Steel Dynamics, Inc.

Moat: 2/5

Understandability: 1/5

Balance Sheet Health: 4/5

Steel Dynamics, Inc. is a large domestic steel producer and metal recycler utilizing electric arc furnace (EAF) technology, with a vertically integrated fabrication manufacturing platform.

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: Steel Dynamics, Inc. (STLD) operates within the highly cyclical steel and metal recycling industry. Their operations include three primary segments:

  1. Steel Operations: This segment focuses on manufacturing and selling steel products using EAF technology. They are one of the largest steel producers in the US. Steel products are primarily flat-rolled, structural steel and steel bars.
  2. Metal Recycling Operations: STLD manages this segment through OmniSource, one of the largest metal recyclers in the United States. They engage in processing and selling ferrous and nonferrous scrap metal.
  3. Steel Fabrication Operations: The newest segment, this consists of fabricating and selling steel joists, deck, and steel beams for construction.

The company’s primary raw material is scrap metal, which is used to create new steel in its furnaces. Its vertical integration is important because this lowers cost and gives them control over their supply chain.

Revenue Distribution:

  • In their steel operations segment, Flat-rolled steel makes up the majority of the sales volume, followed by steel bar and structural steel products.
  • Metal recycling operations derive revenues from the sale of ferrous and non-ferrous scrap metal.
  • Steel fabrication generates revenues based on the sale of fabricated products such as joists, steel decking, and steel beams.
  • The majority of revenues (almost 90%) come from the U.S., primarily domestic customers

Trends in the Industry:

  • Cyclicality: The steel industry is highly cyclical, meaning that demand and pricing fluctuate with the overall economy. The company’s revenues and profits will rise and fall with general economic conditions.
  • ESG Mandates: The trend towards decarbonization is increasing the appeal of EAF technology over traditional blast furnace methods. STLD’s use of recycled scrap in its processes is seen as an advantage and reduces the need for new iron.
  • Infrastructure Spending: Recent government initiatives aimed at infrastructure expansion provide a significant tailwind for steel and metal prices, as well as greater demand.
  • Consolidation: The metals and mining industry is highly fragmented, and there is ongoing consolidation amongst industry players.
  • Technology: There is an increased emphasis on more efficient production and advanced technologies, which can lower costs and improve product quality.

Margins:

  • Steel Dynamics has consistently had solid operating margins, which are above industry averages, largely due to their lower-cost operating method.
  • Metal recycling margins are less volatile compared to the steel operations.

Competitive Landscape:

  • STLD competes with other steel producers, metal recyclers, and building products manufacturers. Competition includes companies such as Nucor, US Steel, Commercial Metals, and Reliance Steel & Aluminum.
  • STLD’s primary competitors include companies with both traditional blast furnaces and EAF processes.

What Makes STLD Different:

  • EAF Technology: STLD’s use of electric arc furnaces gives them a cost advantage over rivals that use traditional blast furnaces, as these can be more expensive to operate and maintain. It is also environmentally friendly due to using recycled materials.
  • Vertical Integration: The company’s ownership of both steel manufacturing and metal recycling operations gives them increased control over costs and supply chain, therefore, creating a more predictable profit stream.
  • New Flat Rolling Plant: STLD’s recent completion of a new flat-roll facility in Sinton, Texas, should help them achieve additional growth and allow it to expand into higher value steel categories. It will also give them higher ROICs.

Financials:

  • Revenue Growth: In the first three quarters of 2024, net sales were $13.5 billion, with Steel operations making up the lion’s share of these sales at $8.7 billion. Metal Recycling and Steel Fabrication accounted for $2.4 and $2.3 billion, respectively.
  • Profitability: In the first three quarters of 2024, the company had diluted earnings per share of $10.46, driven by net income of $1.825 billion.
  • ROIC: The company is typically able to generate a 13-16% ROIC over a cycle, however, this can fluctuate highly depending on the pricing environment.
  • Free Cash Flow: STLD has had very strong FCF over the last few years. In 2023 they generated $1.7 billion and are on pace to generate similar or higher levels in 2024.
  • Debt: The company has a significant amount of long-term debt ($3.5 billion in the recent report), which requires careful monitoring and repayment planning. However, they have been paying down debt lately.
  • Growth: The company expects to continue to increase its operations in steel and recycling. Through 2024 they expect to see strong performance in steel with demand strong from automotive, non-residential construction, and other industries.

Moat Assessment: Steel Dynamics has a narrow economic moat. While the company has a cost advantage through its EAF technology and vertical integration, the steel industry remains highly competitive and cyclical. There are still numerous competitors that can produce steel, reducing the company’s power to generate excess returns. This also reduces the moat’s strength and durability.

Moat Rating: 2 / 5

Risks That Could Harm the Moat:

  • Economic Downturns: Due to the steel industry’s cyclicality, the company’s earnings will be heavily impacted during recessions or economic downturns.
  • Raw Material Prices: Although Steel Dynamics primarily uses recycled steel, prices can still fluctuate widely and cause cost problems if prices move upward quickly.
  • Increased Competition: An increasing number of EAF steel mills is a trend that could pressure the company’s cost advantage and reduce their ability to achieve higher margins.
  • Input Costs: Costs related to energy and labor can be highly unpredictable, and can also eat into STLD’s profit margins.
  • Acquisition Risks: The company continues to acquire businesses in related areas and to achieve synergistic value creation from acquisitions. However, integration of those businesses is not always guaranteed.
  • Commodity Prices: STLD’s earnings are closely tied to the prices of commodities. If prices fall for the products that STLD sells, the company’s profits can fall fast and significantly.

Business Resilience:

  • Management: The company’s management team has been very focused on achieving its goals and has consistently produced results.
  • Low-cost Structure: They are typically the lowest cost producer in the US, which helps them during periods of low prices and margins.
  • Strong Balance Sheet: The company is generating significant FCF and reducing its debt levels. This should allow the company to navigate bad periods well.

Understandability: 1 / 5. While STLD has multiple components to its operations, including steel production, steel fabrication, and scrap metal recycling, their business model is very simple: use cheap, recycled material to produce products for sale, and recycle metal to resell.

  • The business is not difficult to understand on a basic level, which is why they get a low score. The business model is straight forward and they are a commodity business.

Balance Sheet Health: 4 / 5

  • The balance sheet is generally healthy with a manageable debt load, but high debt-to-equity can lead to increased volatility and possible bankruptcy risks. Management has reduced debt recently. The FCF they generate and can generate in future will give them flexibility and options to either return cash to shareholders or to reduce debt.
  • STLD has a debt-to-equity ratio of about 0.75, which is below what is seen at similar levels at other metal companies. This gives them enough strength and stability to navigate difficult cycles.
  • They have high levels of cash flow generation and an ability to operate even through difficult economic conditions.

Recent Concerns / Controversies / Problems & Management’s Response

  • The company has discussed a soft market in their steel segment, with shipments expected to be less in the fourth quarter of 2023 than the previous quarter. However, due to their flexible operations and their vertical integration of metal recycling, they expect to offset this volume reduction in profitability by selling scrap metal produced at high prices in their facilities.
  • The company also believes that they are poised for long-term growth, as they have created new infrastructure with their new plant in Sinton.
  • The company is actively working to manage the risks mentioned above, and they believe their focus on efficiencies and low-cost production will enable them to stay profitable in the future.