Morningstar | Reliance Steel & Aluminum Posts Record Profits Thanks to 21% Sales Growth and Gross Margins Over 30%
Reliance Steel & Aluminum delivered impressive performance in the second quarter, as pricing momentum helped the company generate record profits. Adjusted earnings reached $3.10 per share in the quarter, up from $1.40 in the same period last year. With profitability now trending above our prior expectations, we've raised our 2018 profit outlook.However, having reassessed our long-term outlook for Reliance, we've lowered our midcycle operating margin forecast to 7% from 8%. We believe this to be a more realistic figure, given our outlook that average selling prices will soften in the coming years. Our forecast remains above the company's trailing 10-year average operating margin of 6.7%. It assumes a midcycle gross margin just above 27%, which is within management's long-term guidance of 27%-29%.
At the same time, we've also employed a more granular approach to determining the appropriate terminal enterprise value/EBITDA multiple for the company. The prior 6.8 times multiple we employed did not adequately account for the company's improved efficiency in converting EBITDA to free cash flow. Based on lower reinvestment needs than we previously assumed, we've raised our terminal multiple to 8.0 times. This sits just below the trailing 10-year average of 8.3 times.
After updating our model to implement these changes, our fair value estimate rises to $77 per share from $74. Ultimately, we expect 2018 to represent cyclical peak market conditions for Reliance as revenue and profitability normalize in the coming years as prices decline. Our no-moat rating is unchanged. Although we expect the company to generate returns on invested capital (10.7% including goodwill) modestly above its weighted average cost of capital (9.6%) in 2018, we don't believe this will prove sustainable. We forecast a midcycle 7.5% return on invested capital in 2022, the terminal year of our explicit forecast period.
Reliance Steel & Aluminum is a metals service center company. The company provides metals processing services and distributes a line of metal products, including alloy, aluminum, brass, copper, carbon steel, stainless steel, titanium and specialty steel products, to its customers in a range of industries, including general manufacturing, non-residential construction (including infrastructure), transportation (rail, truck trailer and shipbuilding), aerospace and defense, energy (oil and gas), electronics and semiconductor fabrication, and heavy industry (agricultural, construction and mining equipment). The company also services the auto industry, primarily through its toll processing operations.
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