Reliance Steel: Acquisition-Driven Growth At Attractive Multiples, As Leverage Is A Concern
Feb. 21, 2015 2:43 PM • rs
- Reliance Steel & Aluminum reports solid results for the end of 2014.
- Despite fairly low operating margins, which fall short to the long term targets, the earnings multiple is very appealing.
- Given the strong focus on growth, fair dividends and fair valuation, shares offer appeal.
- The only trouble which I have is the high leverage ratio; I wish that management would be more conservative with its finances.
Reliance Steel & Aluminum ( RS ) reported strong results for the end of 2014. Even as the service center provider reported operating margins that trailed long-term targets, the earnings multiples are quite appealing at current levels.
I like the business for its focus on growth and deals, as well as a fairly compelling dividend yield and a low earnings multiple. The troubleI have is the high leverage load, as I wish that the company would be a bit more cautious by employing less leverage.
Following this observation, I am quite constructive on the shares, especially following the underperformance seen over the past year.
Reliance Steel is a so-called service center for metals and aluminum, among others. That means that the business buys steel from mill producers and then makes modifications to meet customer requirements.
Customers use Reliance's services given the expensive equipment needed to make steel so it fits their requirements. On top of these investment requirements, customers use service centers for inventory availability, a focus on their core operations, timely delivery and quality control.
Reliance Steel went public in 1994. Following its IPO the company has grown both organically as well as through the purchase of some 59 businesses. This has resulted in the largest company of its sort in North America. By now it operates over 300 facilities, supplying over a 100,000 customers each year.
This creates a very diversified customer base, with many customers being quite small. In 2013, the company processed more than 5.5 million orders, on average having an order value of roughly $1,600. Sales of course swing along with business cycles, which should not be a surprise. Margins show some volatility as well, although they tend to remain positive even during the downturns.
To fortify its position in a fragmented industry the top priorities are acquisitions as well as capital expenditures which can fuel organic growth. These priorities actually exceed the desire to pay out dividends or repurchase shares. Typically Reliance makes nice bolt-on acquisitions which only add a few tens of millions. In 2013 the company has made its largest deal to date by acquiring Metals USA in a $1.2 billion deal.
Solid End To 2014
Reliance Steel reported an 11.7% jump in fourth quarter sales which rose to $2.58 billion. Pricing was a big factor behind the revenue growth, with average prices increasing by 6.4% as volumes explain the remainder of revenue growth.
Operating margins were up by 40 basis points to 5.3% of sales as a result of volume growth. Following strict cost control and lower taxes, earnings were up by nearly 50% to $92.3 million, equivalent to $1.18 per share on a GAAP basis.
Note that earnings based on non-GAAP metrics, which exclude LIFO inventory adjustment effects, were up by seven cents to $1.01 per share.
Appealing Valuation, Watch The Leverage
Cash holdings came in around $100 million at the end of the third quarter. Combined with the current debt load of $2.22 billion, this translates into a net debt load of an estimated $2.1 billion. Reliance has posted EBITDA of roughly $830 million for the past year, translating into a fairly high leverage ratio of 2.5 times.
The 78 million shares outstanding value equity in the business at $4.5 billion with shares trading at $57 per share. Including debt, the business is valued at $6.6 billion. For that kind
of valuation, Reliance Steel is a $10.4 billion business which generates EBITDA of $830 million and net earnings of $370 million.
This translates into a sales multiple of 0.6 times and 8 times EBITDA. Equity in the business is valued at just 12 times annual earnings.
Steady Growth Aided By Deals
Over the past decade, Reliance has grown quickly as sales rose from roughly $3 billion in 2005 to little over $10 billion by now. Gross margins have come in between 24-28% of sales, and came in around 25% over the past year.
Operating margins have largely moved between 5 and 10% but have come in at the lower end of the range at 5-6% over the past year. This actually implies that Reliance is falling short of its 8-10% long term target.
This reported revenue growth has resulted largely from deals. For some of these deals Reliance has issued new shares resulting in 20% dilution over the past decade. The net debt position has increased over time as well, although acquisitions have given a boost to EBITDA as well, thereby keeping relative leverage ratio's in check.
Both the growth and cyclicality of the business has been apparent in the share price developments. Shares peaked at $80 in the summer of 2007, only to end that same year around $20 amidst the collapse of the economy. Shares have gradually moved higher to $75 last year, after which they have fallen back to $50 recently. Following the recent momentum shares are trading at around $56 by now.
CEO David Hannah was happy with the performance in 2014, following a seasonally softer holiday quarter. Demand was solid versus industry benchmarks despite weakness in the energy segment.
On the conference call. Mr. Hannah was constructive on the impact of lower fuel prices on the economy, as he admitted that energy sales dropped some 30% in January. He also admitted that dealmaking is a bit more difficult with Reliance being hesitant to overpay for potential targets.
Besides the operational focus Reliance invested another $190 million through capital expenditures in the business in 2014, complemented by three acquisitions. This included the latest acquisition of Fox Metals, adding $50 million in annual sales. Mr. Hannah points towards the a strong balance sheet, while I find the leverage employed on the high side.
Based on the solid US economy, 2015 should be another good year despite the 8-10% exposure the energy business. Lower fuel and energy costs should offset this impact by accelerating growth in other areas. Non-GAAP earnings for the first quarter are seen at $1.00 to $1.10 per share which seems fair.
All in all 2015 could be another good year, as the company continues to execute on its acquisition strategy, combined with a nice 2.5% dividend yield at the moment. Shares now trade at just 12 times earnings, while the operating margins are at historical low levels. If Reliance could achieve after tax margins of 8%, net earnings could come in at $550 million, translating into just an 8 times earnings multiple.
This looks great and could be even better if the company would not try to acquire, pay dividends and repurchase shares all at the same time. To create a margin of safety I would like to see less leverage being employed going forwards, especially if we might see an unexpected economic downturn. The pullback seen over the past year has been nice and despite the leverage risk I am contemplating taking a position on dips in the coming days or weeks.
Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in RS over the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.