Commercial Metals Company

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 4/5

Commercial Metals Company (CMC) is a global manufacturer and recycler of steel and metal products, operating primarily in the U.S. and Europe, with a strong focus on sustainability.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview Commercial Metals Company (CMC) is a vertically integrated company, meaning it controls various stages of the steel production and recycling process. They primarily operate across two segments: North America Steel Group and Europe Steel Group. They also have an Emerging Businesses Group. The North American segment produces steel products from recycled metal (using electric arc furnaces or “EAFs”) and sells steel, fabricated metal, and related products in the US and Canada. The European segment includes mini-mills and fabrication operations in Poland and other European countries. The Emerging Business Group is largely comprised of their other businesses like their CMC System Operations and services. They focus on sustainability throughout their processes, using recycled scrap metal, improving energy efficiency, and reducing water consumption. CMC’s operations span from manufacturing steel to producing finished metal products, and selling to diverse industries such as construction, infrastructure, manufacturing and agriculture.

Industry Trends: The steel industry is highly cyclical, meaning it’s prone to periods of high demand and prices followed by periods of slower demand and declining prices. Competition is fierce, particularly from low-cost international producers. However, there is a trend in the industry towards sustainable practices, as environmental concerns continue to rise. Steel mills are increasingly focused on producing steel from recycled materials. This also creates a secondary market of metal recyclers which feed steel companies, or compete to buy the recycled materials. These factors have been causing companies to vertically integrate to reduce price pressures and secure stable supply chains. The growth of new construction and infrastructure projects have increased demand for steel. Governments and regulatory agencies can impact the business, and also cause certain companies to have an advantage in a region, where others are effectively prohibited from trading.

Financial Performance CMC’s recent financials show a mixed performance:

For the three months ending November 30, 2023, they have seen a notable 6% drop in sales from $2.9B to $2.7B, though that is compared to a high sales figure from last year. They have earned $1.51 per diluted share compared to $1.91 per share in last year’s first quarter. This year, the increase in raw material costs and decrease in steel prices have resulted in a decline in income, which they say is due to the global downturn in steel, higher energy costs, and lower demand, but it is likely the effect of lower revenue prices which impact them more, and which their business is susceptible to. In a broader look at their financials, they mention their diversified operations as a positive, but the financial results across all of their operating groups have declined YoY. The total net sales of the North America Steel Group was at $2,085.0 Million, while the total net sales of the Europe Steel Group was $677.7 Million.
In their FY23 annual reports, sales are reported at $8,827.4 million compared to $8,868.2 million. Net Income was also decreased for the year. It decreased from $1,261 million in 2022, to $856.8 million in 2023.
Gross margins have remained relatively healthy although have been affected by recent price changes. For the three months ending November 2023, gross margins fell to 17.1%, whereas in the year prior it was 22.3%. SG&A expenses also rose year-over-year and contributed to the reduction in income, while total revenues have declined. Operating margins for the same time period were 8.8%.
Their most profitable segment was the North America Steel Group, and the least profitable is the Emerging Business Group. The European segment shows decent revenue but lower profits than the North American Segment.
It’s important to note that many adjustments made by the company in these reports are due to the acquisition of Tensar in May of 2023. The company also recently added other acquisitions and is taking restructuring charges to integrate these businesses.
CMC uses debt to fund operations, acquisitions and their various initiatives. They have a history of managing debt which they have described as one of their main targets, particularly to keep the company in good financial health, and to keep their cost of capital down.

Competitive Landscape The steel and metal manufacturing and recycling industries are highly competitive. It includes many players that range from global giants, to smaller regional players, both from North America and abroad.

Intense Competition: CMC faces significant competition in both steel manufacturing and recycling from large and small players. Intense competition keeps price points low and squeezes profit margins.
Commodity Nature: Steel is essentially a commodity, so price is a significant factor. It’s often hard to differentiate.
Price Volatility: The price of steel is subject to fluctuations in the market, especially due to external forces which makes it extremely hard to accurately predict. The price of scrap steel and steel itself also fluctuates, and since they do not sell at similar prices to each other, their margins may be impacted severely depending on how each of their products are priced and sold, regardless of the production costs.

What Makes CMC Different?

Vertical Integration: Their vertically integrated business is a key differentiator. This should help control costs and improve profit margins during periods of low prices. Although they are susceptible to material and energy cost fluctuations which can impact profitability. The management notes that this strategy, and an additional strategy of having their production facilities located strategically near their customers is something which keeps them ahead.
Focus on Sustainability: They emphasize their commitment to sustainable practices with recycled metal as input. This can be an attractive selling point for customers interested in environmentally friendly products, which are becoming more important to attract new customers.
Geographic Reach: Their operations in both North America and Europe add diversification to mitigate risk from economic downturns in specific regions, although the company has seen similar results across its operational regions in its most recent fiscal quarters.

Moat Analysis CMC’s moat is relatively narrow:

Intangible Assets: Their brand is not exceptionally strong, but could be considered a well-recognized one in the industry.
Switching Costs: The switching costs for customers are mostly low, but in some segments, like their steel structures and fabricated metals business, customers could be stuck with contracts that contain higher switching costs.
Network Economics: Network effects do not feature heavily.
Cost Advantages: CMC has a low-cost advantage due to the usage of recycled materials. They also emphasize how their location strategies help them deliver products to their customers at low cost due to their proximity to customer base. They also claim to have operational excellence throughout all levels of their value chain.

Overall, these are not exceptionally high or difficult to replicate, so CMC only has a narrow moat. They are susceptible to many outside market forces and competitors that are able to offer alternatives. This is the key reason for the low moat score of 2/5.

Risks to the Moat and Business Resilience

Price Volatility: Changes in metal and energy prices, as well as other inputs, can cause extreme fluctuations in their profit margins, which they can sometimes pass onto their customer base and sometimes not. This results in an inconsistent income and makes forecasting harder.
Economic Cycles: The business is highly dependent on general economic cycles, especially in the construction and manufacturing sectors. If demand goes down, or if there are changes to government regulations, CMC’s profitability can suffer greatly.
Competition: The steel industry is very competitive, with a lot of players fighting over market share. Low-cost international producers can cause pricing pressure for domestic companies like CMC, and new domestic players can take their market share if they have an advantage in prices or other variables. In particular, the company is more reliant on US government and infrastructure spending than other competing companies. If the US government changes spending plans in the future, they might be especially vulnerable to changes in the market.
Global Events: Events like the Russian invasion of Ukraine can dramatically impact supply chains and input costs. A large number of assets that they have depend on the cost of natural gas, electricity, and other materials, and if the costs of those increase significantly it can negatively affect profitability. They also have customers throughout Europe and Asia, who may similarly experience problems.
Technological Disruption: While CMC utilizes and invests in the most cutting-edge technologies, these are usually not proprietary, and are easily replicated by other competitors, and new technologies can change market dynamics, which they may not be able to keep up with.
Acquisition risk: CMC has recently focused more strongly on acquisitions, which if not done correctly, can destroy significant value.

Despite these risks, the company does appear to have a resilient business. The company is profitable, and their business model is structured to be resilient to market fluctuations, but it’s very difficult for any firm to avoid damage caused by external factors. Although recent financial performance has been lackluster, due to an increase in pricing and decrease in revenues, over the long-term they will likely continue to be a going concern. This justifies the 4/5 in Balance Sheet Health.

Understandability CMC is a complicated company because it’s highly dependent on commodities, the economy, market cycles, and government regulations. It’s also vertically integrated, with manufacturing, distribution, and recycling arms. Further, they are undergoing changes due to the recent acquisitions, that are not yet totally reflected on their financial statements.

Therefore, given the complexity and number of different drivers of their business, their understandability rating is a 2/5.

Management’s Outlook and Concerns In the most recent earnings calls, the management has highlighted a decrease in shipments, and a downturn in demand, which is consistent across all operating groups. The company says that this has been influenced by global economic trends, and they are managing to minimize impacts from any issues by emphasizing operating excellence. They also mention the impact of the Russia and Ukraine war, as they source some materials and operate some steel factories in Europe and are impacted by energy costs. Despite all of this, they are focused on their integration efforts of newly acquired companies, and their infrastructure projects, and also are trying to reduce the impact of future downturns. There is also worry, amongst some analysts, regarding the timing of these acquisitions, at a period where debt is becoming more expensive, the macro conditions are unstable, and their own earnings are seeing a decline. However, the company maintains that they have a low-leverage business model, and are trying to improve profitability, and to drive results through cost-cutting initiatives. In addition, the company’s debt levels are starting to become a point of contention. Though currently they are comfortable with their leverage levels, their debt levels have greatly increased due to acquisition and are projected to only reduce slightly. They also have many capital expenditures that will require a significant amount of cash.