Investors in steel company Steel Dynamics(NASDAQ: STLD) were presumably (and pleasantly) surprised last week when a mixed earnings report showed Q1 sales falling short of expectations -- but profits coming in comfortably ahead of expectations.
Steel Dynamics earned a non-GAAP (adjusted) profit of $4.01 per share for the first quarter of 2023 --actual generally accepted accounting principles (GAAP) earnings were $3.70 per share -- despite sales coming in at just $4.9 billion. The shares popped nearly 5% the day after earnings came out, and while they've given back some of their gains since then, they remain above Steel Dynamics' pre-earnings price.
But for how long?
The bad news about an earnings beat
Steel Dynamics may have "beat earnings," as the saying goes. But it missed on revenues. Worse, both revenues and earnings fell dramatically in comparison to first-quarter 2022 levels. Sales for the quarter declined 12% year over year. Profits per diluted share were down a staggering $2 per share -- a 35% year-over-year decline.
Curiously, all of this happened even as Steel Dynamics set a new record of 3.3 million tons for steel shipments in the quarter. And the reason for that was that steel prices declined in Q1, even as input costs (scrap steel) were basically unchanged. Hence, Steel Dynamics didn't make as much money per ton of steel shipped.
Now, the good news is that CEO Mark Millett confirms that "steel pricing has since strengthened" since the end of the quarter and that "steel producer lead times have extended as steel demand is strong," with particular strength in the automotive, non-residential construction, energy, and industrial sectors.
The bad news is that this good news may not last.
What analysts say
2022 was a tremendous year for steel profits at Steel Dynamics, with the company pulling down profits of nearly $21 per share, 34% better than seen in 2021 and nearly seven times better than the company earned in the pre-pandemic year 2019. But according to long-term forecasts, 2022 may also have been the high-water mark for profitability in the highly cyclical steel industry.
Looking ahead, analysts forecast falling profits for Steel Dynamics through at least 2025, with profits this year slipping back below 2021 levels (about $15 a share), then falling more than 40% more in 2024 and another 25% in 2025, to about $6.56 per share (which would still be more than twice what Steel Dynamics earned in 2019).
And granted, if the trends Millett referred to in the early second quarter continue throughout this year and beyond, this may not be the way things play out. But what if they do play out this way?
Valuing Steel Dynamics stock
Consider that at a share price of roughly $109 today, Steel Dynamics stock costs just 5.2 times last year's earnings and 5.8 times trailing earnings -- which seems really cheap. For that matter, even if analysts are correct and profits this year slide only to $15 per share -- and stop there -- the stock still doesn't look expensive at 7.3 times forward earnings.
This picture starts to change, however, if profits continue to erode going forward, as analysts say they will and as you might expect to happen if the long-awaited recession first arrives, then drags on for a while. Next year's forecast profits of $8.81 per share, for example, yield a 12.4 price-to-earnings (P/E) ratio based on 2024 earnings, and if profits fall as forecast in 2025, then the P/E ratio rises past 16.6. Moreover, valued on its average earnings over the decade preceding the enormous rise of profits seen in 2021 (about $1.88 per share per year), Steel Dynamics today is trading for about 58 times those historical average earnings.
Even granting that Steel Dynamics has expanded its operations a lot over the past decade, doubling production volume and posting 2022 sales that were 150% greater than average annual sales over the previous decade, I suspect that may be a bit much to pay for a commodity metals producer.
This, in a nutshell, is what has me worried about investing in Steel Dynamics right now. Although a fine company and a stock that's rewarded investors richly over the past few years, Steel Dynamics stock seems richly priced if the global steel market ever returns to something like what "normal" used to look like. Millet doesn't seem to think that's going to happen this year.
But if it ever does, caveat investor.
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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
