics reported $0.13 profit -- down 38% from last year.

So what's going on with Steel Dynamics? Basically, it's exactly what I warned you about last month, after reviewing the disturbing news of weak demand for steel in China, revealed by Schnitzer Steel (NASDAQ: SCHN  ) in its earnings report. Steel Dynamics is hitting headwinds all around the globe:

In China: "slower anticipated economic growth" In Europe: "suppressed economic growth" And here at home: "persistent uncertainty in the domestic economic environment," leading to "low inventory levels" among customers, and a general condition of "domestic oversupply" -- exacerbated by "increased quarter-over-quarter steel imports"

Seeing a steel lining 'round looming clouds
Granted, the news isn't all bad at Steel Dynamics. Management does say that it's seen "meaningful volume improvements for rail, engineered special bar quality products, and galvanized sheet steel," plus "modest growth in the overall construction market." Automotive demand is also said to be "strong", and manufactured goods, "strengthening".

Yet analysts on average project that, even if business improves, the company can only expect to grow its earnings at 12% per year over the next five years, at best -- and that's off of today's low base.

The company's cash balance is another thing to keep an eye on. Although Steel Dynamics still has cash in the bank, its balance sheet shows long-term debt levels of $1.5 billion (after netting out cash). Meanwhile, free cash flow at Steel Dynamics went from $45.8 million a year ago, to negative $16.5 million in this year's Q2. So far this year, the company has burned through $32.2 million in negative free cash flow, consuming cash rather than generating it.

Buoyed by a strong second half last year, the company still has a positive trailing free cash flow number -- $168 million. But at a price of 20 times free cash flow, the stock looks too expensive.

Did someone say automotive steel demand was still good? China is already the world's largest auto market -- and it's set to grow even bigger in coming years. A recent Motley Fool report, "2 Automakers to Buy for a Surging Chinese Market," names two global giants poised to reap big gains that could drive big rewards for investors. You can read this report right now for free -- just click here for instant access.

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