Steel Dynamics, Inc.

The steel industry is a prime example of a notoriously cyclical industry. There are, however, examples of quality operations within the industry.

Steel Dynamics (SD) is one of the larger and higher quality steel operators in the US. It generates revenues from steel production, metals recycling, and steel fabrication. Steel production is the largest contributor to revenues (75%). It has 13m ton capacity for steel production and metals recycling. 95% of sales are in the US and SD’s products are used primarily for construction, auto, and other manufacturing activities.

Its competitive advantages lie in a diversified value-added product offering, control of secure supplies of recycled ferrous metals (65% from own source), and importantly a highly variable cost structure. Management has taken efforts to control the fixed overhead/ton of production over the years.

SD is part of the ‘critical infrastructure industry’ designated by the US government, which allows it to operate uninterrupted during the Covid-19 pandemic. It may also be a beneficiary of higher tariffs on China.

SD generated revenues, EBITDA, and earnings/share of $10.22bn, $1.29bn, and $3/share in the last twelve months. EBITDA margin of 12.6% is slightly below the 5-year average of 13.3% - but represents conservative earning power.

Its net debt was $1.26bn (with undrawn facilities of $1.2bn), or 40% of total book capitalization, which is conservative. Principal payments on debt are not due until 2023.

SD expects to spend $1.2bn in capex, primarily on a Texas plant, which will increase capacity by 3m tons (23%). They’ve secured scrap ferrous supplies for this, and have sufficient cash to execute - though the project may be delayed to 2021 depending on Covid-19 developments.

Management appears to be shareholder-oriented with regular and increasing dividends, and substantial share buybacks. Total shareholder returns were $549m in 2019 – an 80% payout.

The equity sells for $4.66bn or an enterprise value of $5.92bn – representing a trading multiple of 4.6x ebitda and just over 7x earnings (13.6% earnings yield). This doesn’t appear to be screamingly cheap for a cyclical steel company, but may be appropriate considering the relative quality of SD. Shareholder yields, however, were 11.8% for the last year – and unlikely to materially disappear.

The earnings yield provides a substantial margin of safety over the company’s incremental borrowing costs of 3.96% (in 2019). In addition, the shareholder yield appears juicy enough, and sustainable enough, to warrant an investment at the current market price.