Reliance Steel (RS) is an interesting business which I consider to be a long-term value creator in what typically is regarded among the most cyclical and difficult industries to operate within.
Upon request, I am providing coverage on this name at this point in time as quite some interesting developments have taken place in recent times. Despite the current conditions, Reliance is still posting very strong margins, which is quite impressive.
My last take on the business dates back early 2018. At the time, I concluded that Reliance deserved a dominant position in my long-term portfolio. After all, it is a long-term consolidator which operates in a fragmented industry, has diversified operations and is led by an experienced management team which furthermore applies conservative financial practices.
A Look Back
Nearly three years ago I last looked at Reliance with shares trading around the $90 mark, which marked huge returns for investors who participated in the public offering in 1994 at a split adjusted price of just $2 per share.
The company is a huge player in the so-called metals service center business with more than 300 locations in the US and some other countries as well. The company gradually grows the business with 2-3 acquisitions per year, complementing organic growth of the operations.
These acquisitions, a culture of autonomy to individual management teams and conservative financial practices, have been the driver behind the long-term value creation. The basic premise of the company is providing services like welding, cutting and other applications which require expertise and typically expensive and specialized equipment. For many of these tasks, many customers are happy to outsource these services to Reliance Steel.
The degree of diversification is unprecedented with more than 100,000 customers typically placing small order values, making it a real indicator of the performance of the economy. In the decade before 2018, the company had gradually grown sales on a per-share basis by an average of 4% per year to nearly $10 billion, as margins had been trending around 6-7% of sales.
The track record of the business and earnings performance of around $5.50 per share at $90 per share made me compelled to the shares early in 2018. The 16 times earnings multiple marked a small discount to the overall market valuation, with leverage ratios trending around 2 times. With the company guiding for solid earnings improvement for 2018 (basically guiding a run rate of around $8 per share), I was compelled to the vastly lower forward earnings multiples.
The anticipated strong results arrived in 2018 as full-year sales rose nearly 19% to $11.5 billion. Adjusted earnings rose from $5.44 per share to $8.94 per share in 2019, as the number is relatively clean. While these results were very sound, earnings seemed to have peaked in the second and third quarter of the year already. Despite these strong results, shares actually ended in the mid-seventies by the end of 2018.
Following the record results in 2018, revenues fell slightly to $11.0 billion in 2019. While sales fell a bit, margins improved as adjusted earnings (equal to GAAP earnings this year) rose to $10.34 per share, or more than $700 million in actual dollar terms. Net debt has fallen to about $1.5 billion, with vastly lower leverage ratios as EBITDA came in around $1.2 billion.
Amidst the solid cash flow generation, shares rose to $120 per share at the start of the year. Multiples were low, cash flow generation was high and leverage ratios were coming down.
Given the nature of the activities, I was quite surprised to see that shares “only” fell towards $75 in March. First-quarter sales revealed a 13% sales declines, with COVID-19 having a big impact on the final month of the quarter of course.
Second-quarter sales fell 30%, yet I was quite surprised to learn that earnings fell “just” 50%. Third-quarter sales revealed some sequential improvements with sales down 22% to $2.09 billion. Adjusted earnings fell by similar percentages to $1.87 per share; impressive results, certainly on the margin front.
Despite this disastrous year, I see no reason why earnings could not come in around $7 per share this year; in fact, this roughly corresponds with the outlook provided by management. This is encouraging, with net debt down towards the billion mark, as economic conditions remain highly uncertain of course.
With shares having recovered and now trading near their all-time highs around $120, investors have seen approximately 30% capital gains in a time span of less than three years, translating into solid results. On top of these capital gains, investors have seen decent dividends as well.
Nonetheless, I think that there might be more ahead. The company has cut net debt quite a bit over this period of time, thereby providing more financial room and firepower for M&A and/or shareholder returns at this point in time.
I still like the promise of the company a great deal. The long-term margin target has risen substantially from a midpoint of 26% gross margins on a historical basis to 29% currently, which is a huge improvement given the sales base of the business. Greater focus on manager incentives, value-added products and services and quick turnaround orders should be the drivers behind his. To enable this and cut costs, the company has already upgraded its machinery park and production centers in recent years, thanks to substantial capital expenditures.
With earnings power quite a bit higher than anticipated in the past and the impact of cyclicality this year being very modest (especially given the economic circumstances), there is much to like about the business and its shares.
Based on the current earnings, which are down a third from last year, earnings multiples come in at a market multiple of around 17 times, while leverage is very modest. While I am not in a rush to chase the shares at this point in time, I think this remains a very decent long-term play driven by modest valuation, a very strong business, a compelling valuation and leverage down substantially. Especially with inflation trends on the increase, I am compelled to the shares here for the long term. I feel no rush to chase the shares here to further increase my position, although I feel compelled to initiate again on dips.
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Disclosure: I am/we are long RS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Value, and great long term track record.