Stelco Holdings (OTCPK:STZHF) is a Canadian steel producer located near the US border, giving it immediate access to its two main markets while having access to the raw materials necessary for the production of steel (mainly iron ore and coking coal). The flagship asset is the company’s Lake Erie Works steel mill in Nanticoke, Ontario. The plant has a capacity of 3.7 million tonnes of steel per year, but is currently operating under capacity at 3.1 million tonnes per year. Depending on market circumstances, the company may decide to bring slabs from outside into this plant. There is therefore a possibility to further increase the production rate when the market circumstances allow it.
Stelco’s primary listing is on the Toronto Stock Exchange where the company trades with STLC as its ticker symbol. The average daily volume is 360,000 shares per day, which definitely makes the Canadian listing more attractive than any secondary listing.
Unfortunately, the company’s website contains many “download only” links, but you can find all relevant information here.
With the steel market hot, it makes sense to look at Stelco’s annual results for a more conservative picture.
The price of steel exceeded all expectations for most of last year, and while the company was earning just a few dollars per ton of steel produced (EBIDA was only C$58 /t in 2019 and C$37/t in 2020), 2021 was an incredible year. The steel was sold at an average price of C$1473/t (more than double the high price compared to the C$729/t and C$705/t in 2019 and 2020. The additional revenues were almost entirely added to EBITDA and EBITDA margin per ton increased twenty-fold compared to 2020. And even compared to the pre-COVID 2019 year, the EBITDA margin per ton increased by just over 1 200% to reach C$764/t.
And that’s the annual average. The image above shows how EBITDA per ton continued to increase throughout the year. It reached an average of nearly C$1,100/t in the second half of the year thanks to an exceptionally high steel price. That’s great, but I don’t think it would be fair to use this exceptional steel price as a base case. Even the average steel price of C$1,470/t (which is just below US$1,200/t) is already quite optimistic, but still gives a better idea of Stelco’s potential performance.
The business was obviously exceptionally profitable and, as shown in the income statement below, the reported net profit was C$1.6 million. This includes a relatively high finance cost of C$162 million, which is a non-cash expense as it relates to the revaluation and increase in employee benefit liabilities. On the other hand, the tax burden was rather low. Net income of C$1.61 billion represented EPS of C$19.08. Note that EPS is based on the average share count of over 84 million shares throughout the year. By the end of fiscal 2021, the number of shares had decreased to 77.3 million shares (and it continues to decline).
Since the income statement contains a bunch of non-cash items, I was also curious to see the company’s free cash flow result. Reported operating cash flow was C$1.61 billion, but this included a C$132 million investment in working capital, but excluded C$9 million in lease payments. On an adjusted basis, operating cash flow was C$1.73 billion.
Total capex was C$236 million, but the vast majority was related to growth spending. Depreciation expense was only C$69 million and sustaining capital expense is expected to be even lower. But even if we used C$75 million in sustaining capital (which is a very conservative estimate), the adjusted free cash flow was C$1.65 billion on a sustaining basis. Spread over the 77.3 million shares outstanding at the end of 2021, sustainable free cash flow per share exceeded C$21. Which means the company was trading at just over 1.5 times its full year free cash flow when my previous article was published.
The balance sheet remains strong
At the end of 2021, Stelco’s balance sheet contained approximately C$955 million in cash, while debt had shrunk to just C$84 million, meaning the company had approximately C$870 million in net cash on the balance sheet.
This excludes the nearly C$600 million in liabilities related to the obligation to employee trusts. The majority of this amount (C$487 million) relates to the employee benefits liability (pension and health and life trusts). These agreements were signed in 2017 while the company was undergoing bankruptcy proceedings. In addition, approximately C$108 million of these liabilities relate to the acquisition of assets from the Legacy Lands partnership, which is a partnership formed during the company’s restructuring in 2017 for the benefit of pension plans. Stelco essentially purchased land and assets for a price of C$114 million with a 25-year mortgage with a cost of debt of 8%. These payments are made to the partnership, which is the official seller of the assets, and the partnership allocates the income (both principal and interest payments) to the pension and post-retirement benefit entities. employment for Stelco retirees.
The cash is really flowing and Stelco generates around C$4-5 million a day in operating cash flow, while sustaining capital expenditure remains very minimal. This means that Stelco will likely continue to buy back its own shares. In 2021, it spent around C$400 million to buy back its own shares from LG Bedrock, the largest shareholder. These 11.4 million shares were repurchased at an average price of just under C$35/share.
And Stelco continues to buy back shares. The company announced a tender offer to repurchase up to C$250 million worth of shares at a modified Dutch auction. There was very little appetite among shareholders to tender shares (because the maximum price offered by Stelco was relatively low) and only C$165 million worth of shares were tendered and the company repurchased 4.4 million shares at an average price of C$37 per share. This means that the current number of shares is approximately 73 million shares, which will further support the company’s performance per share.
The price of steel is exceptionally strong these days, but prices in the futures markets still indicate that the best days are behind us. That being said, average HRC steel prices for delivery in the second half of the year are still around C$1200-1300/t, so I think the realized price this year won’t be that low. than in 2021 (but it is very clear will be a cooling compared to the steel prices realized in the third and fourth quarters of 2021.
Although I spent C$165 million to repurchase shares, I expect Stelco’s net cash position to have increased further to over C$1 billion, which is nearly C$15 per stock. And this cash position will continue to build because Stelco cannot buy back its own shares at the same rate as the money comes in. Meanwhile, the quarterly dividend is only C$0.30 per share, which means the dividend-related cash outflows are lower. more than 25 million Canadian dollars per quarter.
The steel market is a game of musical chairs. But even when the music stops, Stelco’s balance sheet will likely be exceptionally strong, as the company is on track to have half of its current market capitalization backed by net cash on the balance sheet. The price of steel will weaken, it’s almost a given. But Stelco appears to be very well protected heading into the expected downturn.