Olympic Steel: Deep Value Alert, Trading Below Liquidation Value (NASDAQ: ZEUS)


Vladimir Zapletin

I had Olympic Steel, Inc. (NASDAQ: ZEUS) as one of my top picks for 2021. You can read that article here and learn more about his activity. In this article, I had 3 main dynamics that would drive to increased profits for Olympic Steel and the steel industry as a whole:

  • End of demand COVID – reopening of the economy
  • Pressure from the new administration for more investment in infrastructure
  • Growing demand for steel due to the growing movement of electric vehicles.

We still see these tailwinds for the steel industry today. Our economy has opened up, we are at or near full employment, the revised Build Back Better Act is soon to pass, and the continued rollout of the $1 trillion infrastructure bill.

But, with the reopening of the US economy and the remaining supply chain issues, we have seen very high levels of inflation. This led the Federal Reserve to aggressively raise borrowing rates. So even with all this demand, we have seen GDP fall for 2 straight quarters.

The current state of the steel industry

As my last steel article showed, steel prices have been rising rapidly in 2021, peaking at around $1,500 per ton for hot rolled coil – HRC. This has created an excellent environment for the steel industry. Over the past few months, prices have fallen rapidly – all the way down to under $900. We have seen similar declines in many other commodities such as copper, timber, fertilizers, etc.

For the steel industry, $800-900 for HRC is still a very profitable level. All of the steel companies we follow are forecasting lower Q3 earnings and EBITDA due to this drop in steel prices. But due to this drop in the price of steel, stocks have been hammered – many are trading with P/Es below 4.

With this configuration, why Olympic Steel? You could say that many steel companies are “deep value alerts”: United States Steel (X), Cleveland-Cliffs (CLF), Ternium (TX), etc. In this article, I’ll make it pretty simple. Olympic Steel is the top choice because of the number one rule of value investing:

Principle #1: Always invest with a margin of safety – Benjamin Graham

Benjamin Graham was an investor and is generally considered the father of stock analysis and value investing. Margin of safety is the principle of buying a security at a significant discount to its intrinsic value, which is believed not only to provide opportunities for high returns, but also to minimize the risk of loss of an investment. Simply put, Graham’s goal was to buy assets worth $1 for 50 cents. He did it very, very well.

One metric I look at for this concept of margin of safety is “liquidation value”. My formula for this metric is:

(cash and cash equivalents + accounts receivable + inventory) – (accounts payable + debt).

Or more simply – Current assets – Current liabilities and debts.

Olympic Steels 2nd quarter results

There’s no other way to describe the Q2 numbers – blowout! The company achieved record quarterly sales and had the most profitable second quarter in its history. Net income for the second quarter totaled $37.6 million, or $3.26 per diluted share, a 26% increase from a year ago. The company posted record quarterly sales of $709 million in the second quarter of 2022, a 28% increase from a year earlier.

As my last article on Olympic Steel shows, they have made several key acquisitions over the past few years to diversify away from steel prices like HRC. Currently they are around 50% down significantly in HRC prices compared to 5 years ago. With this new level of diversification, the company increased its quarterly dividend from $0.02 per share to $0.09 per share in March 2022.

Here is a brief overview of Olympic Steel’s product and end-user market diversification:

From the company's website

Olympic steel

From the company's website

Olympic steel

For us, the most positive comment from CEO Richard Marabito was:

While metal prices are down in the third quarter, we remain optimistic about underlying demand and our ability to consistently generate earnings through all market cycles,” Marabito concluded.

For such a cyclical industry, and Olympic Steel is such a small company, this is a bold statement. Olympic Steel has earned over $13 per share in the past 12 months – P/E of around 2. Yes, we all know that’s part of the “cyclical” high point, but now Olympic Steel is saying that ‘they will be profitable at “cyclical” low points.

Looking ahead, and with their dividend now around 40 cents per share, we could estimate a 12-month down cycle period to have $1-2 EPS. So a full cycle – the highs and lows would see a P/E of around 4 – that’s really Deep Value…

Liquidation value of Olympic Steel

This very hypothetical metric could be described as follows: what if another entity bought Olympic Steel – say another steel company or a private equity firm, and decided to simply sell its assets and cash them in? So in 6-9 months reduce inventory, collect all receivables and pay all accounts payable and payable. Here is a chart of my liquidation values ​​for the past 12 months:

Sep 21 December 21 March 22 Jun-22
Cash $15 $10 $8 $8
Accounts Receivable $303 $285 $313 $321
Inventory $418 $485 $475 $511
Total current value $736 $779 $797 $840
Accounts payable $160 $149 $163 $182
Asset Backed Lending – ABL $302 $330 $312 $288
Total current liabilities $462 $479 $475 $470
Current net asset value $275 $300 $322 $370
Liquidation value per share $24.97 $27.31 $29.23 $33.65

So we can see that the current value is around $34 per share – 10% above its closing price on August 4th. And as we can see, this is a 35% increase from September 2021. It should also be noted that Olympic Steel is trading at a 30% discount to its net asset value. And management said that value will continue to rise. This is a special deep value alert from Benjamin Graham.

Investor takeaways

Olympic Steel has diversified its business model, producing record levels of revenue and profit, and has the ability to perform well even in times of economic downturn and low steel prices. With a current market capitalization below $350 million, this micro cap could also become an acquisition target.

We find Olympic Steel to be a solid buy below its net asset value of around $40 per share.

Risks to investors here are low in our view since this company is currently trading below its liquidation value, but risks remain:

  • The Federal Reserve raised rates too much, plunging the US economy into a deep, deep recession.
  • Individual stock risk – accounting issues, lawsuits, etc.

We are also very positive about other steel companies: US Steel, Ternium and Steel Dynamics (STLD).

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