Commercial Metals Company: Very Impressive (NYSE:CMC)

In the final days of 2021, I wondered if shares of Commercial Metals Company (NYSE:CMC) were a steel or a steal. The company has seen strong deleveraging of the balance sheet as end markets recovered, earnings rose, and an interesting deal was announced. While expectations were low, I feared the cyclical component of the business.

The Business

Commercial Metals Company is a manufacturer and fabricator of steel reinforcing bars to make concrete solutions. Other products produced include merchant bars, fencing, wire rods, all used in major infrastructure projects like highways, bridges, airports, skyscrapers and other buildings.

The company operates a vertically integrated model which includes more than 50 raw material sites in the U.S. and Poland which supply mills and downstream locations. The company claims to use recycled steel for 98% of raw material purposes, claiming to produce in a more environmental friendlier way compared to many peers.

The company generates about a third of sales from the infrastructure segment, non-residential sectors and the remainder from residential, OEM and agricultural activities. The company typically generated some $5 billion in sales with EBITDA margins posted in the low double digits, following some margin gains in recent years, with 85% of the sales generated in the US, as the European activities are relatively small and post subpar margins.

In October 2020, the company posted a small decline in sales from $5.8 billion to $5.5 billion. The company managed to grow EBITDA from $423 million to $577 million, as net earnings were reported at $279 million, as earnings rose from $1.66 per share to $2.32 per share. This earnings power looked decent with shares trading at $22 in October 2020, for a less than 10 times earnings multiple at the time. This was based on a $2.6 billion equity valuation, as a $541 million net debt load translated into a $3.1 billion enterprise valuation, with leverage ratios being very manageable at around 1 times EBITDA.

Ever since shares have risen to the $35 mark by late 2021 as the company reported very strong results in its fiscal year 2021, a year in which sales rose to $6.7 billion and EBITDA improved to $754 million, with earnings per share up more than a dollar to $3.43 per share. Trading at around 10 times earnings and less than 1 times EBITDA, the valuation was quite reasonable, certainly if US infrastructure budgets would increase as well.

Amidst this solid momentum, CMC reached a $550 million deal to acquire Tensar Corporation in December of last year, expanding its engineering construction ground reinforcement capabilities, to deepen existing relationships in the field and focus on more environmentally friendly solutions compared to traditional reinforcement and stabilization methods. The 8.4 times EBITDA multiple (including a $5 million synergy number) comes in two times higher than CMC, but given the positioning of the acquired activities, that makes sense.

With leverage seen around 1.5 times and earnings power seen around $4 per share, the situation looked pretty upbeat at $35 given the positioning and momentum, although near term cash flow conversion would be challenged amidst large investments. Amidst all of that, I thought of CMC as a diversified play and solid operator, just like Nucor (NUE), for instance. Despite many positive items, I failed to have conviction to hold in size given the cyclicality of the business, yet a small position was warranted at the time.

Solid Performance

Since late 2021 shares have been trading in a $35-$45 price range, currently trading in the middle of the range which marks solid gains compared to December, certainly if we factor in the decline of markets at large.

In January, CMC posted very strong first quarter results with $314 million in quarterly EBITDA posted on $1.98 billion in sales. Net earnings of $233 million came in at a whopping $1.92 per share, partially aided by a tax benefit, as adjusted for that earnings still came in at $1.62 per share, all while net debt was posted at $650 million, albeit that of the Tensar deal. With that deal pending, CMC announced a huge $600 million senior offering a few weeks later, at average coupons at 4.5%.

Second quarter revenues rose to $2.01 billion with adjusted EBITDA coming in at $262 million as adjusted earnings came in at $1.53 per share, with GAAP earnings coming in far higher following the sale of land in California. Net debt only fell to $626 million amidst heightened capital spending, as strong momentum was seen for the third quarter as well, despite global uncertainties being on the rise.

In April, the Tensar deal closed, pushing up net debt to $1.2 billion, yet with EBITDA trending around a billion here that is no major issue. Of course the core operations posted earnings close to $6 per share already on the back of strong momentum, with Tensar boosting near term earnings power on top of that.

In June, CMC posted third quarter revenues of $2.52 billion with adjusted EBITDA strong at $465 million. Adjusted earnings came in at $2.61 per share, for a $10 per share run rate which is incredible as net debt has already come down to $1.13 billion, all which EBITDA trends close to $1.9 billion already on an annualized basis as the Tensar deal only contributed partially during the quarter.

What Now?

Truth is that I am positively surprised by the massive positive performance of CMC here. Net debt is inching down rapidly as earnings power is very strong, a very welcome combination. It goes without saying that $10 per share in earnings power is not sustainable, with shares trading at just 4 times earnings here.

The question is what normal rates would look like and how quick and big a reversal in margins would be, given the deteriorating end markets amidst softer economic growth. Nonetheless, there is a real structural growth component to CMC at least, so it seems.

Hence, I am really fearful that some metals like copper and steel have pulled back significantly, and their stocks alongside with them. While CMC looks very cheap and the stock is holding up amidst very strong operating performance, I simply can not put myself to buying more shares despite all the positive reasons mentioned above.