Russel Metals a buy for growth and income

The steel cycle may have peaked but Russel Metals still offers good value and high income.

The US has finally removed its crippling tariffs against the Canadian steel and aluminum industries. And Canada has responded likewise, ending its retaliatory duties on US steel, aluminum and other products.

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Removal of retaliatory duties on steel and aluminum lets Russell Metals sell across the border more freely.

For Russel Metals, the removal of the tariffs should not make a great deal of difference to its business. Because of its North American reach, the company was well positioned to adjust to the tariffs in the first place. It simply limited cross-border sales between its metals service centres and distribution facilities where possible. But now that the trade dispute has been resolved, it can sell across the border more freely.

Lower margins, profits follow higher materials costs

Russel Metals Inc. (TSX—RUS) is one of the largest metals distribution companies in North America. It carries on business in three metals distribution segments: metals service centres, energy products and steel distributors, under various names including Russel Metals, A.J. Forsyth and Acier Leroux.

After experiencing an exceptional year in 2018, the company has had to contend with a tightening market this year. For the three months ended March 31, 2019, Russel made $34 million, or $0.55 a share, compared with $38 million, or $0.62 a share, in the same period of 2018.

Though steel prices remained consistent with levels at the end of 2018 during the quarter, demand was slightly lower than the 2018 first quarter. What’s more, margins across all of Russel’s segments came under pressure due to the higher cost of material. This led to lower operating profits.

Earnings decline but dividend protected

Operating profit at the metals service centres fell eight per cent to $26.7 million, caused by the higher average cost of inventory and increased competitive pricing pressure. At the energy products segment, operating profit was down nine per cent to $29.5 billion on lower revenue and a decrease in the gross margin to 18.9 per cent from 19.3 per cent, mainly due to product mix.

Finally, operating profit at the steel distributors segment was $9 million, down 14 per cent, as the gross margin returned to historical levels.

The steel markets in Canada and the US appear to have peaked. Under these circumstances, Russel is expected to earn less this year than the $3.52 a share it earned in 2018.

But, even with the lower earnings expectations, the stock is attractively valued. Also, it offers a generous dividend, which is fairly well protected by expected 2019 earnings, with a payout ratio of 62.6 per cent.

The stock trades at a low 9.1 times the $2.43 a share that Russel should earn in 2019. Its annual dividend of $1.52 a share yields 6.9 per cent.

Russel Metals is a buy for growth and income.

This is an edited version of an article that was originally published for subscribers in the June 14, 2019, issue of Money Reporter. You can profit from the award-winning advice subscribers receive regularly in Money Reporter.

Money Reporter, MPL Communications Inc.
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