Our view: Stelco offers investors leverage to high steel prices through its highly fixed, low cost operations and it trades at a discount to peers. With operations humming along and the company executing on its strategy we expect strong free cash flow and earnings at current spot and forecast steel prices, which we expect to translate to capital returns. We have revised our model marking-to-market for steel prices in H2/21 and tweaked realized prices up in 2022 which increased our estimates and took our target to $59 from $54. We maintain our Outperform rating.
Key points:
Harvest mode - fixed cost structure paying off: Stelco is positioned to generate strong FCF in the current steel price environment given its highly fixed cost structure and following the completion of major investments over the past several years. We estimate the company will generate $1,170M in FCF in 2021 (30% yield), $586M in 2022 (15% yield) and $417M in 2023 (11% yield).
Further capital returns expected in Q3: Management continues to guide for an update regarding capital returns in late Q3, with an emphasis from the prior conference call on share buy-backs. Based on our estimates we forecast a cash balance at the end of Q3 of $749M and expect Stelco to generate another $374M of FCF in Q4. We think the company could support a return of capital in the ~$500M range in Q3 while maintaining a healthy cash balance to fund potential investments and WC needs.
Steel market outlook: Demand for steel remains solid and supply is tight. Steel mill capability utilization has been above pre-pandemic levels for 9- weeks (exhibit 5), but prices have continued to rise (HRC up 9% QTD & avg. up 19% thus far q/q). We expect supply to remain tight in the near-term as upcoming maintenance shutdowns at steel mills will result in weaker supply and support prices.
Estimate revisions: We marked-to-market for steel prices thus far in Q3, increasing our expected realized pricing for the remainder of the year. We also tweaked our realized pricing up in 2022 to reflect lagged sales which resulted in our increased earnings estimates. We increased our shipped tons of steel slightly to a run rate of 675Kst per quarter in 2022 and beyond (from 660Kst) inline with the current run rate.
Valuation remains attractive: Stelco shares are currently trading at 4.8x our estimate 2022 EV/EBITDA, below peers at 6.3x. While some discount to the US mills could be justified due to Stelco being a single asset company with no Canadian listed peers, we believe the fixed cost structure and recent investments to upgrade the assets should mostly offset. However, given the historical trading range we use a 5.5x multiple (the avg. of Stelco and peers historic ranges) to get to our $59 price target. We use our forecast net debt at YE 2021 in our calculation to reflect the strong FCF generation we expect in H2/21.