guruXOOX/iStock via Getty Images

guruXOOX/iStock via Getty Images

Steel prices will probably drop more, but Reliance Steel & Aluminum Co. (NYSE:RS ) is still a great company and stock pick at the current price. They generate value through many ways such as consistently strong financials through downturns, a growing dividend, share repurchases, high return on capital projects and maintaining a low cost of capital. Furthermore, they are currently undervalued through a conservative Discounted Cash Flow ("DCF") analysis.

Reliance Steel & Aluminum Co. is a diversified metal solutions provider and the largest metals service center company in North America. RS purchases metal products from producers, or mills, and then process them through various metal forming, chemical, and heating processes. They then distribute these transformed products to customers through a broad range of industries. Over the last three years, gross dollar sales were broken down to 58% carbon steel, 16% stainless steel, 14% Aluminum, 4% Alloy, 8% other. As mentioned in my article about Steel Dynamics (STLD), steel prices have dropped 40% YTD and a 3.3% CAGR is projected into 2025. This covers roughly three-quarters of the market for RS, but they are exposed to around 5.7% CAGR for the aluminum industry through 2027 as well. They also have their hands in an alloy market that is likely to grow somewhere around 5.1% CAGR through 2030. Overall, RS is still in a lower-growth steel industry, but they have some reach towards other higher-growth metal markets. Being so involved in many materials and processes also indicates they are in an essential industry as well.

Prior to 2021, when steel prices rocketed, RS had an average revenue growth of 1.65% YoY from 2012 to 2020. Under the same parameters, we see a 6.93% net income growth, and growth in cash flow, albeit very cyclical high and low years. From the balance sheet, we see a very high current ratio of 3.0 which should help during the low years coming up. We also see they have been repurchasing shares at an average of 1.75% YoY since 2012, creating value for investors. More good signs include beating earning expectations over the last four quarters and a growing dividend since 2012.

Profitability and Momentum grades look good, but they are midline in valuation, growth, and peer grades. Some of these may be viewed as risks, but I will counter-argue the valuation grade with my own in-depth valuation. Growth against peers seems to be currently being taken care of through their capital allocation plan with a 50% increase. They have a good history of return on capital as well, so I'm sure this increase will be put to good use.

RS Growth (Author) RS Growth 2 (Author)

A fair value of $216 per share was calculated by a 10-year Unlevered Discounted Cash Flow ("DCF") analysis using CAPM with a 2.5% terminal growth rate ("TGR") and a 10% weighted average cost of capital ("WACC") discount. Note that RS' WACC was actually calculated to be 8.5%, but since it was such a low cost of capital, I decided to discount by 10% for a premium over the market and forgo the WACC section, since it was not used. A worst-case, best-case, and normal-case scenario were averaged to arrive at the fair value. Revenue and EBIT projections were used from average results of (11) analysts for 2022 and (14) analysts for 2023 from Financial Modeling Prep (Red Text). Personal projections were used thereafter, with the following conservative assumptions in the tan boxes.

For those more interested in how this value was calculated, I included a sheet that outlines the equations and process used (Mitchell_s_Reference_Sheet.pdf). I also go into more detail on this in my article about STLD.

RS DCF Fair Value (Author)

RS DCF Fair Value (Author)

The results show almost a 20% upside with extremely conservative assumptions at a $216 price. This does not include their 1.96% dividend or the consistent share buybacks, which should add more upside. A very conservative best-case scenario exhibits almost a 45% upside at a $260 price.

RS has shown it can generate value even before the skyrocketing steel prices. They do this through consistent financial growth, dividends, share buybacks and high return on capital. When steel prices drop, I think they will still be a great company at a great price by looking at our conservative DCF. They also have the added benefit of exposure to higher-growth aluminum and alloy markets. RS is the middle step between the mill and the customer, which means they don't compete with them, but they grow and fall with them. Steel prices will drop, and RS revenue and margins will likely not repeat 2021 for some time, but it is still undervalued and is a "Buy" at the current price for investors holding for ten years.

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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in RS over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.