Reliance Steel & Aluminum Stock At All-Time High – Time To Exit?

After rising more than 95% from its March 2020 lows, at the current price of $139 per share, Reliance Steel & Aluminum Co. stock (NYSE: RS) now looks overvalued. RS stock rallied from $71 to $139 off its recent bottom, compared to the S&P 500 which increased 75% from its recent lows. The stock has been able to beat the broader market in the last eleven months as steel and aluminum prices have jumped sharply over recent months following the announcement of a string of measures in the US, along with stimulus packages announced in other economies to keep businesses afloat. In addition, the gradual lifting of the lockdowns and successful vaccine rollout has led to expectations of steel prices remaining strong. The stock is currently at its all-time high. China’s recent announcement of cutting its crude steel production took a toll on steel companies’ stocks in the beginning of 2021. We believe, with steel capacity utilization expected to take longer to reach its pre-Covid levels, the market has been too exuberant and RS stock will likely see a drop in the near term. Our dashboard Buy Or Fear Reliance Steel & Aluminum Stock provides the key numbers behind our thinking.

Though RS stock suffered following the outbreak of the pandemic in early 2020, it recovered in the second half and ended the year at its December 2019 level. The stock price increased despite revenues dropping 20% in 2020. The effect of lower revenue was exacerbated by deterioration in profitability as margins declined from 6.4% in 2019 to 4.2% in 2020. This led earnings per share (EPS) to drop by 45% in a year. Despite deteriorated financials, RS’ stock rise in 2020 was justified by almost a 90% rise in the company’s P/E multiple, which went up from 11x in 2019 to 21x in 2020. This was because the market expected the company to recover quickly after the crisis as faster economic recovery would lead to higher steel and aluminum demand. The P/E multiple went up further in 2021 and currently stands at 24x. We believe stabilization of steel prices will mellow the market’s enthusiasm and the P/E multiple will likely drop to around 20x in the near term.

Outlook

The global spread of coronavirus led to lockdown in various cities across the globe, which affected industrial and economic activity. Lower steel demand from construction and automobile players, led to a drop in global steel prices recently, which had already declined due to the ongoing US-China trade war. This was reflected in the company’s Q2 and Q3 2020 results. RS’ total revenues saw a y-o-y drop of 30% and 22% in Q2 and Q3 2020, respectively. This was mainly due to lower shipments and the shutdown affected steel demand in the economy.

However, with the lifting of lockdowns, and as global economies open up, steel demand is rising and is expected to remain strong while supply constraints will also decline, leading to a rise in steel shipments. Our dashboard Trends In U.S. Covid-19 Cases provides an overview of how the pandemic has been spreading in the U.S. and contrasts with trends in Brazil and Russia. The US raw steel capacity utilization for the week ending 20th February 2021 was 77%, which is lower than 81% recorded in the prior year period. However, this is an improvement over the 51% utilization in the beginning of May 2020, which indicates that there are signs of a rebound in activity in the steel sector. Expectations of revenue and earnings rising in 2021 and with investors’ focus shifting to the 2021 and 2022 numbers, RS’ stock has seen a formidable rise over recent months. But China’s recent announcement of cutting down on crude steel production has made the global steel and iron ore markets volatile recently. We believe that the market has been too enthusiastic about the stock and that any further major rise in RS stock looks unlikely anytime soon. In fact, until the impact of China’s lower production becomes clear, RS stock is likely to remain volatile and could even see a drop of close to 10%.

While RS stock may have moved, 2020 has created many pricing discontinuities which can offer attractive trading opportunities. For example, you’ll be surprised how how the stock valuation for Compass Minerals vs Southwest Gas shows a disconnect with their relative operational growth. You can find many such discontinuous pairs here.

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