STLC.TO - Stelco

[petec]

Stelco was the Canadian part of US Steel. It came to my attention after Fairfax bought a stake. I thought it was interesting enough to have its own thread.

 

It's not in an attractive industry - commoditised and low ROIC. But as a stock, at a superficial level, it has attractions:

- Newest a lowest cost plants in North America (they claim)

- Recently out of bankruptcy with no debt and low, fixed payments for legacy employee liabilities - a practically unique balance sheet within the industry

- A management team who claim to have created great shareholder value before, with a vision to grow Stelco by buying distressed assets when no-one else has money

- Cash on the balance sheet and a stated aversion to structural debt (i.e. they'd lever to acquire, but then pay down)

- 2x run rate ebitda plus a plan to develop and divest noncore assets (land)

 

The epic caveat is that steel prices are high and falling. Part of the reason they rose is because China has been shuttering old, inefficient, polluting capacity and I expect this to be permanent. Also, Stelco started this year with prices well below market and has been playing catch-up. Nonetheless, one can't assume that run rate ebitda is sustainable.

 

Other than that I don't yet know a lot about the stock, management's history, or the industry. If anyone can educate me I'd appreciate it.

[BeachHouse]

I've been reading up on this one as well. The problems in my view are that:

 

- it's a hyper cyclical and terrible industry that is unlikely to attract many long-term investors to the stock. Seriously high fixed cost, over-capacity, levered peers, and exposed to very cyclical end markets -- very poor returns. 

 

- While China appears to be focused on reducing pollution and may create a more rational global steel market in the process, it's very hard to make this bet, and if I'm wrong in making this bet, the industry will have years of weak prices and the stocks will do nothing; I feel least comfortable about the fundamentals of the China aspect of the idea.

 

- the steel stocks basically move in-line with steel prices, and steel prices are near all-time peaks, but have been extraordinarily volatile over the last few decades, suggesting that there are very few cases where steel prices held at this level and didn't crash -- which means that the stock is more likely to underperform.

 

- it's hard to tell what the "true" free cash flow of the business will be relative to the "true" enterprise value of the business, or how long we can trust that free cash flow given #1. the company could do a better job focusing investors on its true FCF, which is where the valuation discrepancy is the widest with its peers.

 

- given the low liquidity in the stock it seems to me that a significant buyback is unlikely, which means that there is a significant risk that they will be taking capital and putting it into (definitionally given the low valuation on the parent company) lower returning businesses. 

 

The positives are that:

 

+ It appears that the US and Canada are serious about revitalizing their steel industry, and we should have at least 2 more years of these tariffs and inflated steel prices. 

 

+ Stelco appears to have a competitive advantage in North America on its cost structure due to removing legacy liabilities and balance sheet issues. this is probably the best aspect of the entire idea.   

 

+ Stelco generates a large amount of FCF relative to its market cap and EV, and with the right bets, could turn that FCF into an even larger and more profitable business. this is the reason to hold the stock for 5 years.

 

+ It's certainly the cheapest steel company in the world on EV/FCF.

 

I'm pretty torn! Does anyone know the management team well, or what Fairfax was thinking?

 

 

[wondering]

https://www.stelco.com/sites/default/files/2019-02/Q4%202018%20-%20Investor%20Call%20Deck%20%20FINAL2.pdf

 

"HAMILTON — Stelco Holdings Inc. says it saw a significant earnings boost in the fourth quarter as both shipments and steel prices rose while it reduced tariff costs. 

 

The company says it had a net income of $110 million, or $1.23 per share for the quarter ending Dec. 31, up from $15 million or 21 cents per share for the same quarter a year earlier.

 

Adjusted net income came in at $100 million or $1.13 per share, which was up from $52 million a year earlier but below analyst expectations of $142 million or $1.36 according to Thomson Reuters Eikon.

 

The company says it has been using a flexible model that allowed it to reduce costs from the U.S. metal tariffs by 41 per cent from the third quarter to $23 million.

 

Stelco says it continues with efforts to reduce tariff exposure into 2019, and supports the Canadian government's efforts to eliminate the tariffs as well as measures to safeguard increases of foreign imports into the Canadian market.

 

It says it has issued a special dividend of $100 million or $1.13 on top of its regular quarterly dividend on the strength of its results."

[Spekulatius]

Stelco seems  pretty cheap and well run. I was surprised to see EBITDA margin above 20%, which is higher than Nucor’s. Also revenue is comparable to Nucor’s, which seems to indicate a very well run company. The balance sheet looks very clean and it seems like post bankruptcy, the assets seem to be on the book far below replacement value, which keeps depreciation low (but this won’t matter when looking at EBITDA).

 

I don’t own this, and there is stigma of operating in the steel industry, but I agree this looks quite interesting. Anybody owns this and has done a deep dive in this?

 

Edit - meant revenue per employee....

[petec]

Stelco seems  pretty cheap and well run. I was surprised to see EBITDA margin above 20%, which is higher than Nucor’s. Also revenue is comparable to Nucor’s, which seems to indicate a very well run company. The balance sheet looks very clean and it seems like post bankruptcy, the assets seem to be on the book far below replacement value, which keeps depreciation low (but this won’t matter when looking at EBITDA).

 

I don’t own this, and there is stigma of operating in the steel industry, but I agree this looks quite interesting. Anybody owns this and has done a deep dive in this?

 

Don't own it. Did a shallow dive in about November of last year. Currently considering revisiting it. Clearly cheap on current operating metrics. My main issues are:

- I know flat nothing about steel so I have no idea where we are in the cycle, or what FCF (my main metric of interest) might look like at the bottom of the cycle or through the cycle.

- whether to include the employee benefit liability at the discouned rate or the full estimated amount - I can't quite shake the feeling that this is basically debt and should be looked at undiscounted.

 

The land value optionality intrigues me longer term.

 

 

[John Hjorth]

... Don't own it. Did a shallow dive in about November of last year. Currently considering revisiting it. Clearly cheap on current operating metrics. My main issues are:

- I know flat nothing about steel so I have no idea where we are in the cycle, or what FCF (my main metric of interest) might look like at the bottom of the cycle or through the cycle ...

 

Pete,

 

The answer to your question here quoted is - for me : "Bad" - plain & simple. It's simply not worth your time. [i know - by reading the board, now for many years - how you think & how you operate.]

 

[That also implies that I'm not a avid fan of everything going on at BAM & BBU, btw.]

 

The overall psychology in the steel market somehow reminds me of the psychology of the market of container shipping [not rational].

[petec]

John, the thing about irrational industries is that a rational person can do very well in them. In the land of the blind, the one-eyed man is king. One of the reasons I own Seaspan is because a smart guy like Sokol might be able to do clever things with all that cash. Stelco is the same, without the contracts (but also without the debt).

 

The questions, for me, are: do you like the management; do you like the price; is there too much debt?

 

The issue for me is price: I can't judge where steel is in its cycle so I don't know how to think about current cash flows (which make it look super cheap).

 

In Stelco's case I am pretty close, although I would likely fund it out of Seaspan rather than add to this "type" of investment.

[Spekulatius]

There is no bad asset, there are just bad prices. Stelco looks to me to have a squeaky clean balance sheet and is earnings quite a bit of money (likely overearning at the moment), but is also distributing a lot of cash via special dividends.

 

I see headwinds in earnings from higher input costs (the Vale dam incident has reduced Vale’s ore supply by about 20%) so I think earnings might fall this year and who knows what happens after that.

 

They do seem to be a low cost producer based on current EBITDA earnings, which means a lot in a commodity industry. I think it’s a questionable buy for FFH to obtain a huge stake, because they can’t easily exit and might be stuck investors for a long time, but each of us could get out in a NY minute, if the thesis (which is really around dividend distributions) does not work out.

[wondering]

stock is down about 50% from April 2019.  PE 3.5X, dividend yield 3.6%, no debt on the balance sheet.  If I understand correctly, the US tariffs on Cdn steel have been lifted.

 

I saw this interesting article in the Hamilton Spectator that made me think it is run by good capital allocators.

 

https://www.thespec.com/news-story/9563133-stelco-the-landlord-sees-big-bucks-in-leasing-out-surplus-industrial-land/

[Viking]

I am doing a quick review of the various investments Fairfax currently has. Petec, thanks again for all your work laying much of the ground work during Fairfax’s winter :-) Some investments appear to be in cyclical industries with histories of players not behaving very rationally (resulting in poor results for shareholders).

 

Their investments in Stelco and Seaspan are interesting. It looks like Fairfax feels a well managed company with the right capital structure can succeed in what have historically been tough industries. The key ingredients appears to be strong managment teams (outsiders who think outside the box) and low debt (or no debt in Stelco’s case).

 

In reading the last q conference call notes for Stelco i was impressed with how mangement is managing the business and their creativity in finding value for shareholders. The discussion of the real estate purchase, lease and future opportunities was interesting. Wondering in the post above provided a link summarizing the land purchase and lease. It is very early days in the life of the new Stelco and we will get a better read on management as they report earnings in the future. It will be interesting to see if they can pull it off (be an investment that is good for shareholders through the cycle).

 

I am not looking to buy Stelco shares; rather, trying to understand the company as one small input into Fairfax’s current equity holdings. Bottom line, at $10/share i like the risk/reward of Stelco for Fairfax on a go forward basis. Especially if the US economy continues to grow GDP at 1.9-2%

 

PS: there is not alot of information available for Stelco. Here is a 10 minute interview from May

Stelco executive chairman: End of metal tariffs could lead to more M&A in steel sector

- https://www.bnnbloomberg.ca/video/stelco-executive-chairman-end-of-metal-tariffs-could-lead-to-more-m-a-in-steel-sector~1687752

 

[Spekulatius]

As far as Stelco is concerned, how do you reconcile their claim being a loc cost producer with the  fact they were barely profitable in Q2, which was by no means a crisis environment. Nucor, a known low cost producer was solidly profitable during the same quarter, although their price was down YoY.

In my opinion, Stelco’s claim of being a low cost producer makes no sense. I like what they did with their real estate purchase, but any earnings from this sector will be swamped by changes in their main business.

[Viking]

Spekulatius, i am taking what management has to say with a very large grain of salt. I am by no means an expert but it sounds like tarriffs (on and then off) caused Stelco to have to pivot fast (shifting a big chunk of business from US to Canada). I am not sure their competitors had to deal with the same adversity. With the tarriff issue resolved we should get a better feel for how Stelco is performing (especially versus peers) in the coming quarters.

[Spekulatius]

Spekulatius, i am taking what management has to say with a very large grain of salt. I am by no means an expert but it sounds like tarriffs (on and then off) caused Stelco to have to pivot fast (shifting a big chunk of business from US to Canada). I am not sure their competitors had to deal with the same adversity. With the tarriff issue resolved we should get a better feel for how Stelco is performing (especially versus peers) in the coming quarters.

 

I am not a steel expert either, but I am getting concerned when managements statements and income statement don’t tell the same story. Stelco Details the impact of the steel tariffs (~13M)  and it doesn’t even come close to explaining the loss in profits from slower realized prices and lower volumes. The volumes for Stelco in particular are all over the map and vary a lot from quarter to quarter and 2018 seems to have been a particular outlier and my concern would be that it’s not likely to be repeated. Nucor for example sees changes in pricing and profits too, but the volume variation are far lower than what we see with Stelco. One logical explanation for this would be that Stelco is a marginal swing producer that can only make profits when product prices are high.

 

Perhaps there are other explanations - it could be that the tariffs caused a disruption in the market more so than the stated impact in Stelcos income statement, but then again, why didn’t Stelco earning release explain this better? In those cases, I tend to take what management says at face value.

[petec]

Spekulatius, i am taking what management has to say with a very large grain of salt. I am by no means an expert but it sounds like tarriffs (on and then off) caused Stelco to have to pivot fast (shifting a big chunk of business from US to Canada). I am not sure their competitors had to deal with the same adversity. With the tarriff issue resolved we should get a better feel for how Stelco is performing (especially versus peers) in the coming quarters.

 

I am not a steel expert either, but I am getting concerned when managements statements and income statement don’t tell the same story. Stelco Details the impact of the steel tariffs (~13M)  and it doesn’t even come close to explaining the loss in profits from slower realized prices and lower volumes. The volumes for Stelco in particular are all over the map and vary a lot from quarter to quarter and 2018 seems to have been a particular outlier and my concern would be that it’s not likely to be repeated. Nucor for example sees changes in pricing and profits too, but the volume variation are far lower than what we see with Stelco. One logical explanation for this would be that Stelco is a marginal swing producer that can only make profits when product prices are high.

 

Perhaps there are other explanations - it could be that the tariffs caused a disruption in the market more so than the stated impact in Stelcos income statement, but then again, why didn’t Stelco earning release explain this better? In those cases, I tend to take what management says at face value.

 

I have the same question/issue. The issue is the gross margin on steel product sales which seems hugely volatile (notes 11 and 12 of the 2q). They don't break out what's in the cost of steel inventory but I think the possible explanations for a volatile gross margin are:

1) there's a high fixed cost component in cost of inventory. I think this would have to be personnel costs, which would be disappointing in a company just out of bankruptcy.

2) an unusually volatile sales mix between low and high margin products, which seems unlikely and doesn't come across from the commentary.

3) timing oddities e.g. if they buy raw materials expensively this quarter and sell them cheaply next quarter.

 

Sadly I think (1) is most likely. Looking back over the last 3 half-years, if you assume a fixed cost of $300m per half the remaining/variable cost of steel inventory becomes a fairly consistent 22-23% of sales. I have no idea if this relationship is meaningful but it's the only way I can think of to try to triangulate the size of the potential fixed component of cost of steel inventory.

[Viking]

Regarding Stelco, my understanding is they do not hedge their production. If their competitors hedged when prices were high this would likely explain a chunk of any recent underformance by Stelco.

 

Timely article posted at Globe&Mail: Why Trump tariffs haven’t revitalized American steelmakers

 

https://www.theglobeandmail.com/business/international-business/us-business/article-why-trump-tariffs-havent-revitalized-american-steelmakers/#comments

 

Two quotes from article:

 

“For the first few months after Trump’s tariffs took effect, steel prices did rise. The price of a metric ton of hot rolled band steel hit $1,006 in July 2018, according to the SteelBenchmarker website, which tracks steel prices. Since then, it has plunged to $557 – lower than before the tariffs.”

 

“The first sign of trouble showed up on the stock market. Shares of steelmakers had topped out on Wall Street in February 2018 before the tariffs hit. Since then, the NYSE Arca Steel Index has plunged 32%. The combined earnings of US Steel, AK Steel, Steel Dynamics and Nucor tumbled more than 50% in the first two quarters of this year. Capacity utilization dipped back below Trump’s 80% target in July and August.”

 

———————————

Steel prices report: http://steelbenchmarker.com/files/history.pdf

[Viking]

Stelco just released Q4 earnings last night and shares are currently trading down 8% so Mr Market is not impressed. Likely due to: ‘$90 million decrease in finance and other income mainly due to a loss on commodity-based swaps.’ Ouch!

 

I just listened to the conference call. And bought a started position in the stock. Company looks exceptionally well positioned moving forward. Especially if steel prices remain elevated (and it sounds like they might).

 

My key takeaways (i need to listen to the call again to make sure my notes are right...)

- there is about a three month lag between market steel pricing and Stelco results, driven by order lead times. As an example Stelco said Feb steel pricing will show up in May results

- steel pricing is crazy high right now. They expect Q1 EBITDA per net ton to be in the $450-$500 range (was $123 in Q4).

- their cost per ton will be lower in Q1 than Q4

- they are producing at full capacity (hit full capacity in Dec)

- 15% of production is hedged with swaps; leaves 85% unhedged. Hedges are used from time to time to lock in profit.

- free cash flow will be large moving forward. First priority is to build liquidity. Then shareholder returns via special dividend or buybacks. They are also looking for opportunities.

- expect more merger activity in industry; feel Stelco may actually be a target.

- land sale is coming; not sure on timing (hopefully 2021 but could be 2022). Land parcel is considered best site of its kind in all of Canada (and North America?). Sounds like it will be a significant cash generator when it finally happens.

- dividend of $0.10/share/quarter declared

 

[petec]

Couple of additions/questions:

- they said Q2 ebitda per ton would be significantly higher than the $450-500 per ton they will see in Q1.

- do you know what production capacity is after the q4 upgrades? I can’t find a figure.

- I’m not sure the land is a sale - I thought it was a development. They refer to severance. What’s that?

[petec]

Scotia have capacity at 675,000 tons per quarter / 2.7mt per year.

 

If the low end of the q1 range ($450) is sustainable for the year that’s $1.2bn in ebitda for a multiple of 1.9x.

 

Scotia also have $8.50 in FCFPS over the next 2 years, which is significant vs. a share price of $21.

 

I think the disappointment in q4 was production - 490kt vs guidance of 600kt because they ramped slowly after the upgrade and because they ran slow after a cyberattack.

[Viking]

RBC just started coverage of Stelco and they are using 2.6 Mnt as their annual production number. They have not sent out an updated report yet (covering Q4 results).

 

Here is a presentation that touches on the lands and severance. You are correct; not a sale. Redevelop and lease.

- https://pub-hamilton.escribemeetings.com/filestream.ashx?DocumentId=246196

 

Brief history of the Severance of the Stelco Lands

- Seven Parcels

- City Staff commented on the Severance application in 2019.

- Application for the Severance was approved by the Committee of Adjustment in October 2019 with staff support.

- We have been working with the City staff over the last year to clear the consent conditions in order finalized the severance.

- We are before the Public Works committee because we have been requested city staff to amend a City sewer bylaw in order to clear the Infrastructure consent condition of the severance.

- The clearance of a bylaw is not under our control but we are trying to comply with this request.

———————————

Article (Oct 2020): MOVING SURPLUS STELCO LANDS TO NEW USES

- https://bayobserver.ca/2020/10/19/moving-surplus-stelco-lands-to-new-uses/

 

...Stelco sits on an 800-acre site and as a result of the shutdown of primary steelmaking there is about 550 acres surplus to Stelco’s needs. Stelco wants to develop the property as an industrial park but needs to get an amendment to a Sewer Bylaw allow for the servicing of the lands.

 

...Staff outlined some technical issues that needed to be sorted out to make it possible to agree to the Stelco request. But the clear mood around the table was that the development needed to be supported one way or another.

——————————-

Article (Aug 2019): Stelco the landlord sees big bucks in leasing out surplus industrial land

- https://www.thespec.com/business/2019/08/23/stelco-the-landlord-sees-big-bucks-in-leasing-out-surplus-industrial-land.html

 

Stelco says it is on course to make a windfall profit from surplus Bayfront property it bought in a controversial land deal more than a year ago.

 

...June, 2018 — Stelco and the land trust administrators suddenly announced the steelmaker had changed its mind about the arrangement and wanted to buy almost all of the property the land trust was administering. In total, $114 million was paid for 3,000 acres of property in both Hamilton and Nanticoke — property that was both in active use and surplus. It was sold under carry-over supervision from the bankruptcy protection process, before the land trust governance was up and running and before any remediation was completed.

 

Especially significant about the deal was a highly unusual, if not unprecedented, provision that protected Stelco's Bedrock Industries owners from future liability from historical environmental contamination. The protection it had under the former arrangement was being grandfathered forward.

[petec]

Bought a small position. Likely to do $6 in fcf this year, mostly in the first half, so in my mind I’m paying about $15, which is a very fair valuation for a low cost producer with no debt, and I think I’m getting the land for free.

[Viking]

I listened to the Stelco conference call a second time. Here some additional comments:

- scroll to bottom of this link for mgmt Powerpoint presentation: https://investors.stelco.com/events?item=13

 

Bull case for Stelco (as laid out by CEO on conference call):

1.) no debt

2.) free cash flow generation machine

3.) ‘top of the heap’ asset capabilities on auto front

4.) no legacy liabilities on balance sheet - all sitting in trust

5.) clean profile environmentally

6.) most modern integrated facility

 

- competition: there has been a significant amount of consolidation in NA in recent years to benefit of industry

- Dec production was 250,000 tons and over capacity (2,600-2,700/year?). Production was strong to start 2021.

- additional cash will come from Hamilton land development; City of Hamilton is highly motivated; timing uncertain (thinking 2021 but could be pushed to 2022). Value of this asset is certain and large.

 

EBITDA potential (conservative base case) for:

- Q1 2021 = CAN$450/ton x 600 tons = $270 million.

- Q2 2021 = CAN$550/ton x 600 tons = $330 million

 

Of note, they are currently taking some orders for May delivery for HRC at price of +CAN$1,500/ton. Their average cost is about CAN $600. EBITDA numbers for Q1 and Q2 are likely low. Please let me know if i am missing something with my numbers! :-)

 

If HRC steel prices remain elevated Stelco could earn +$1 billion in EBITDA in 2021.

- https://ca.investing.com/commodities/us-steel-coil-futures

 

Stelco has a market cap of just under CAN $2 billion ($22.50 share price x 88.7 million shares)

 

The key will be production levels and how fast and how much of the rise in prices they are able to capture in selling price. In terms of production, management said they are currently producing to capacity. And in terms of selling prices management said to think in terms of a three month lag (driven by order lead times).

—————————

Management owns 14% of Stelco. Their interests (stock price) are highly aligned with shareholders (they almost sounded too motivated on the call to drive the share price higher :-)

[petec]

I read the same numbers and would agree your numbers are conservative. For example they’re selling their cheapest product at 1500 for May now. That’s a $900 margin per ton, or thereabouts. If they can get 650-700k tons out in q2 you could in theory be looking at something silly like $600m in ebitda in just that quarter. I doubt it will be that high, but this supports the possibility that your numbers are reasonable/conservative.

 

Then you have to consider ongoing earnings. I’m going to switch to USD here. On the q3 call they mentioned that once they’ve finished the cogen plant their costs will drop to $400per ton. Over the last 10 years HRC has generally traded above $600 per ton. That’s a $200 margin or $250 Canadian.

 

Allow for some maintenance downtime and assume 2.5mt of annual production at $250 per ton. Could we be looking at $600m in average annual ebitda through the cycle? If so it’s on 4.3x, which I think leaves plenty of room for error in the estimate. There is no debt and I think they still have tax loss carryforwards (need to check this) so much of this drops to free cash, giving a >20% FCF yield.

 

And then there’s the land, which could be developed into a very considerable asset.

 

Perhaps the most amazing thing is that this was available for $4 per share not long ago and I was too stupid to buy it.

[Viking]

I read the same numbers and would agree your numbers are conservative. For example they’re selling their cheapest product at 1500 for May now. That’s a $900 margin per ton, or thereabouts. If they can get 650-700k tons out in q2 you could in theory be looking at something silly like $600m in ebitda in just that quarter. I doubt it will be that high, but this supports the possibility that your numbers are reasonable/conservative.

 

Then you have to consider ongoing earnings. I’m going to switch to USD here. On the q3 call they mentioned that once they’ve finished the cogen plant their costs will drop to $400per ton. Over the last 10 years HRC has generally traded above $600 per ton. That’s a $200 margin or $250 Canadian.

 

Allow for some maintenance downtime and assume 2.5mt of annual production at $250 per ton. Could we be looking at $600m in average annual ebitda through the cycle? If so it’s on 4.3x, which I think leaves plenty of room for error in the estimate. There is no debt and I think they still have tax loss carryforwards (need to check this) so much of this drops to free cash, giving a >20% FCF yield.

 

And then there’s the land, which could be developed into a very considerable asset.

 

Perhaps the most amazing thing is that this was available for $4 per share not long ago and I was too stupid to buy it.

 

Petec, thanks for chiming in... the numbers just seem so high. But i guess this is what can happen with a commodity producer when prices start to take off. I am very impressed with Stelco management. They have made so many crazy good decisions the past couple of years. Imaging what they will do with windfall profits to further build shareholder value. My guess is a pivot in production to support green economy investments that are coming by government and industry.

 

PS: i doubled my position size today... second largest holding after FFH.

[Viking]

One of the keys to being bullish on Stelco is steel prices and where they go over the next year. I am not a steel expert so please chime in if you see errors below :-)

 

The industry appears to use hot rolled coil (HRC) as a price benchmark and prices are currently about US$1,160 = CAN$1,500. The trough price was about US$500 in Aug 2020. The peak price of the last cycle was US$900 in May 2018.

- https://ca.investing.com/commodities/us-steel-coil-futures

 

Stelco management feels the current strong pricing environment will persist into 2021. Why?

 

Electric arc furnaces (EAF) are the dominant production method for producing steel in US today (2/3 production, up from 50%). Feedstock for EAF is primarily scrap and also pig iron.

 

Today scrap metal costs CAN$657 (from Stelco management presentation). Why is it so high? Supply was not keeping up with increasing demand (from EAF). China also has lots of EAF steel production. They did not allow imports of scrap. China recently reversed course and since the beginning of 2021 are now allowing imports of scrap. So a tight market has now been hit with a demand shock. So prices for scrap will likely remain elevated.

 

The second source of feedstock for EAF is pig iron. Stelco just added this capability in 2020 (Stelco management is either exceptionally smart or lucky; probably some combination of both). Needless to say, other steel producers are calling Stelco and wanting their excess pig iron. Quote from Stelco CEO: “we are turning the pig iron market on its head”. How? They will sell pig iron; but they want a price closer to the HRC price of US$1,200. Not the spot pig iron price on the market. Why would they sell pig iron low and allow other steel makers to earn the current windfall margins? Stelco wants some of the windfall margin. Stelco does not have any orders today for pig iron; however, customers who blew them off initially are re-engaging. This will be a very important thing to watch. If more pig iron producers take the same approach as Stelco it will keep feeder prices for steel producers high. This in turn should keep selling prices for steel elevated.

 

Another big factor is demand. Has anyone heard about a commodity super cycle? Needless to say, a rapid movement to a green economy is likely quite bullish for the steel industry; just think about all the cool new things that will need to be built. And if infrastructure becomes the next big spend by the US (and other governments) then this will also spike demand for steel.

 

Both the supply/cost and demand dynamics look pretty good for higher steel prices that could last some time.

-----------------------------------

Here are the comments from the CEO (Alan Kestenbaum) on the Q4 call yesterday:

 

"Going forward, we see a very exciting opportunity for Stelco. In the early 2000s, electric arc furnaces, or EAF, as they are known, ...accounted for approximately half of all steel production in North America. Today, that share of production dominates and stands at roughly 2/3 of all steel production in North America. Over the last couple of years, the industry has seen several additional expansions to EAF production capacity, combined with planned rationalization of integrated steelmaking. However, notwithstanding the growth in EAF production, there has not been a corresponding growth in availability of scrap steel, the primary raw material required for this method of steel production. Increasing upward pressure on scrap steel availability has created a growing demand for a reliable source of alternative iron units. In response to this, we recently commissioned North America's only integrated pig iron caster, which will perfectly complement our strategic investments to date and allow us to opportunistically capitalize on this growing market. This situation is just beginning and will become even more acute as China, which previously prohibited imports of scrap has now begun to import steel scrap from North America in response to their own shortages as they expand their own EAF production.

 

Moreover, Paul will share with you a dramatic slide with you this morning. When you look at our overall average production cost of all products, which includes hot-rolled, cold-rolled and galvanized, our implied average production cost in Q4 - by the way, a quarter where because of the blast furnace start-up in October was really only operating at 2/3 of capacity. Still, the average production cost of all products (CAN$600) are lower, I am repeating lower, than the cost of busheling steel scrap (CAN$657). Think of the magnitude of this accomplishment when you consider that the EAF producers drive the steel price based on their cost of scrap plus yield loss, which, of course, grows as fuel scrap prices go higher, and conversion costs.

 

I won't run the math for you, but consider the implications of that fact in a world where scrap demand exceeds supply, about the earnings and cash flow generation potential of our company. Our end markets such as auto, construction and appliances are very strong, and we expect they will continue to improve as the broader economy and our key market segments continue to grow and diversify. Now even the energy markets are just beginning to recover, a key end market that has been virtually nonexistent during this recovery. Our customers report to us that their inventories remain low and their end market demand is strong.

 

In addition to the opportunities I have already mentioned, Stelco is positioned to capitalize on emerging opportunities, in particular, in the electric vehicle market, with increased capacity to produce a full suite of products in response to the demands of that growing market. We are excited to be working with participants in that sector as they evaluate their steel requirements and their supply chain needs."

[petec]

I read the same numbers and would agree your numbers are conservative. For example they’re selling their cheapest product at 1500 for May now. That’s a $900 margin per ton, or thereabouts. If they can get 650-700k tons out in q2 you could in theory be looking at something silly like $600m in ebitda in just that quarter. I doubt it will be that high, but this supports the possibility that your numbers are reasonable/conservative.

 

Then you have to consider ongoing earnings. I’m going to switch to USD here. On the q3 call they mentioned that once they’ve finished the cogen plant their costs will drop to $400per ton. Over the last 10 years HRC has generally traded above $600 per ton. That’s a $200 margin or $250 Canadian.

 

Allow for some maintenance downtime and assume 2.5mt of annual production at $250 per ton. Could we be looking at $600m in average annual ebitda through the cycle? If so it’s on 4.3x, which I think leaves plenty of room for error in the estimate. There is no debt and I think they still have tax loss carryforwards (need to check this) so much of this drops to free cash, giving a >20% FCF yield.

 

And then there’s the land, which could be developed into a very considerable asset.

 

Perhaps the most amazing thing is that this was available for $4 per share not long ago and I was too stupid to buy it.

 

Petec, thanks for chiming in... the numbers just seem so high. But i guess this is what can happen with a commodity producer when prices start to take off. I am very impressed with Stelco management. They have made so many crazy good decisions the past couple of years. Imaging what they will do with windfall profits to further build shareholder value. My guess is a pivot in production to support green economy investments that are coming by government and industry.

 

PS: i doubled my position size today... second largest holding after FFH.

 

Agree re management.