Reliance Steel & Aluminum Becomes an Undervalued Predictable Stock

Overvalued or undervalued? Reliance Steel & Aluminum Co. (

RS, Financial) has its feet in two contradictory camps. The GuruFocus Value Line considers the stock of this $10.15 billion company to be overvalued. At the same time, the GuruFocus discounted earnings calculator shows the company is undervalued.

In this discussion, we will find out how Reliance made it to the Undervalued Predictable listdespite the run-up of its share price over the past year:

Reliance Steel price chart

About Reliance

On its website, the company describes itself as “a leading global diversified metal solutions provider and the largest metals service center company in North America.”

Based in Los Angeles, Reliance has a network of about 300 locations in 40 states and 13 other countries. It was founded in 1939 and has traded publicly for 25 years. The current company operates under dozens of subsidiary names.

According to its March 2021 Investor Presentation, the service centers act as intermediaries:

  1. They acquire products from primary metal producers, the mills and process them to provide value-added services to customer specifications.
  2. Using specialized equipment, the service centers are able to achieve high-volume production.
  3. Their customers are unwilling or unable to buy this equipment, preferring instead to buy from service centers.
  4. It cites these customer benefits: “value-added metals processing, readily available inventory, reliable and timely delivery, flexible order size and quality control.”

Reliance reported in its 10-K that 49% of orders shipped in 2020 had some value-added processing.

These are the company’s main customers, according to the presentation:

Reliance Steel customers

Competition

The industry is fragmented and highly competitive, with Reliance facing competition from other metal processing companies and the mills themselves. The company states that it competes on several factors, including price, service, quality, processing capability and availability of products and services.

The company does not name competitors, but the GuruFocus system lists Steel Dynamics Inc. (

STLD, Financial) and Ternium SA (TX, Financial). It compares their 10-year performance in this chart:

Reliance Steel competitorsRisks

Multiple risks exist for Reliance shareholders, including:

  • Covid-19, which was first on the list of risks presented in the 10-K. It reported the pandemic disrupted supply chains and more, leading to “reduced demand of our products and services in all end markets we sell to. During 2020, our tons sold declined 10.8% from 2019 primarily due to the adverse impacts of COVID-19.”
  • The price of metals fluctuate because of factors beyond its control and could affect operating results, especially if it cannot pass on the higher costs to its customers.
  • It complained of foreign dumping of metal products in the past. Tariff barriers were erected in 2018, and if those tariffs change, prices could again become depressed.

Financial strength

Reliance Steel financial strength

Reliance receives a middling score for financial strength.

Starting with the debt lines, we see it has an interest coverage ratio of 5.94, meaning that it generates enough quarterly operating income to pay its interest expenses nearly six times over. Still, it does have a small mountain of debt:

Reliance Steel cash and debt

Both the Piotroski F-Score and the Altman Z-Score are strong, signifying the company operates effectively and that there is practically no risk for it getting into financial trouble.

The table also shows the company putting its capital to good use, with return on invested capital outpacing the weighted average cost of capital by more than one point.

Profitability

Reliance Steel profitability

The green bars indicate above-average operating and net margins. Checking a chart for the past decade shows they have been bumpy, and the trendlines show they have been growing:

Reliance Steel net margin operating margin chart

Revenue took a tumble in 2019 and 2020:

Reliance Steel revenue chart

Ebitda kept increasing in 2019, but fell off in 2020:

Reliance Steel EBITDA chart

Earnings per share (diluted) dipped in 2020, against the long-term trend:

Reliance Steel earnings per share chart

Dividend and share buybacks

Reliance Steel dividend and share buybacks

Reliance’s dividend per share has risen steadily over the past decade:

Reliance Steel dividends per share chart

However, the dividend yield has fallen as the share price pushed up:

Reliance Steel dividend yield chart

The dividend payout ratio is relatively low at 29%, leaving room for higher dividends.

Shareholders have also received more benefit per share because the company has been repurchasing its stock:

Reliance Steel shares outstanding chart

Generally, returns have been good for shareholders, especially over the past three years.

Annualized returns:

  • Year to date: 34.03%
  • One year: 86.38%
  • Five years: 18.62%
  • 10 years: 12.10%

Total returns:

  • 2017: 7.86%
  • 2018: -17.04%
  • 2019: 68.27%
  • 2020: -0.01%
  • 2021: 33.45%

Valuation

There are two schools of thought about Reliance, and they go in opposite directions. First, there is the GuruFocus Value Line, which looks at three factors:

  1. Historical multiples, including the price-earnings, price-sales, price-book and the price-to-free cash flow ratios.
  2. A black-box adjustment factor that includes past returns and growth.
  3. What the company is expected to earn in the future.

That input generates a rating of significantly overvalued:

Reliance Steel GuruFocus Value Line

On the other hand, the Undervalued Predictable screener uses two factors:

  1. The predictability score, based on the consistency of revenue and earnings growth. Reliance receives a predictability score of 4 out of 5, which is considered high.
  2. The discounted cash flow or discounted earnings calculation. For Reliance, earnings is considered a better metric than cash flow.

This is the output from the discounted earnings calculator, using the default values:

Reliance Steel discounted earnings calculator

As we see, the calculator finds a margin of safety of slightly more than 10%. That’s not a big margin, but it puts the stock into an entirely different light than the GuruFocus Value Line.

Other valuation measures of interest:

  • Price-earnings ratio: 17.98, which is in line with the rest of the Steel industry.
  • Price-earning-to-Ebitda growth ratio (PEG): 2.12, which is above the industry median of 1.42 (1.00 is considered fair value).
  • Price-book: 1.91, which is higher than the industry median of 1.11.

Overall, I’m inclined to think Reliance is modestly overvalued, but investors will have to determine their own valuations.

Gurus

Nine of the gurus followed by GuruFocus had positions in Reliance at the end of 2020. Evidently, many more had sold out, perhaps taking profits as the stock rose in value:

Reliance Steel guru buys and sells

The three largest holdings were those of:

Conclusion

Reliance Steel & Aluminum has had an outstanding year, one in which its share price rose dramatically. At the same time, it operates a solid business, punctuated by ups and downs. Thanks to its high predictability and discounted earnings calculations, it has achieved Undervalued Predictable status.

More contentious is the issue of valuation. There’s no arguing that the share price has risen dramatically, while Ebitda and earnings per share fell. That suggests the company should be overvalued, but those who put their faith in discounted earnings will disagree.

Although there is a margin of safety, it is probably not enough for most value investors (who will also have their eye on the Reliance’s debt load). Growth investors may take an interest based on what the share price has done over the past year. Income investors will need a much lower price if they wish to harvest a healthy dividend.

Disclaimer: I do not own shares in any of the companies named in this article and do not expect to buy any in the next 72 hours.

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