Morningstar | Schnitzer Steel Delivers Healthy Sequential Profit Increase in 3Q, but We Remain Cautious. See Updated Analyst Note from 26 Jun 2019
We anticipated that Schnitzer Steel Industries would suffer sharply lower profits in fiscal 2019 after enjoying cyclical peak market conditions in 2018. Accordingly, we forecast $88 million of adjusted operating income for 2019, a 40% decline from $147 million last year. Regardless, even though profits have declined year to date, the company continues to perform fairly well versus historical standards, and third-quarter results were solid. Having updated our valuation model, we are not changing our $19 fair value estimate and no-moat rating.During the company's earnings call, management cited a scrap/iron ore price ratio of only 3 times, well below historical levels. However, we believe this spread is indicative of iron ore supply disruptions stemming from the January Vale dam collapse, which will gradually be resolved, rather than an imminent recovery in scrap prices. Additionally, although an eight-year high for the domestic rebar/scrap metal spread during the quarter provided a tailwind for steelmaking profits, we contend that it will be unlikely to persist.
On the bright side, management continues to usher in productivity improvements, the company's steelmaking utilization rate reached an impressive 98% in the quarter, and financial leverage remains low. Schnitzer would benefit significantly from a major uptick in U.S. nonresidential construction spending, but we remain skeptical that a clear-cut plan will be announced soon.
Schnitzer's shares continue to trade above our fair value estimate, in 2-star territory, as we see no major upside catalysts in the offing.
Schnitzer Steel Industries is engaged as a recycler of ferrous and nonferrous scrap metal, including end-of-life vehicles, and a manufacturer of finished steel products. The company has two segments: Auto and Metals Recycling, which acquires and recycles ferrous and nonferrous scrap metal for sale to foreign and domestic metal producers, processors and brokers, and procures salvaged vehicles and sells serviceable used auto parts from these vehicles through a network of self-service auto parts stores; and Cascade Steel and Scrap, which produces a range of finished steel long products using ferrous recycled scrap metal and other raw materials.
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