Stelco Holdings (OTCPK:STZHF) is a Canadian steel producer located near the US border, which helps the company gain instant access to its two core markets while having access to the raw materials needed for steel production (primarily iron ore and coking coal). Its flagship facility is the company’s Lake Erie Works steel mill in Nanticoke, Ontario. The plant has a capacity of 3.7 million tons of steel per year but is currently running under capacity at 3.1 million tons per year. Depending on market conditions, the company may decide to run externally sourced slabs through this mill. So there is an opportunity to further increase the production rate if market conditions allow.
Stelco’s primary listing is on the Toronto Stock Exchange, where the company trades with STLC as its ticker symbol. The average daily volume is 360,000 shares per day, which definitely makes the Canadian listing more attractive than any secondary listing.
Unfortunately, the company’s website contains many “download-only” links, but you can find all the relevant information here.
While the steel market is red hot, it makes sense to look at Stelco’s annual results for a more conservative picture
The price of steel has exceeded all expectations for most of the last year and while the company earned only a few dollars per tonne of steel produced (EBIDA was only C$58/t in 2019 and C$37/t in 2020), 2021 was an incredible year. The steel was sold at an average price of C$1473/t (more than double compared to C$729/t and C$705/t in 2019 and 2020). The incremental revenue was almost entirely added to the EBITDA and the EBITDA margin per ton increased twentyfold compared to 2020. And even compared to the pre-COVID year 2019, the EBITDA margin per ton increased by just over 1,200% to C$764/t.
And that’s the annual average. The image above shows how EBITDA per ton continued to grow throughout the year. Thanks to an exceptionally strong steel price, it averaged almost C$1,100/t in the second half of the year. That’s great, but I don’t think it would be fair to use this exceptional price of steel as a base case. Even the average steel price of C$1,470/t (which is just under US$1,200/t) is quite optimistic, but still gives a better impression of Stelco’s capabilities.
The company appears to have been exceptionally profitable and as shown in the income statement below, reported net income was $1.6 million. This includes a relatively large financing cost of $162 million that is not a cash expense as it relates to the reassessment and appreciation of employee benefit plans. On the other hand, the tax pressure was rather low. Net income of $1.61 billion represented earnings per share of $19.08. Note that EPS is based on average share count of over 84 million shares over the year. At the end of fiscal 2021, the share count had fallen to 77.3 million shares (and it’s still falling).
Since the income statement includes a number of non-cash items, I was also curious about the company’s free cash flow result. Reported operating cash flow was $1.61 billion, but included a $132 million investment in working capital but excluding $9 million in lease payments. On an adjusted basis, operating cash flow was $1.73 billion.
Total investments were CA$236 million, but the vast majority of that was related to growth spending. Depreciation costs were only $69 million and ongoing capital expenditures should be even lower. But even if we used $75 million in sustained capital expenditures (which is a very conservative estimate), adjusted free cash flow on a sustained basis was $1.65 billion. Based on the 77.3 million shares outstanding at the end of 2021, underlying free cash flow per share exceeded C$21. That means the company was trading at just over 1.5 times its full-year free cash flow at the time of writing my previous article.
The balance sheet remains robust
At the end of 2021, Stelco’s balance sheet contained approximately CA$955 million in cash while debt had reduced to just CA$84 million, meaning the company had approximately CA$870 million in net cash on the balance sheet.
This excludes nearly $600 million in liabilities related to the obligation to employee foundations. The majority of this amount (C$487 million) relates to employee benefits (pension, health and life insurance). These agreements were signed in 2017 when the company was in bankruptcy proceedings. Additionally, approximately $108 million of these liabilities relate to the acquisition of assets from the Legacy Lands partnership, a partnership formed during the Company’s 2017 restructuring for the benefit of the pension plans. Stelco basically bought a piece of land and assets for a price of CA$114 million with a 25-year mortgage and a borrowing rate of 8%. These payments are made to the partnership, which is the official seller of the assets, and the partnership distributes the proceeds (both principal payments and interest payments) among the pension and retirement plans for Stelco retirees.
Cash is really flowing in, and Stelco is generating about CA$4-5 million per day in operating cash flow while ongoing capital expenditures remain very light. This means that Stelco will likely continue to buy back its own stock. In 2021, the company spent approximately CA$400 million to buy back its own stock from LG Bedrock, the majority shareholder. Those 11.4 million shares were repurchased at an average price of just under $35/share.
And Stelco continues to buy back shares. The company announced an issuer bid to buy back shares worth up to CAD$250 million in a modified Dutch auction. There was very little interest from shareholders to tender shares (since the maximum price offered by Stelco was relatively low) and only CAD$165 million of shares were offered and the company purchased 4.4 million shares at an average price of 37 CAD per share return. This means that the current share count is around 73 million shares, which will further support the company’s per-share performance.
Steel prices are exceptionally strong right now, but prices in the futures markets still suggest the best days are behind us. That being said, average HRC steel prices for delivery in the second half of the year are still around C$1200-1300/t, so I think this year’s realized price will not be much lower than 2021 (but there is very clearly a Cooling down compared to steel prices realized in Q3 and Q4 2021.
Although I spent CA$165 million buying back shares, I believe Stelco’s net cash has continued to grow to over CA$1 billion, which is nearly CA$15 per share. And that cash position will continue to grow as Stelco can’t buy back its own stock at the same rate as the cash is coming in. Meanwhile, the quarterly dividend is just $0.30 per share, meaning the dividend outflow is less than $25 million per quarter.
The steel market is a game of gaming chairs. But even when the music stops, Stelco’s balance sheet is likely to be exceptionally resilient, as the company is on track to have half of its current market cap backed by net cash on the balance sheet. The price of steel will fall, that is almost a matter of course. But Stelco seems to be very well protected in the expected downturn.