Reliance Steel – Stronger Than Steel (NYSE:RS)

Shares of Reliance Steel (NYSE:RS) have been on fire as very strong pricing power of the business have lifted the shares, for obvious reasons. With my last take on the company dating back to December 2020, it is time to update the investment thesis and my conclusion that Reliance is made out of steel.

Investment Take

I have long regarded Reliance Steel as a long-term value creator in what is among the most cyclical and difficult industries to operate within. Reliance Steel is a huge player in what is called the metals service center industry, as the company has steadily grown to operate hundreds of locations, with bolt-on deal making resulting in the occasional add-ons, all while the company has seen solid organic growth as well.

The materials service industry includes services like welding, cutting and other applications which requires expertise and equipment in order to be done, which makes that many customers typically outsource these services.

The role of long-term consolidator in this industry has been the driver behind shares having risen from a split-adjusted price of $2 per share in 1994 to a level which topped the $100 mark towards the end of 2020.

The company has more than 100,000 customers which typically place small order values, which gives the company great insights into the state of the economy. The company generated $11 billion in sales in 2019, ahead of the pandemic, as the company posted net earnings of more than $700 million, or just over $10 per share, in what has been a stronger year in terms of margins.

During the pandemic, the company took a beating with sales down 13% in the first quarter, as sales fell 30% in the second quarter as earnings fell “just” 50%. That was the worst of the downturn already as third quarter sales trends improved to a minus 22% decline. Despite the tough year, there was no reason for earnings to come in around $7 per share, highly encouraging at that time of economic uncertainty. With shares trading at 17-18 times earnings, in an uncertain period of time, I saw appeal. After all, there was potential for earnings to improve as well, as net debt had come down a bit.

While the business has seen some cyclicality, the pandemic showed that the business has become stronger, as the company has improved the business, by diversifying, adding more expertise, and focusing on incentivized management teams. Trading at $120 at the time, I saw long-term appeal, but was not in a rush to add to my existing long position.

Boom Continues

Since my cautious, yet truly constructive stance late in 2020, shares have risen in a fierce rally to $180 in spring of 2021, to consolidate around the $150 mark for the remainder of the year. Shares rallied to a high of $210 in May of this year, now settling around $195 per share.

The strong share price performance has been the result of Reliance actually posting year-over-year revenue growth for 2020. This made that full year sales only fell back 20% to $8.8 billion, as adjusted earnings fell a quarter to $7.71 per share, but trended above $8 per share by the end of 2020 already.

Following the solid operating performance and improved balance sheet, Reliance Steel pursued more deal-making in 2021. In August of the year, Reliance announced the acquisition of Merfish United, a distributor of tubular building products which generates half a billion in sales, adding approximately 6% to pro forma sales, albeit that no margin details were announced. This deal was followed by a bolt-on deal for Nu-Tech Precision Metals which added $44 million in sales late in the year and the purchase of Admiral Metals in a deal adding $134 million in sales.

Forwarding to February of this year, the company has benefited from a great 2021, with the results furthermore seeing a boost as a result of higher material pricing, a recovery of the economy as well as the impact of bolt-on deal-making pursued during 2021. Full year sales rose sharply and rose 60% to $14.1 billion as earnings exploded and essentially quadrupled to $1.4 billion, with reported earnings coming in at $22 per share.

Net debt has inched up to $1.36 billion, yet with EBITDA having improved to $2.2 billion, so that is no threat at all, certainly as momentum was even stronger in the fourth quarter of the year. Despite some signs of a peak, the company guided for first quarter earnings around $7 per share.

In April, the first quarter results were stronger than guided for as sales rose another 12% on a sequential basis to $4.5 billion as earnings topped $8 per share for the quarter, running at approximately $33 per share here! Net debt was cut to $1.1 billion, with leverage ratios down to 0.4 times. Despite the cyclicality of the business and 63 years of continued dividend payouts (and often hikes) the company hiked the dividend payout in a convincing way, up 27% to an annual payout of $3.50 per share!

The business is not showing any signs of a slowdown with second quarter earnings seen at $9 per share, or a bit higher. This suggests that the company trades at around 5-6 times earnings, as these multiples of course do not seem sustainable, that is the current earnings power comprised out of peak margins and sales.

What Now?

The company benefited from the earnings boom in 2021 by reducing debt and pursuing 4 deals at a combined cost of nearly half a billion. These deals are set to bolster total revenues by about a billion, providing a real roadmap for 2022 earnings sales and earnings growth.

The truth is that the current earnings pace of $36 per share (based on the second quarter earnings guidance) is not sustainable as it is based on second quarter operating margins of around 15% on sales which trend at $18 billion here. So even if we see a big pullback which results in sales falling to $12 billion and margins were to fall to 10%, we have a business which posts operating earnings at around $1.2 billion, or about $900 million after taxes and interest rates.

This still works down to earnings power of $15 per share, even if earnings fall by 60%. Even if this happens, we have a business which trades at just 13 times earnings, as the company operates with a largely unleveraged balance sheet.

This reveals to me that Reliance remains a long-term winner and while I fully believe in the name, I am hoping for a near-term volatility induced pullback to potentially add to my existing long position.