Deep Dive into STLD -- Are These Shares Fairly Valued?

One of Wall Street's biggest winners of the day is Steel Dynamics, a steel company whose shares have climbed 4.9% to a price of $101.47 -- 9.37% above its average analyst target price of $92.77. The average analyst rating for the stock is buy. STLD outperformed the S&P 500 index by 5.1% during today's morning session, and by 62.5% over the last year with a return of 47.7%.

Steel Dynamics, Inc., together with its subsidiaries, operates as a steel producer and metal recycler in the United States. The company is included in the basic materials sector, which groups together the steel, coal, precious metals, chemical, and copper industries. From miners to producers, what these companies have in common is a strong correlation between their stock price and the strength of current economic conditions.

This is why basic materials companies are considered to be cyclical stocks. A well-timed investment at the beginning of an economic upswing can offer strong returns, but investing during a downturn may result in months or even years of mediocre performance.

Steel Dynamics's trailing 12 month P/E ratio is 4.5, based on its trailing Eps of $22.62. The company has a forward P/E ratio of 9.7 according to its forward Eps of $10.46 -- which is an estimate of what its earnings will look like in the next quarter.

As of the third quarter of 2022, the average Price to Earnings (P/E) ratio for US basic materials companies is 8.57, and the S&P 500 has an average of 15.97. The P/E ratio consists in the stock's share price divided by its earnings per share (Eps), representing how much investors are willing to spend for each dollar of the company's earnings. Earnings are the company's revenues minus the cost of goods sold, overhead, and taxes.

The main limitation with P/E ratios is that they don't take into account the growth of earnings. This means that a company with a higher than average P/E ratio may still be undervalued if it has high projected earnings growth. Conversely, a company with a low P/E ratio may not present a good value proposition if its projected earnings are stagnant.

When we divide Steel Dynamics's P/E ratio by its projected 5 year earnings growth rate, we obtain its Price to Earnings Growth (PEG) ratio of 0.17. Since a PEG ratio of 1 or less may indicate that the company's valuation is proportionate to its growth potential, we see here that investors are undervaluing STLD's growth potential .

To better understand the strength of Steel Dynamics's business, we can analyse its gross profits, which are its revenues minus its cost of goods sold only. The extent of gross profit margins implies how much freedom the company has in setting the prices of its products. A wider gross profit margin indicates that a company may have a competitive advantage, as it is free to keep its product prices high relative to their cost.

STLD's gross profit margins have averaged 19.6% over the last four years. While not particularly impressive, this level of margin at least indicates that the basic business model of the company is consistently profitable. These margins are increasing strongly based on their four year average gross profit growth rate of 23.9%.

Another key to assessing a company's health is to look at its free cash flow, which is calculated on the basis of its total cash flow from operating activities minus its capital expenditures. Capital expenditures are the costs of maintaining fixed assets such as land, buildings, and equipment. From Steel Dynamics's last four annual reports, we are able to obtain the following rundown of its free cash flow:

Date Reported Cash Flow from Operations ($) Capital expenditures ($) Free Cash Flow ($) YoY Growth (%)
2021-12-31 2,204,136,000.0 -1,006,239,000.0 1,197,897,000.0 667.66
2020-12-31 987,032,000.0 -1,198,055,000.0 -211,023,000.0 -122.35
2019-12-31 1,396,290,000.0 -451,945,000.0 944,345,000.0 -19.7
2018-12-31 1,415,469,000.0 -239,390,000.0 1,176,079,000.0 n/a
  • Average free cash flow: $776,824,500.00
  • Average free cash flown growth rate: 175.2 %
  • Coefficient of variability (the lower the better): 86.1 %

With its positive cash flow, the company can not only re-invest in its business, it can offer regular returns to its equity investors in the form of dividends. Over the last 12 months, investors in STLD have received an annualized dividend yield of 1.3% on their capital.

Another valuation metric for analyzing a stock is its Price to Book (P/B) Ratio, which consists in its share price divided by its book value per share. The book value refers to the present liquidation value of the company, as if it sold all of its assets and paid off all debts.

Steel Dynamics's P/B ratio indicates that the market value of the company exceeds its book value by a factor of 2, so the company's assets may be overvalued compared to the average P/B ratio of the Basic Materials sector, which stands at 1.86 as of the third quarter of 2022.

With a very low P/E ratio, an average P/B ratio, and an irregular stream of positive cash flows with an upwards trend, we can conclude that Steel Dynamics is probably undervalued at current prices. The stock presents mixed growth indicators because of its weak gross margins and a PEG ratio of less than 1. Thanks for dropping by! If you liked this article, please subscribe to our newsletter -- it's free and delivered daily!

The above analysis is intended for educational purposes only and was performed on the basis of publicly available data. It is not to be construed as a recommendation to buy or sell any security. Any buy, sell, or other recommendations mentioned in the article are direct quotations of consensus recommendations from the analysts covering the stock, and do not represent the opinions of Market Inference or its writers. Past performance, accounting data, and inferences about market position and corporate valuation are not reliable indicators of future price movements. Market Inference does not provide financial advice. Investors should conduct their own review and analysis of any company of interest before making an investment decision.