Reliance Steel & Aluminum: Steel Stocks Outperforming S&P 500 (NYSE:RS)

Investment Thesis

Reliance Steel & Aluminum (NYSE:RS) has three characteristics that make it a very compelling investment.

In the analysis that follows, I’ll only fleetingly mention that it’s priced at close to 7x 2023 earnings. Because yes, the stock is cheap. But I know that when it comes to investing cheap can always become cheaper.

I’ll put the bulk of my thesis on the underlying driver for RS. Recall, approximately 70% of RS’ revenues come from steel. And I believe that steel demand will be stronger than investors realize. Hence, RS will be a much strong performer in 2023 than many investors are pricing in.

And here’s why an investment in RS is compelling.

Steel is an Outperforming Sector

In the first instance, let’s focus on the facts presented above. Steel is clearly outperforming the broad S&P 500 (SPX) index. For the past 3 months, the S&P 500 is up 4% while all steel stocks have clearly performed better.

And to demonstrate that I have not cherry-picked my data, at 11% outperformance, RS isn’t even the best-performing steel stock.

The point that I’m making is that this outperformance is across the sector. Why? What’s Happening?

What’s Happening Right Now?

There are a few different tailwinds afoot.

In the very near term, China’s reopening is providing support for the sector. As China’s reopening story gains traction, we can see this being reflected in steel prices increasing.

As a reminder, China’s real estate market is the world’s biggest consumer of steel. And with China showing some support for its overleveraged property sector, by providing funds for the sector and removing financial restrictions, this has by extension provided support for steel prices.

Why RS Steel?

The point to understand here is this. Most analysts largely agree 2023 is going to be brutal for RS steel. After all, China’s a big consumer of steel, but it’s not the only end market for steel.

Steel is used for buildings, bridges, warehouses, and wind turbines, both onshore and offshore, it is truly widely used.

And yet this is my core argument, throughout more than a quarter of a century and through many different economic cycles, RS has been profitable, including the pandemic and the Great Financial Crisis.

Furthermore, as we look ahead to 2023, even though most analysts expect things to be brutal for RS there’s still a widely accepted agreement that RS will be profitable in 2023.

So, this is what I believe is of utmost importance. The fact that we can agree that 2023 is expected to be brutal for RS steel. And yet, it has its balance sheet in top shape already, as it’s about to embrace a challenging year ahead.

RS’s Balance Sheet Position

As you can see above, RS’s net debt to EBITDA was 0.4x as of its latest results. We also know that last month RS announced that it will redeem all its $500 million 2023 notes. This won’t affect its net debt to EBITDA position, given that its net debt calculation already factors this in, but it is yet another step towards providing the company with stability.

This means that its next debt stack isn’t until 2025, and that stands at $400 million.

Accordingly, what we have here is a profitable company, without much in the way of debt, stopping RS from returning excess capital to shareholders.

Note, I’ve not put my focus on the capital returns angle here. I’ve wanted to provide context for why steel in 2023 will be stronger than many investors presently believe.

Next, let’s discuss its valuation.

RS Stock Valuation – 7x EPS

This is what I believe is of tantamount importance. What you see in the graphic that follows, is that analysts following RS have in the past several months been upwards revising their revenue estimates for RS.

Let me put it another way, you have a stock that is clearly cheap, something I’ll soon put more emphasis on, plus a sector that has been out of favor for a considerable amount of time, to the point that most investors are unwilling to pay a large premium for the sector, and yet, it’s in a sector that will be at the epicenter of the energy transition.

Analysts presently believe that for 2023, RS’ EPS will be around $29 putting the stock at approximately 7x this year’s EPS. That being said, as stated already, I don’t want to over-dramatize its valuation, because I understand that valuation isn’t everything. Valuation is important, but context is more important.

The Bottom Line

There are three tailwinds at play here for RS.

• In the first instance, there’s a company that is cheaply valued. Indeed, too cheap for what’s on offer.
• Secondly, every renewable energy structure – a wind turbine or a solar panel requires steel. Put another way, there’s no green energy transition without steel.
• Thirdly, despite all the doom and gloom facing RS steel and its peers, analysts are still upwards revising RS’s revenue estimates for 2023.

Any one of those elements above would make RS worthy of further inspection. All three together in the same stock? Well, knowing something and not acting, is called an error of omission.