Reliance Steel & Aluminum Co
/ (RS-NYSE)We are upgrading our recommendation on Reliance Steel to Neutral. Adjusted earnings for the third quarter missed the Zacks Consensus Estimate while sales beat. Revenues rose on improved demand across the aerospace and energy markets and contributions from acquisitions. The company, however, sees pricing pressure through the balance of 2014 and expects sales volumes to decline on a sequential basis in the fourth quarter. Reliance Steel continues to be challenged by weak steel industry fundamentals, and contends with soft steel and metals pricing. Moreover, the non-residential construction market remains a weak link. However, the company is well placed to leverage the strong momentum across a number of end markets, including aerospace. It should also gain from its broad and diversified product base, wide geographic footprint and aggressive acquisition strategy.
/ Equity Research / RS | Page 1
Current Recommendation / NEUTRAL
Prior Recommendation / Underperform
Date of Last Change / 01/05/2015
Current Price (01/02/15) / $61.44
Target Price / $65.00
SUMMARY
/ Equity Research / RS | Page 1SUMMARY DATA
52-Week High / $76.1252-Week Low / $57.14
One-Year Return (%) / -16.33
Beta / 1.71
Average Daily Volume (sh) / 633,402
Shares Outstanding (mil) / 79
Market Capitalization ($mil) / $4,854
Short Interest Ratio (days) / 2.11
Institutional Ownership (%) / 82
Insider Ownership (%) / 4
Annual Cash Dividend / $1.40
Dividend Yield (%) / 2.28
5-Yr. Historical Growth Rates
Sales (%) / 14.3
Earnings Per Share (%) / 15.8
Dividend (%) / 40.7
P/E using TTM EPS / 13.0
P/E using 2014 Estimate / 12.5
P/E using 2015 Estimate / 10.6
Zacks Rank*: Short Term
1–3 months outlook / 3 - Hold
* Definition / Disclosure on last page
Risk Level * / Below Avg.,
Type of Stock / Large-Value
Industry / Metal Prd-Distr
Zacks Industry Rank * / 191 out of 267
OVERVIEW
Los Angeles, California-based Reliance Steel & Aluminum Co. (RS) is a leading metals service center company engaged in value-added materials management and metals processing services. It also distributes over 100,000 metal products to more than 125,000 customers across a vastspectrum of industries, such as galvanized, hot-rolled and cold-finished steel, stainless steel as well as aluminum, brass, copper, titanium, and alloy steel.
Reliance has 200 processing and distribution centers spread across 39 states in the U.S. and in foreign countries such as Belgium, Canada, China, Malaysia, Mexico, Singapore, South Korea and the United Kingdom. Although the company has a diverse geographic presence, the southeastern region of the U.S. generates the majority of its sales. Reliance improves its operating results through strategic acquisitions and the expansion of its existing operations. It has made 56 acquisitions since its 1994 IPO.
Reliance Steel provides metals processing services such as cutting-to-length, blanking, slitting, burning, plasma burning, and precision plate sawing, sawing, and shearing, among others, all to customer specifications. These services save time and labor and reduce overall manufacturing costs for the customer.
Acquisitions
On April 4, 2012, Reliance Steel acquired all the outstanding limited liability company interests of National Specialty Alloys, LLC (“NSA”). NSA, headquartered in Houston, is a global specialty alloy producer and distributor of premium stainless steel and nickel alloy bars and shapes. NSA has operations in Anaheim, California, Buford, Georgia and Tulsa, Oklahoma and had net sales of approximately $96.0 million for the twelve months ended October 31, 2011. The company’s primary end market is the energy market with specific focus on horizontal drilling and completion tools, pumps and valves used in the drilling and production of oil and gas. NSA will operate as a wholly-owned subsidiary of Reliance Steel. The terms of the transaction were not disclosed.
The acquisition enhances Reliance Steel’s existing offerings and also adds specialty stainless steel and nickel products to its portfolio. Furthermore, the acquisition augments Reliance Steel’s exposure to the fast-growing energy market.
On February 1, 2012, Reliance Steel, through its wholly-owned subsidiary Diamond Manufacturing Company, concluded the acquisition of McKey Perforating Co., Inc. and its subsidiary McKey Perforated Products Co., Inc. McKey is a contract manufacturer providing a complete range of metal perforating and fabrication services to customers primarily based in the U.S. McKey had net sales of approximately $18 million in the year 2011. The terms of the transaction were not disclosed.The acquisition brings McKey’s expertise to Reliance Steel’s table and is expected to help the company expand its presence in the perforated metal market.
In July 2012, Reliance Steel, through its newly-formed subsidiary Bralco Metals (Australia) Pty Ltd, acquired most of the assets of Airport Metals (Australia) Pty Ltd, a subsidiary of Samuel Son & Co. Limited. Based in Melbourne, Airport Metals (Australia) functions as a stocking distributor of aircraft materials and supplies.The terms of the deal were not disclosed.
In October 2012, the company wrapped up the acquisition of all of the outstanding shares of Alabama-based steel processor, GH Metal Solutions, Inc. The entity, which has annual sales of roughly $44 million, will now operate as a fully-owned unit of Reliance Steel’s subsidiary Feralloy Corporation.
Reliance Steel, in October 2012, purchased Texas-based privately-held Sunbelt Steel Texas, LLC for an undisclosed price. Sunbelt, which has annual sales of roughly $48 million, distributes special alloy steel bar and heavy-wall tubing products to the oil and gas industry. The entity will operate as a fully-owned unit of Reliance Steel with its current management remaining in place.
Reliance Steel, in February 2013, entered into an agreement to acquire all outstanding shares of Metals USA Holdings Corp. for $20.65 per share in cash, representing an enterprise value of around $1.2 billion. The company wrapped up the acquisition in April 2013 following the approval of the transaction by Metals USA’s shareholders. Metals USA, which makes steel and aluminum components, has now become a fully-owned subsidiary of Reliance Steel. Metals USA will continue to operate under its current brand names. Reliance Steel financed the buyout with the proceeds from the recently amended $1.5 billion unsecured revolving credit facility, a new term loan worth $500 million and the recent $500 million senior notes offering.
REASONS TO BUY
Reliance Steel’s core business strategy is to enhance its operating results by way of strategic acquisitions and expansion of its existing operations. The company is focused on diversifying its products, customers and geographic coverage which helps it to counter the adverse effects macro and microeconomic events. The acquisitions of McKey and National Specialty Alloys enabled the company to improve its product offerings along with expansion into newer markets. Moreover, the company, in April 2012, wrapped up the acquisition of all the assets of the Worthington Steel Vonore plant from Worthington Industries Inc. (WOR).The acquisition, which complements Reliance Steel's existing portfolio, expands its presence in the Southeastern regions of the U.S. The acquisition of the assets of Airport Metals markedReliance Steel’s first foray of into the Australian market. The company further expanded its global network with the addition of these assets. Moreover, the acquisition of Sunbelt has allowed Reliance Steel to serve customers across a number of oil and gas well drilling categories including vertical, horizontal, directional and deepwater drilling applications. The company hopes to leverage Sunbelt’s growing presence in specialty markets.Moreover, the acquisition of Metals USAis a strategic fit with Reliance Steel’s portfolio and complements its existing customer base, product mix and geographic footprint.With the acquisition, Reliance Steel added about 48 service centers, which are strategically located throughout the U.S. The company expects synergies of $15 million to $20 million a year. The acquisition of primarily carbon steel and aluminum products processor Haskins Steel will also allow Reliance Steel to penetrate into locations where it did not have a presence earlier. Moreover, the acquisition of Aluminium Services UK Limited will enable the company to expand its presence in the aerospace market. The recent buyout of Fox Metals and Alloysis also expected to strengthen Reliance Steel’s foothold in the oil and gas space which has been an attractive and growing market for the company.
Reliance Steel is seeing strength across energy, aerospace, automotive and heavy equipment markets. Energy remains among the company’s strongest end markets. Aerospace also remains a strong market as manifested by healthy demand and pricing. Demand in this market in 2014 is expected to be supported by higher commercial aerospace build rates. Strong demand is also witnessed in the automotive market, backed by the company’s toll processing businesses in the U.S. and Mexico. Reliance Steel expects sustained momentum across these markets and sees improvement in demand environment in the balance of 2014.
Reliance Steel remains committed to offer incremental returns to its shareholders through incremental dividend payouts. The company, in February 2014, raised quarterly dividend by 6% to $0.35 per share. It increased its quarterly dividend twice in 2013 and made dividend payments of roughly $97 million during the year, up 61% year over year. The company has sufficient liquidity and cash flows to support incremental dividend payouts moving ahead.
The company is also focused on growing its business organically. As a result, it closed down a few small operations in 2011 without impacting its ability to serve its customers. In addition, it opened new facilities and expanded current ones. These moves are further expected to improve the company’s operating performance going forward. Reliance Steel made capital spending of $168 million during 2013 and is expected to incur capital expenditure of less than $200 million in 2014 ($220 million budgeted). Majority of the capital expenditure has been focused on expanding its facilities and improving its geographical footprint. This is in line with the company’s growth strategy and would probably deliver the desired results in the long run.
REASONS TO SELL
Reliance Steel’s non-residential construction market is its largest end market. However, it continues to be its weakest. While there has been a modest recovery of late, demand levels remains significantly below the peak level achieved in 2006. Some customers in the construction industry are in seasonal business. As a result, revenues in some months are lower due to reduced number of working days for shipments of products, resulting from vacation and holiday closures at some of its customers.In addition, raw material prices are expected to remain volatile.
Reliance Steel’s operating results depend primarily on prices for and availability of metals. The company is still experiencing a weak pricing trend for most of the metals it sells. Average selling prices fell 10% year over year in 2013. Prices for carbon steel products and nickelare expected remain soft in the near term.For carbon steel products, excessive imports are keeping prices for flat roll and plate under pressure. The overall pricing environment is expected to be volatile. A significant decrease in carbon steel product prices from current levels may have an adverse impact on the company’s gross profit margins and profitability.
Reliance Steel remains challenged by the weak steel industry fundamentals. The U.S. steel industry has been hit by increased imports of cheaper steel products. Consumers in the U.S. are importing cheaper steel from China, forcing domestic steel producers to sell at lower prices, and sometimes even at a loss.
The steel industry remains affected by overcapacity which continues to outpace demand. There is not enough demand for steel products due to weakness in construction end markets, resulting in excess supply. Contributing towards this inventory glut are production ramp ups by domestic steel producers and rapid growth in Chinese production.
RECENT NEWS
Reliance Steel's Q3 Earnings Lag Estimates, Sales Beat– October 23, 2014
Reliance Steel posted earnings (as reported) of $1.21 per share in the third quarter of 2014, down from $1.22 per share logged a year ago. Profit inched up 0.4% year over year to $95.5 million from $95.1 million a year ago.
Barring one-time items, including costs related to settlement of antitrust litigation matters, earnings were $1.33 per share, a roughly 8% rise from $1.23 recorded a year ago. However, it trailed the Zacks Consensus Estimate of $1.36. Adjusted earnings were near the top end of the company’s expectations.
Reliance Steel saw its consolidated costs rise around 12% year over year in the reported quarter. It recorded an inventory adjustment related charge of $20 million (included in cost of sales) in the quarter.
Revenues, Volume and Pricing
Revenues rose 10.7% year over year to $2,705.1 million in the reported quarter as volumes rose on improved customer demand. Higher pricing and Metals USA acquisition also contributed to the gain. Sales beat the Zacks Consensus Estimate of $2,695 million.
Overall sales volume rose 6.4% year over year in the quarter while same-store sales volumes moved up 6.6%. Gains were witnessed across all commodities on a year over year basis. Average prices per ton went up 4.3% year over year.
Financials
Reliance Steel exited the quarter with cash and cash equivalents of $100.7 million, down roughly 4% year over year. Total debt increased roughly 8% year over year to around $2.3 billion. Net debt-to-capital ratio was 35.1% at the end of the reported quarter, up from 34.9% a year ago. The company generated operating cash flows of $53.3 million in the quarter.
Outlook
Moving ahead, Reliance Steel sees a slow but steady recovery in the U.S. economy and expects sales volumes to decline sequentially in the fourth quarter resulting from lesser shipping days due to the holiday season and closures at many of its customers’ facilities. The company expects pricing to fall in the quarter due to softness in many carbon steel products and lower nickel prices. It expects earnings per share for the fourth quarter to be in the range of $1.00 to $1.10.
Reliance Steel sees continued strength in the aerospace market and expects further demand improvement through the rest of 2014. For automotive, the company expects strong production rates in the fourth quarter and in 2015. Higher use of aluminum in the automotive industry represents a positive for the company.
Energy demand has been forecast to continue to improve in the fourth quarter and the next year. For non-residential construction, demand continues to improve but remains way below its peak levels and the company cautiously expects further improvement in 2015.
Reliance Steel's Q2 Earnings & Revs Trail Estimates– July 24, 2014
Reliance Steel saw higher profit in the second quarter of 2014 on increased sales but its earnings missed expectations. Profit, as reported, moved up roughly 19% year over year to $96.5 million or $1.22 per share in the quarter from $81 million or $1.05 per share a year ago.
Barring one-time items including costs related to sale of non-core assets, earnings were $1.30 per share, a 14% rise from $1.14 recorded a year ago. However, it missed the Zacks Consensus Estimate of $1.39. Adjusted earnings were at the bottom end of the company’s expectations, impacted by lower-than-expected volume improvements.
Reliance Steel saw its consolidated costs rise around 6% year over year in the reported quarter. It recorded an inventory adjustment related charge of $5 million (included in cost of sales) in the quarter.
Revenues, Volume and Pricing
Revenues rose 6.9% year over year to $2,616.8 million in the reported quarter, but missed the Zacks Consensus Estimate of $2,667 million. Metals USA acquisition contributed to the top line growth.
Overall sales volume rose 8.2% year over year in the quarter while same-store sales volumes moved up 4.6%. Average prices per ton fell 0.9% year over year.
Financials
Reliance Steel ended the quarter with cash and cash equivalents of $113.5 million, up roughly 13% year over year. Total debt declined roughly 9% year over year to around $2.1 billion. Net debt-to-capital ratio was 33.3% at the end of the reported quarter, down from 37.6% a year ago. The company generated operating cash flows of $40.7 million in the reported quarter.
Outlook
Looking ahead, Reliance Steel expects the demand environment to improve in the third quarter at a modestly higher rate than the second amid a slow but steady recovery in the U.S. economy. The company sees pricing to remain essentially stable with current levels. It expects earnings per share for the third quarter to be in the range of $1.25 to $1.35.
While pricing is expected to remains under pressure, Reliance Steel sees continued strength in the aerospace market and expects further demand improvement in second-half 2014. For automotive, the company expects strong production rates in the second half and in 2015. Higher use of aluminium in the automotive industry represents a positive for the company.
Energy demand has been forecast to be better in the second half and the next year while a modest improvement is expected in heavy industry. For non-residential construction, demand is improving but remains way below its peak levels and the company cautiously expects further improvement in the second half and in 2015.
VALUATION
Reliance Steel’s current trailing 12-month earnings multiple is 13X compared to the 9.3X average for the peer group and 18.9X for the S&P 500. Over the last five years, the company’s shares have traded in a range of 8.1X to 22.1X trailing 12-month earnings. The stock is trading at a premium to the peer group based on the estimated earnings for 2014 and 2015. Macroeconomic factors may play a role in reducing the company’s earnings power if demand doesn’t go up as expected and prices of raw materials continue to rise. Our Neutral recommendation on the stock indicates that it should perform in line with the broader market. Our price target of $65 is based on 13.2X our 2014 earnings estimate