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Steel spiel - Schnitzner Steel

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November 17, 2007 – Comments (4)

Motley Fool provides some excellent tools to look at stocks, http://caps.fool.com/Ticker/SCHN.aspx.  Walking through what I looked at did not give me confidence in Schnitzer Steel Industries, SCHN.  I did not dig deep, but what I did see says "YUCK" to me.

Open the chart in a new window and set it for 5 years.  The stock was trading around $5 five years ago.  That's about a 1200% increase in 5 years and that kind of growth is always a red flag for me.  I generally tend to think the money that was there to be made has already been made.  There might be strong reasons for that growth, but nothing else I see on the surface makes me think this is a stock worth spending the time to dig deep and really understand it.

If you click on the "Growth Rates" tab on the quote page in CAPS you get some beautiful bar graphs.  Looking at these is what I would say really killed any interest what-so-ever in this stock.  I looked at the 5 year graph after I saw the bar graphs, trying to understand why people were rating this one as outperform.

Revenue growth has been fantastic.  The bar graph shows three quarters that end in August, so $212 million, $605 million and $749 million.  If you compare the 2005 revenue to the 2007 revenue, well, unbelievable growth, about 250%.  Go Schnitzer go!

But...  I'm the type that couldn't give a dang about revenue growth...  The way I look at revenue is say I have two "brands" of blue jeans, both for $50.  Say I make $10 on the one brand and $25 on the other brand.  What's important here isn't my revenue, but how many of the 50% margin jeans I can sell.  If my revenue growth comes at the "cost" of selling less of the 50% margin jeans in favour of the 20% margin jeans, my growth is garbage.

Here in is the problem with Schnitzer's growth.  First, the bar graph shows that earning are volatile, but in the big picture, they really aren't going up much.  The 3 year eps growth is 5.63%, and if you multiply that out, you get 17.9% over the past three years, the period where most of the revenue growth has occurred.  The share price was about $35 then, so we are seeing about an 80% growth in share price for an 18% growth in earnings.

Look at that one year EPS growth.  Is is NEGATIVE 8.2%.  Revenue is up roughly 25% in that one year.  In my books this looks like imploding earnings, and earnings ought to be a significant measure of a stock's value.

Then, I also think about how does this business fit into the economy.  The strongest point it has in its favour is the declining US dollar.  It means that relative wages compare to other countries in this business are declining, making them more competitive.  That may help those dismal margins improve.

But what potentially works against this company?  Steel is energy intensive and $90 oil is very expense.  Do you see the dollar signs with wings flying away as I do?

They have their metals recycling segment.  Metal prices went through the roof, and that's going to have caused revenues to explode, but, if I have scrap metal to sell, as the metal prices go up, I'm going to demand my fair share, so that's why margins did little.  In this business you are going to get periods where timing is going to give explosive earnings and explosive cost increases.  Metal commodities have done the dramatic unsustainable increases and now they are coming back down into line with reality.  My thinking ahead tells me this segment is going to show an implosion in revenue due to metal price declines.  If they are holding too much scrap metal through price declines, that's going to hurt, but over a longer period it shouldn't change the earnings that much.  They will pay me less for my scrap metal going forward, earning should not change that much, but it explains why that amazing revenue growth isn't worth much.  If metal prices decline too much, it may be hard to find scrap metal for sale, and that will hurt this segments earning.

Then they have their auto parts group.  I just don't see this kind of business doing well.  The competition for used vehicles is going to go up as people buy less new vehicles, so their costs here have to go up.  I can see demand for this segment increasing as people patch up older vehicles, but it seems all costs associated with it will increase significantly.

If I look at debt over the past three years I see $7.7 million in 2005, $103 million in 2006 and $124 million this year.  It isn't high relative to revenue or even earnings, but it is has increased a lot relative to the almost flat earnings by comparison.

Now, look at the dividend they just declared, $0.017/share.  It hasn't increased since inception in 94.  That's 6.8c/share per year, or one tenth of one percent.  Seriously, even if I go back to that $5/share price 5 years ago the dividend yield was still only around 1.4%.

THE DIVIDEND HAS DONE ABSOLUTELY NOTHING TO KEEP UP WITH THE SHARE PRICE!

This was something else interesting to find, I calculated about $2 million in dividends based on all shares yet yahoo is saying there was $6 million paid out, so a closer look, dividends $2 million and minority interests $4 million.  The dividends paid in two years have declined a bit, 1.6%, I guess due to the share buy back, yet the minority interest payment has increased , by 1.7%.  I didn't find out how the payout to the "minority interest" works, but it is working better for the minority interests than dividends are working for share holders.  I was looking for a reason that company is making over $100 million per year yet only paying out $2 million in dividends and no increase.  It looks like capital expansion.  The capital expansion for 2006 was much larger than for 2007 and judging by the decline in earning growth, well, it does make the picture look much worse...

Words I do not like in a volatile period "fully leverage its investments in PNE and MRL."  I don't know what that means, but in an up market fully leveraged is a total cash cow, but look out if the market turns.  Leverage can wipe you out.

And what would a look at a stock be without looking at what the insiders are doing?  In the last six months net sale of 706,631 shares, leaving insiders still holding a total of 500,350 shares.  Insiders have reduced their holdings big time, to about 2% of the shares.  Institutions are net sellers as well, selling 1.6 million shares in one quarter.

Dang, I did go opening the annual report.  California accounted for 42% of the steel manufacturing business.  How much of that went into condo construction?  "The steel manufacturing business customers are principally steel service centers, construction industry subcontractors, steel fabricators, wire drawers and major farm and wood product suppliers."  This doesn't look good to me.  They use natural gas and they will actually see a decrease in costs here.

I decided to take a look at the world market, emerging economies and such.  This is a story I found, http://www.thedailystar.net/story.php?nid=12098.  Must I learn geography to write a post?  Banladesh sounds like an emerging economy place, you know, India, but I admit my knowledge here isn't that good, all of India is emerging or just parts of India.  Regardless, this article talks about steel rods being stockpiled in India due to a downturn in construction in INDIA.  That growing world economy thing doesn't sound good from this article.

$110 million share repurchase.  That $110 million means that each share now "paid" $3.75 plus carrying costs to do this.  It looks like about $7-8 million in interest per year, or about $0.25/share per year carrying costs for the first year.  Net tangible assets are about $16/share, fully diluted.

What the heck does "Stock options totaling 200,00 and 600,000 shares as of August 31, 2007 and 2006, respectively, were excluded from the calculation of diluted earnings per she because the options were anti-dilutive" mean?

When I look at the market cap on Motley, it looks like they are not including the 7 million something class B shares in their calculation.  Yahoo is better, http://finance.yahoo.com/q?s=SCHN

I can't stand goodwill, and goodwill seems to be the fastest increasing "asset" on the balance sheet.  Over two years shareholder's equity has increase by 32%, yet if you only look at the tangible assets, well they are only up by 13%.  Share price was about half of what it is now two years ago, well, about $33 vs $63.

So, my main reasons for not liking this one are:

1) Poor earning growth relative to very high revenue growth
2) Downward corrections in metal commodity prices
3) Useless dividend and no dividend growth in 13 years.
4) Insiders and institutions selling out.
5) High energy costs can squeeze earnings
6) Parts business will see increased costs from increased competition for used vehicles.
7) Increased debt.
8) Reliance on construction industry in some poor looking markets for sales.
9) Debt for share repurchase.
10) Capital expansion from 2006 shows no benefit for earnings in 2007, ie, growth is negative 8%.

4 Comments – Post Your Own

#1) On November 17, 2007 at 5:23 PM, dwot (97.03) wrote:

So, if you made it to here, I challenge to read out loud the title of this post 10 times as fast as you can...

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#2) On November 17, 2007 at 7:58 PM, bullshiite (34.45) wrote:

LMAO at dwot's post :)

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#3) On November 18, 2007 at 6:52 PM, GS751 (27.55) wrote:

Great In depth analysis
PropsFool On

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#4) On November 18, 2007 at 10:38 PM, abitare (58.10) wrote:

Good post! I am out of Red Thumbs

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