Morningstar | Steel Dynamics Delivers Record Profits but No Upside Catalysts on the Horizon; Shares Overvalued
Steel Dynamics continues to fire on all cylinders, delivering record profits once again in the third quarter. The company benefited from wider metal margins, supporting steelmaking operating margins above 20% for the second consecutive quarter. However, we expect metal margins to normalize in the coming quarters. With our outlook intact, our $34 per share fair value estimate remains well below current share prices and our no-moat rating is unchanged.Many would consider our outlook overly bearish. However, our 10% assumed midcycle operating margin for Steel Dynamics is roughly in line with the company's 2017 margins, a year in which market conditions were widely considered favorable for U.S. steelmakers. We'd be hard-pressed to believe that the far more favorable market conditions of 2018 will prove sustainable.
Although we believe Steel Dynamics' share prices reflect unwarranted optimism about the future of the broader U.S. steel industry, the company remains a best-in-class operator. The only steelmaker to which we assign an Exemplary stewardship rating, Steel Dynamics has been disciplined in pursuing both M&A and reinvestment. Thanks to the company's attractive positioning on the industry cost curve, we are less concerned about its prospects as steel prices decline than we are about its vertically-integrated, blast furnace-operating peers. Regardless, with the current operating environment allowing for record profits, we feel investors have lost sight of the degree to which metal margins can contract when steel prices fall. Therefore, even a well-run, high-quality company such as Steel Dynamics is likely to suffer significant profit declines amid our negative outlook for U.S. steel prices.
Steel Dynamics is a steel producer and metal recycler. The company manufactures and sells steel products, processes and sells recycled ferrous and nonferrous metals, and fabricates and sells steel joists and deck products. The company's segments are: Steel, which produces steel from ferrous scrap and scrap substitutes, utilizing casting, automated rolling mills and several downstream steel coating and bar processing lines, and Iron Dynamics; metals recycling, which involves the purchase, processing, and resale of ferrous and nonferrous scrap metals into reusable forms and grades; and steel fabrication, which produces steel building components, including steel joists, girders, trusses, and steel deck.
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