Metals processing and warehousing firm Reliance Steel & Aluminum (RS, Financial) has been sent lower by about $3 or nearly 6% after first quarter results failed to live up to Wall Street’s expectations. Net income more than doubled to $44.7 million compared to last year’s earnings of $20.1 million. That equates to about 60 cents per share, but analysts were anticipating EPS of 64 cents per share. Revenue also came in a little light, falling 7% to $1.45 billion, slightly worse than the consensus view of $1.49B.
Reliance Steel’s business is to buy raw materials in bulk and then process, shape, treat, etc to fit the customer’s specific needs. Obviously, this process is essential to aerospace, energy, construction and manufacturing companies who use metals to facilitate creating their end-product, and it is a great place to be in the supply chain during economic booms. The fact that the first quarter results were weaker than hoped may suggest less of a rebound than hoped in various industries that utilize Reliance Steel’s products. Their more than doubling in net income (122% growth y-o-y) was due primarily to cost cutting and better inventory control, as evidenced by further sales declines. According to statements attached to the release, the company does anticipate steady improvement in the operating environment through the balance of the year.
At Ockham, we have viewed Reliance Steel as Overvalued since about February as it became clear that the stock was advancing well ahead of fundamentals. This stock has recently been touted by Barron’s and others as a way to extract above average returns from the economic recovery already underway. However, in the mid-$50’s, the stock was already priced for a robust recovery and little upside remained if that came to fruition. Of course, if the recovery is slower than originally hoped, the stock was vulnerable to a pullback which is exactly what we are seeing today. For example, the company now trades at a price-to-cash earnings level of 14.4x, which is well above the market’s historically normal range of 5.6x to 12.6x (based on the past ten years of data). In order to justify such a valuation, investors must expect to see rapid earnings growth, which is something that management was not willing to forecast in the release. The economic recovery is clearly underway, but certain stocks have already priced that in.
Ockham Research Staff
http://www.ockhamresearch.com
Reliance Steel’s business is to buy raw materials in bulk and then process, shape, treat, etc to fit the customer’s specific needs. Obviously, this process is essential to aerospace, energy, construction and manufacturing companies who use metals to facilitate creating their end-product, and it is a great place to be in the supply chain during economic booms. The fact that the first quarter results were weaker than hoped may suggest less of a rebound than hoped in various industries that utilize Reliance Steel’s products. Their more than doubling in net income (122% growth y-o-y) was due primarily to cost cutting and better inventory control, as evidenced by further sales declines. According to statements attached to the release, the company does anticipate steady improvement in the operating environment through the balance of the year.
"We continue to anticipate that demand for most of our products will recover slowly and steadily as the year progresses, with the exception of nonresidential construction, where we expect some further weakness, although we believe we are close to the bottom.” — Reliance Steel & Aluminum CEO David Hannah.However, it appears the rebound will not come quickly enough as the company forecast EPS of $.70 to $.80 per share for the second quarter. Analysts had expected next quarter’s earnings per share to be $.92 per share, and will surely be disappointed by this conservative outlook. The second half of the year may not be much better either, as they warned of the possibility of continued weak demand as well as the potential of downward pricing pressure. After RS had returned better than 25% year-to-date, we are a bit surprised that the stock is not down more after the weak quarter followed by conservative guidance.
At Ockham, we have viewed Reliance Steel as Overvalued since about February as it became clear that the stock was advancing well ahead of fundamentals. This stock has recently been touted by Barron’s and others as a way to extract above average returns from the economic recovery already underway. However, in the mid-$50’s, the stock was already priced for a robust recovery and little upside remained if that came to fruition. Of course, if the recovery is slower than originally hoped, the stock was vulnerable to a pullback which is exactly what we are seeing today. For example, the company now trades at a price-to-cash earnings level of 14.4x, which is well above the market’s historically normal range of 5.6x to 12.6x (based on the past ten years of data). In order to justify such a valuation, investors must expect to see rapid earnings growth, which is something that management was not willing to forecast in the release. The economic recovery is clearly underway, but certain stocks have already priced that in.
Ockham Research Staff
http://www.ockhamresearch.com
