Steel Dynamics' Recovery Already Priced In

NEW YORK (TheStreet) -- The recent activity in shares of Steel Dynamics (STLD) affirms that when sentiment in a once-struggling industry takes a turn for the better, investors prefer to align themselves with an industry leader rather than laggards. While I don't necessarily have a problem with that, it just doesn't always work.

Unlike ArcelorMittal (MT) and U.S. Steel (X), underperformers in the trailing twelve months, Steel Dynamics stock enjoyed close to 50% gains in 2013. But investors seem to have quickly forgotten that back in December, management issued fourth-quarter earnings guidance in the range of 21 cents to 25 cents per share, which would (on the low end) represent a 22% year-over-year decline. The company's clearly getting the benefit of the doubt

Steel Dynamics has a solid reputation as a leading producer of integrated steel, yet has shown no immunity to what remains a brutal steel environment hurt by weak prices and slumping demand. With shares now resting near 52-week highs, investors still resting their faith on an uptick in non-residential construction must decide if there's immediate value in these shares relative to what Steel Dynamics can realistically offer in the future. And I don't believe the risk-reward tips in their favor.

Steel Dynamics is due to report fourth-quarter earnings Monday. Hoping that there's hidden value to the slight improvement in flat roll pricing, investors have disregarded management's cautious tone. Even if pricing did perk up, there's still too much at stake here to believe that it will be enough to offset the weakness in overall steel shipments or the recent increase in scrap costs.


Nevertheless, the Street will be looking for 24 cents in earnings per share on revenue of $1.85 billion, which would represent almost a 9% year-over-year revenue jump. These targets would certainly be encouraging when compared to the year-ago quarter. On a sequential basis, however, they would be essentially flat, particularly in terms of profits. (Something to keep in mind.)

The good news is that during the December update, management offered encouraging remarks regarding non-residential construction. Given that segment's importance to Steel Dynamics, the Street seems to have latched on to that projection. The company also cited improvements in areas like structural steel, fabricated joist and decking products.

As we've said, positive sentiment can only take a company and stock so far. At some point, the absolute performance will weigh more. Even though consensus seems to support a pickup in construction activity, I can't feel 100% comfortable given that there was still the typical seasonal slowdown.

Investors should focus more on what management says about other segments, such as the automotive business where domestic automotive and manufacturing markets have been consistently strong. Given the cyclical strain this company has endured over the past couple of years, management should find ways to better diversify the operation. It's the only way to achieve this without some form of merger deal.

I realize that I've analyzed this company with more of a near-term focus, and acknowledge that management has been very clear about its long-term plans, including several initiatives that are on track, like the expansion of its rail capacity.

All told, I do believe that Steel Dynamics is a well-run company that has suffered at the hands of an unforgiving industry. While I can't deny that this company has significantly improved over the past couple of years, there's still plenty of work to be done from a cost-management perspective, particularly in raw material costs.

While automotive markets continue to be trotted out regularly as a reason to remain bullish on the stock, there are now signs that dealer inventories have begun to inch up a bit. That's not good news. This now makes the pace of this non-residential construction recovery even more important. And that, to me, is too big a bet to place on an already expensive stock.

At the time of publication, the author held no position in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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