STLC.TO - Stelco

[petec]

Just bought a little more. Couldn't resist! Now watch the HRC curve unravel at speed...

[Xerxes]

2 hours ago, petec said:

The huge difference was the lack of liabilities, in my view

Right, we can argue about liking or not liking cyclical names, but at the end, a cyclical with a lots of liability (i.e. resolute), would need a once-in-a-hundred-years event to raise the tide high enough to hide its "nakedness".

Sure, the once-in-a-hundred-year event also helped the zero-debt Stelcos of the world as well, but the permanence of their business was not in doubt.

[petec]

11 minutes ago, Xerxes said:

Right, we can argue about liking or not liking cyclical names, but at the end, a cyclical with a lots of liability (i.e. resolute), would need a once-in-a-hundred-years event to raise the tide high enough to hide its "nakedness".

Sure, the once-in-a-hundred-year event also helped the zero-debt Stelcos of the world as well, but the permanence of their business was not in doubt.

Agreed. Plus, frankly, the free cash flow yield at midcycle economics was superb. That drives the outcome.

[petec]

Not liking cyclical names as a structural position is as dumb as liking quality growth regardless of other factors. Everything depends on worst case outcomes and price. 

[hasilp89]

going down the rabbit hole on this lithium thing now. Looks like this Neometals has a couple of these potential JV's hanging around. 

This random and potentially unreliable research note was on their website and my take away below - https://www.neometals.com.au/wp-content/uploads/2021/05/20210507_Recycling-ECS.pdf

-cost is $165M USD for 20ktpa of capacity. EBITDA will be 1/3 of that so a ~three year payback. Really just incremental Cash if Stelco is only contributing land - So maybe ~$80m in EBITDA

 

[RichardGibbons]

5 hours ago, petec said:

The huge difference was the lack of liabilities, in my view.

I think you're actually analyzing this wrong, because at the bottom a cycle that is turning upward, lack of liabilities and good margins are a bad thing for investors (relatively speaking), not a good thing.

It's perverse that investors should actually favor the weaker company, but it makes sense because of operational leverage.

Like, suppose that you have the leader in a space that's making $1 a year, trading at a PE of 10, selling $5 of goods at net margins of 20%, and no debt. If the price it sells its goods for goes to $6, and it remains at the same PE, then profit goes to $2, and the stock doubles.

Meanwhile, Crapco is barely hanging on with a bunch of debt. It's making $0.20 per year selling $5 of goods annually, and trading at a PE of 6. So, its shares are at $1.20. If the price it's selling goods at increases to $6, suddenly it's making $1.20, and no longer looks like it's teetering on the edge of bankruptcy.

If Crapco maintains its 6 PE, then it's worth $7.20, skyrocketing 6x. If it gets a better multiple because of less risk of bankruptcy and because of the debt component of enterprise value doesn't share equally in the profit increase, maybe it hits $10, up 8x.

Because the lower-margin, more leveraged companies have way higher operating leverage, in the upcycle, investors should get much better returns from the weaker companies, and should favor them.  (And vice versa when you think there's a cyclical top.)

Edited May 27, 2021 by RichardGibbons

[Xerxes]

True, but only if you are trading the asset, because you are enjoying the operating leverage as well as the financial leverage, as earning pick up from the trough.

No different than buying junior high-cost gold miner in a down cycle, and capturing that massive windfall, when gold price lift considerably, with share price moving exponentially because its shares did not have a high probability weighing on the up cycle. But then you need to sell. I own Barrick Gold, a major miner, that one i don't have to sell into an up cycle.

And that is why it is important to liquidate Resolute, because that moment of joy that is having now is elevated due to its high leverage. Good for those that bought it at $2. 

[hasilp89]

3 hours ago, RichardGibbons said:

If Crapco maintains its 6 PE, then it's worth $7.20, skyrocketing 6x. If it gets a better multiple because of less risk of bankruptcy and because of the debt component of enterprise value doesn't share equally in the profit increase, maybe it hits $10, up 8x.

 Not sure I follow here. You’re counting on another idiot paying that multiple for a levered and cyclical asset right? And you’re assuming we can predict cycles (I can’t do this). My take is with stelco the set up is asymmetric they have good margins (through the cycle), no debt, and the cash comes to me this year. Downside is limited, upside is great. In your levered scenario downside is wipe out, upside is better than my great. I like my bet better, I’ll live to see another day no matter what. 

Edited May 28, 2021 by hasilp89

[RichardGibbons]

19 minutes ago, hasilp89 said:

 Not sure I follow here. You’re counting on another idiot paying that multiple for a levered and cyclical asset right? And you’re assuming we can predict cycles (I can’t do this). My take is with stelco the set up is asymmetric they have good margins (through the cycle), no debt, and the cash comes to me this year. Downside is limited, upside is great. In your levered scenario downside is wipe out, upside is better than my great. I like my bet better, I’ll live to see another day no matter what. 

Yeah, that's fair. My argument rests upon the belief that it's a terrible idea to hold a commodity producer through a full cycle, when you can instead deploy that capital in something that has a long-term competitive advantage selling stuff that isn't commoditized. The only reason I see to ever own a commodity producer is to ride the operational leverage on the up cycle.

So, yeah, I think your point make sense. If you think it's a good idea to hold a commodity producer over the long term and don't want to pay any attention to the market cycle, then it makes sense to buy the strongest business.

[petec]

Richard, I think we were debating Prem’s purchase and comparing it to Resolute. Prem didn’t buy at the bottom of the cycle. He bought in late 2018 after a good year. But he will get a good outcome because there are few liabilities and great midcycle economics (in my view). 
 

I also disagree that there’s no point holding cyclicals for the long term. Price matters. Stelco priced at a 25% midcycle free cash yield and run by a good capital allocator (which is the deal I think Prem got) is going to outperform the world’s highest quality compounders priced to return 10%.

But if you’re going to do that, position on the cost curve and strong balance sheets are key. 

Edited May 28, 2021 by petec

[RichardGibbons]

I agree with most of what you say, petec. I'm not defending Prem's Resolute purchase, or saying it was better than his Stelco purchase. (Just that, if you can accurately predict the bottom of the cycle, the crappiest cyclical will have the best investment returns.)

That said, price mostly doesn't matter if you are comparing the long-term results from holding a commodity company and a high quality compounder. Price only matters if you are willing to sell when the commodity producer's discount to fair value no longer exists. People almost always underestimate the power of long-term compounders.

If you own long term, you'll get the long-term ROE returns from both. The compounder with the sustainable competitive advantage will have a much better ROE and will reinvest its cash flow at that ROE. The commodity producer will have a terrible ROE, spending a lot of its cash just to run in place (i.e. upgrading to the latest technology at the same time all its competitors do, resulting in a bunch of money spend for no relative advantage, but just to remain a price-competitive business.)

If you're holding for the long term, the only thing that matters is sustainable competitive advantage.  (Well, outside of extreme, ridiculous situations, like a stock trading at 30 times its estimated PE fifteen years in the future.)

[RichardGibbons]

Thinking about it, I remember I had a roommate back in 1994 who owned Stelco. So I was thinking that it would be fun to go back 20 years and compare the returns of Stelco to a random assortment of businesses that had decent 5-year average ROEs at the time. (Off the top of my head, the one that Stelco would probably beat was Coke.)

But it looks like Stelco went bankrupt in 2007, so that makes the comparison less interesting.

[petec]

Hence the importance of liabilities!

[petec]

1 hour ago, RichardGibbons said:

I agree with most of what you say, petec. I'm not defending Prem's Resolute purchase, or saying it was better than his Stelco purchase. (Just that, if you can accurately predict the bottom of the cycle, the crappiest cyclical will have the best investment returns.)

That said, price mostly doesn't matter if you are comparing the long-term results from holding a commodity company and a high quality compounder. Price only matters if you are willing to sell when the commodity producer's discount to fair value no longer exists. People almost always underestimate the power of long-term compounders.

If you own long term, you'll get the long-term ROE returns from both. The compounder with the sustainable competitive advantage will have a much better ROE and will reinvest its cash flow at that ROE. The commodity producer will have a terrible ROE, spending a lot of its cash just to run in place (i.e. upgrading to the latest technology at the same time all its competitors do, resulting in a bunch of money spend for no relative advantage, but just to remain a price-competitive business.)

If you're holding for the long term, the only thing that matters is sustainable competitive advantage.  (Well, outside of extreme, ridiculous situations, like a stock trading at 30 times its estimated PE fifteen years in the future.)

I agree with 100% where you're going philosophically, but there are some pedantic but important points I would highlight.

It is not accurate to say that long term returns equal ROE and I have never understood why people always quote Munger on this. Your long term returns are a function of the ROE and the reinvestment rate. If a company pays out 100% of earnings then your return will be your going in free cash yield unless the ROE changes. Only if the company reinvests 100% will your return tend towards the ROE - and even then, only if the return on incremental equity equals the ROE.

My view is that people often overestimate the reinvestment economics of compounders. In many cases FCF=NI, meaning the reinvestment rate is 0%, and in fact any reinvesting is being done through buybacks in which case the stock price determines the "ROE". This is often hidden by rising returns on prior investments. For example, at Microsoft, the reinvestment rate is around zero but the returns on legacy investments (such as the IP behind Office) are rising as the business shifts to a subscription model. 

Your point about commodity producers upgrading to the latest tech is a good one and needs factoring into your free cash analysis when you enter. But once that is done, your return is nothing to do with when you sell since we are (presumably) debating the return on the going-in price. Selling is a different skill (which can add to returns).

Edited May 28, 2021 by petec

[petec]

21 hours ago, petec said:

I haven't checked the numbers, but the way I read it is that Kestenbaum is not Bedrock's only shareholder, and it is the other shareholder who is selling Stelco. So Bedrock is spinning its Stelco shares out to its shareholders, and the selling shareholder is then doing the deal with BMO, while Kestenbaum is holding on.

Kestenbaum’s partner in Bedrock is PE firm Lindsay Goldberg, so I think that’s who’s selling.

[petec]

The BMO snippet is good for a giggle: Jamie Murray on Twitter: "Steel prices are either way too high or $STLC.TO price is way too low. From BMO: https://t.co/JnWgtSrsMI" / Twitter

[hasilp89]

That is awesome

[bearprowler6]

As expected, it was just announced that Stelco (STLC) will be added to the S&P/TSX Composite Index at the start of trading on June 21st:

 

https://www.newswire.ca/news-releases/s-amp-p-dow-jones-indices-announces-changes-to-the-s-amp-p-tsx-composite-index-814863880.html

 

This will bring additional positive focus onto the shares of this company.

 

A good time to remind everyone of the comments made by the CEO Alan Kestenbaum and the CFO Paul Scherzer on May 4th as part of the Q1 2021 earnings release.

 

In an interview on BNN Bloomberg Kestenbaum was quoted as follows:

“The Q1 results (adjusted EBITDA of $185 million), which are fantastic, which are 10 times over a year ago and three times the Q4 results, are at a price which is actually half of what steel prices are today. That entire half flows to our bottom line because the costs don’t go up from where they are,” he said.

Kestenbaum said the rally in steel prices, unlike with other commodities, is being driven purely by strong demand seen in auto and infrastrucutre sectors.

“As you know it’s not a speculative commodity like others: It's real fundamentals,” he said. “It’s been driven by lean inventories, enormous demand in the auto sector, enormous demand in the infrastructure sector and energy is coming back."

Kestenbaum said he expects adjusted EBITDA in the forthcoming quarter to rise as much as three times on its first-quarter results, while the third-quarter could be “probably another double from there.”

 

And in the Q1 2021 press release the CFO suggested that Adjusted EBITDA for all of 2021 in excess of $2 billion was not out of the question based on the HRC forward pricing curve, current cost structure, current order book and product mix in place on that date.  Staggering really given that the company's entire market cap  is a little more than $3 billion. 

 

Since the release of the the Q1 results on May 4th the CME's HRC forward pricing has continued to strengthen with  pricing up an average of approx 15% for each and every month for the remainder of 2021. Average HRC forward pricing for Q3 now exceeds $1650 and more than $1440 for Q4. HRC forward prices are strengthening into Q1 2022 also.

 

https://www.cmegroup.com/trading/metals/ferrous/hrc-steel_quotes_globex.html

If these elevated forward HRC pricing figures hold then the $2 billion EBITDA projection offered up by Kestenbaum and Scherzer on May 4th will be made to look pessimistic which will result in major buybacks and special dividend payments to the company's shareholders.

 

 

Edited June 11, 2021 by bearprowler6

[hasilp89]

[Viking]

Looks like investors were given a nice opportunity with Stelco selling off pretty hard. It was off over 7% at one point today  Unlike lumber HRC futures pricing is up today and holding at highs. 

 

Q2 will see monster earnings for Stelco. Stelco has about a 3 month lag between orders and shipments so July and August are already done and they are likely taking orders for September. Q3 is shaping up to be better than Q2. The CAN $2 billion in EBITDA for 2021 is looking doable. 

 

I would expect we will get some clarity on capital return at some point in the next 6 weeks (perhaps when Q2 earnings come out). My guess right now would be a very large share repurchase. Perhaps tied to locking in a large hedge on steel pricing into 2022. Or perhaps pull a Fairfax and use derivatives to lock in a price near current levels. It is crazy how much money Stelco is earning right now  

Edited June 15, 2021 by Viking

[petec]

38 minutes ago, Viking said:

Looks like investors were given a nice opportunity with Stelco selling off pretty hard. It was off over 7% at one point today  Unlike lumber HRC futures pricing is up today and holding at highs. 

 

Q2 will see monster earnings for Stelco. Stelco has about a 3 month lag between orders and shipments so July and August are already done and they are likely taking orders for September. Q3 is shaping up to be better than Q2. The CAN $2 billion in EBITDA for 2021 is looking doable. 

 

I would expect we will get some clarity on capital return at some point in the next 6 weeks (perhaps when Q2 earnings come out). My guess right now would be a very large share repurchase. Perhaps tied to locking in a large hedge on steel pricing into 2022. Or perhaps pull a Fairfax and use derivatives to lock in a price near current levels. It is crazy how much money Stelco is earning right now  

Agreed. I don’t know why they didn’t repurchase the shares sold via BMO a few weeks ago. Very odd. 

[Viking]

With the benefit of hindsight, the capital allocation decisions made by the company/CEO since taking the company out of bankruptcy certainly have been very well done. Very strategic and executed over many years. I am looking forward to seeing what they do with all the cash given their outstanding track record.

 

Yes, the shares sold to BMO look like a very good fit. We will see...

Edited June 15, 2021 by Viking

[Spekulatius]

Hopefully, Stelco returns the cash to shareholder. Everything else is almost guaranteed to get a worse outcome.

 

I haven’t looked in much detail at Stelco recently ( I looked at it deeper when FFH invested) and it is clear they are high cost or at least high fixed cost.

 

Part of this is due to Stelco running a blast furnace rather than an electro mini I’ll (like low cost leader Nucor does). While at full utilization, both may have similar costs, the blast furnace seem to have much higher fixed cost components , so when utilization trends down best furnaces show worse unit cost trends.

 

At least that’s how it seems to me when I did some eight grade math a few years ago when Trump’s tariffs threw a wrench into Stelco’s business and profits quickly turned into losses (even thigh the business impact from the tariffs wasn’t all that much) while Nucor remainder solidly profitable.

 

I guess at this point the bet on Stelco is essentially high steel prices for longer, same than it is for the lumber plays.

[Viking]

Spec, i am really having a hard time wrapping my head around the balance sheet of companies like Stelco and West Fraser. How does an investor value the cash sitting on the balance sheet? And the cash that will soon be sitting on the balance sheet (once they report Q2 earnings and with Q3 earnings also being near historic highs)? Given where shares are currently trading for both companies i hope they aggressively buy back shares. I think this is better than a special dividend (given where shares are priced today); although i think it is very possible both companies will do a special dividend when they announce Q2 earnings. I wonder if Stelco does not simply let cash build on the balance sheet for another quarter or two in the hopes of getting taken out at CAN +$50/share. For West Fraser i wonder if they do not make a move into Europe; strategically, it looks to me like the lumber world is quickly shrinking and ESG is for real and Europe might provide some learnings they can fast adapt back to North America. Wood really is in the sweet spot of being THE environmentally friendly building product and lumber companies are all talking this aspect up. 
 

Mr market currently does not believe prices for steel or lumber will stay above historical averages into 2022 and 2023. This makes no sense to me for lumber given we are in a housing boom (bubble in Canada) driven by historically low interest rates (which will likely be staying low for another year or two). I wonder if we do not have a bit of an oligopoly in the steel market in NA today; and the few larger producers today appear to be very focussed on profitability and less so on volume. Record high steel pricing has been exceptionally resilient (so far)  Lumber also has consolidated greatly over the past decade (Canadian producers aggressively moving into US) although not as much as steel. 
 

In terms of Stelco and their cost position versus the EAF steel producers it appears that with all the new EAF mills that have come on stream the past couple of years the current demand for scrap steel in the US is running far in excess of the supply which is causing pricing for scrap steel to increase dramatically (doubled in price the past year from $250 to over $500 today). It appears this could be a structural issue (not temporary). Bottom line, Stelco’s cost position today is very good; not sure what it looks like in a bad steel market when plants aren’t running full out (which will come again :-). 

- https://ca.investing.com/commodities/steel-scrap

Edited June 15, 2021 by Viking

[hasilp89]

1 hour ago, Viking said:

How does an investor value the cash sitting on the balance sheet?

Doesn’t it just depend on what management plans to do with it. Ie if they reinvest you can value the cash flows from the reinvestment, if they dividend you value the dividend yield, if they buy back you determine how much more you’ll own and what that value will be. In this case Alan has left the gate somewhat open but has indicated he’d buy back half the shares.
 

Take a private market view - if you owned the entire business yourself how would you value the 1.5b of cash that was on the come this year? Personally I’d be pleased at the current price - call it 50% of my investment in year 1. Sure the cycle can turn and prices fall but there’s no debt and I likely won’t have to put more capital in. Not very academic but how I’d think about it.

 

On the industry cost curve. @Viking hit the nail on the head. There are potentially longer term structural issues at play. If scrap/ton is more expensive than stelcos cash cost, who is the low cost producer. Stelco has a few good slides out there that makes their case and also indicates higher scrap has set new (higher) floors for steel prices. However, EAFs have brushed it off on calls. Steel dynamics specifically commented that scrap supply wasn’t a longer term issue. Another thing steel dynamics ceo said “And with the rationalization of the integrated side of the industry, it's quite possible that you're starting to see them actually produce pig iron which help the supply balance, supply demand balance as well.”  Interesting given stelco has increased pig iron capacity and I believe mentioned that they have the flexibility/optionality to sell to EAFs.
On the whole I think it is not a simple their cost structure sucks but at the same time I’m not making a prediction one way or the other (would love anyone who has deeper insight) but with 50% cash returned by year end I like the setup.