Morningstar | Steel Dynamics' New Mill Announcement Doesn't Reflect Our Concerns About Deteriorating Fundamentals. See Updated Analyst Note from 28 Nov 2018
Steel Dynamics announced plans to construct a new steel mill in the Southwestern United States with a capacity of 3 million tons per year. In doing so, the company would increase its existing flat-roll capacity by roughly one third. At an estimated cost of $1.7 billion-1.8 billion (for a company with a market capitalization of roughly $8 billion), this investment is a sizable project. The company plans to begin construction in 2020 and management forecasts operations would commence in the second half of 2021.Having assessed the overall opportunity, we are concerned that the project will ultimately prove modestly value-destructive. First, we believe current market conditions represent a cyclical peak, with metal margins likely to contract by the time the mill is operational. Although operating margins were 23.3% for the steel segment in the second quarter, we forecast only a 14% midcycle margin by 2022. Second, we are concerned that incremental supply will limit potential pricing upside. Even with recent tariff protection, U.S. steelmakers are not immune to the persistence of global overcapacity. We currently assign an Exemplary stewardship rating to Steel Dynamics' management team based on a record of disciplined capital allocation. However, the history of the global steel industry is rife with cautionary tales about overinvestment during cyclical peaks, and we are concerned that this might reflect such an investment.
Having updated our valuation model, we now include a downward enterprise value adjustment of just above $50 million based on the economics of this project. However, this adjustment is not enough to lower our fair value estimate, which is unchanged at $34 per share. Our no-moat rating is also intact. Because the project economics are captured solely via an enterprise value adjustment, our explicit forecast period does not consolidate associated cash flows into the company's flagship steel segment.
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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