How Steel Dynamics, Inc. Could Spend Its Billion Dollar Cash Hoard

By Markets Fool.com

Image source: Steel Dynamics

Continue Reading Below

Steel Dynamics, Inc. (NASDAQ: STLD) is a relative newcomer to the steel industry when you compare it to old hands like United States Steel (NYSE: X), AK Steel (NYSE: AKS), and Nucor (NYSE: NUE). But that's giving it an edge in some ways, leaving it one of the best positioned steel mills in the country. Add in a notable cash hoard and good things are happening...

Well positioned

Like Nucor, Steel Dynamics' business is focused around more modern electric arc technology, which makes heavy use of scrap metal and is easier to ramp up and down as demand waxes and wanes. The blast furnaces that form the basis of US Steel and AK Steel's businesses aren't nearly as flexible.

This helps explain why those two steel giants have lost money in six of the last seven years and seven consecutive years, respectively. US Steel and AK Steel are symptomatic of a steel industry that has been in a malaise since the 2007 to 2009 recession.

Steel Dynamics, with its more flexible business model, has only lost money twice over the same span. Once in 2009, along with just about every other major steel company including Nucor. And again last year, due to a large fourth quarter write off. In fact, only Nucor, which last posted red ink in 2009, has put up a better record through this tough downturn, which has been driven by overcapacity and a flood of cheap foreign imports.

Continue Reading Below

Performing better than most peers has put Steel Dynamics in a relatively good position.

Company
Cash and Equivalents as of Second Quarter 2016
Nucor $2.3 billion
Steel Dynamics $1.1 billion
U.S. Steel $0.8 billion
AK Steel $0.05 billion

Data source: Company quarterly earnings releases.

Cash on hand

At the end of the second quarter Steel Dynamics had roughly $1.1 billion worth of cash on its balance sheet, as the table above shows only Nucor had more. Since red ink isn't as big a deal for the company as some other industry players, and its facilities are relatively modern, it can do things that companies like AK Steel and US Steel can't... Namely expand during a downturn -- which is a great use of that cash burning a hole on its balance sheet.

A good example of this is the company's recent acquisition of Vulcan Threaded Products, Inc. for $114 million. To be sure, the acquisition isn't huge, but that's actually the point. It was a bolt on deal that allowed Steel Dynamics to move up the value chain.

Vulcan is the largest manufacturer and supplier of threaded rod products in the United States. The benefit here is that Vulcan's products are value added, which should help to smooth out the ups and downs of the steel market and also come with higher margins. It's a small deal, but it makes Steel Dynamics a better company, overall.

Competitors like AK Steel and US Steel have been focusing on cutting costs and closing operations. While such moves will help both survive the downturn, they certainly aren't going to help the companies grow their businesses. Steel Dynamics, meanwhile, looks like it will come out the other side of this downturn a stronger company, thanks largely to the cash it can deploy toward growth.

A limit

That said, there's a limit to just how much Steel Dynamics can do. Long-term debt makes up around half of the company's capital structure. That's a little lower than the 60% or so at US Steel and much better than AK Steel. But Steel Dynamics is nowhere near as well positioned as Nucor, where long-term debt is roughly a third of the capital structure.

Company Debt-to-Capital (Q2 2016)
Nucor 35%
Steel Dynamics 50%
U.S. Steel 60%
AK Steel N/A*

*AK Steel's shareholder's equity was negative because of asset write downs, meaning that debt makes up more than 100% of its capital structure. Data source: Company quarterly earnings releases.

So you probably shouldn't expect any really big deals out of Steel Dynamics. But that's OK, small bolt-on deals that can get done mostly, if not totally, with cash allow the company to cherry pick assets that will best compliment its strengths. It's a good position to be in.

The steel industry is starting to rebound as the threat of imports has been increasingly countered by U.S. tariffs. That may lead to higher prices for desirable acquisitions like Vulcan, but the downturn has been so long and deep that worthwhile assets are likely still available. Which is why being one of the few companies in a position to put a billion dollar cash hoard to work is a good thing. If you are considering the steel industry, Steel Dynamics is definitely worth a closer look as it uses its cash to become a better company.

A secret billion-dollar stock opportunity
The world's biggest tech company forgot to show you something, but a few Wall Street analysts and the Fool didn't miss a beat: There's a small company that's powering their brand-new gadgets and the coming revolution in technology. And we think its stock price has nearly unlimited room to run for early in-the-know investors! To be one of them, just click here.

Reuben Brewer owns shares of Nucor. The Motley Fool recommends Nucor. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.