Morningstar | Fiscal 2019 Will Be Year of Transition for Commercial Metals, but 1H Results Encouraging
Having issued steady second-quarter results, Commercial Metals remains modestly undervalued. Given our negative long-term outlook for the U.S. steel industry, this reflects our view that Commercial Metals' business model will hold up better than many peers' amid falling steel prices. After updating our valuation model, we are keeping our fair value estimate at $18 per share.With losses from the Americas fabrication and international mill segments exceeding our prior expectations, we've tempered our near-term profit forecast for the company. Separately, we've increased our terminal enterprise value/EBITDA multiple to 7.0 times from 6.5 times. Given considerable reinvestment to modernize the company's Polish steelmaking operations as well as the ramp-up of its new Oklahoma micromill, conversion of EBITDA to free cash flow should continue to improve. This stems from modestly lower reinvestment needs per ton of steel produced versus the legacy asset base. This brings our exit multiple for Commercial Metals in line with those we apply to Nucor and Steel Dynamics. The change establishes greater internal consistency, as the companies enjoy similar reinvestment needs, weighted average costs of capital, and growth prospects. The impacts of lower near-term profits and an increase to our exit multiple on our fair value estimate are offsetting.
Fiscal 2019 represents a year of transition for Commercial Metals due primarily to the integration of the acquired Gerdau steelmaking and fabrication assets. Although we forecast lower operating margins next year for every other U.S. steelmaker we cover, we expect Commercial Metals' margins to expand as unfavorable Gerdau contracts roll off the books and synergies are realized. Our long-term operating margin forecast is unchanged at 6%. This is higher the the company's trailing 10-year average, which is closer to 3%, largely because of materially improved results from Commercial Metals' revitalized steelmaking assets in Poland.
Commercial Metals, together with its subsidiaries, manufactures, recycles and markets steel and metal products, related materials and services. The company has four reportable segments: Americas Recycling, which processes scrap metals for use as a raw material by the company and other manufacturers of new metal products; Americas Mills, which operates electric arc furnace (EAF) mini mills, EAF micro mills, rerolling mill, scrap metal shredders, and scrap metal processing facilities; Americas Fabrication, which includes warehouses that sell or rent products for the installation of concrete; and International Mill, which consists of an EAF mini mill, recycling and fabrication operations located in Poland.
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