Worthington Industries Looks Forward to Lower Steel Prices
Lower steel prices
Previously in this series, we learned that Worthington Industries (WOR) has seen profit margins narrow in the recent quarter. It has incurred inventory holding losses.
Worthington isn’t a primary steel producer like Nucor (NUE) and Gerdau SA (GGB). It acquires raw steel products from primary steel producers and then processes it into value-added products. Reliance Steel & Aluminum (RS) also buys steel products from primary producers and distributes steel and aluminum products. It currently forms 4% of the SPDR S&P Metals and Mining ETF (XME).
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Volatility in steel prices is one of Worthington’s business risks. To mitigate this risk, it simultaneously fixes steel purchase price and the final selling prices of its products. But steel prices have corrected sharply in the last couple of months, as you can see in the above chart. Worthington follows a first-in-first-out, or FIFO, system. This means that inventories that are purchased first should be sold first.
Cost of production rises
Following the FIFO system, Worthington first offloads the high-cost inventories, which were purchased when steel prices were much higher than what they are currently. But this pushes up its unit cost of production. As a result, its profit margins took a hit in the recent quarter. The effect should taper down, however, in the coming quarters, as newly purchased inventory comes into play.
If steel prices rise in the future, Worthington will benefit from the FIFO system. It has, in fact, increased its inventory by almost 30%, having negotiated better deals with its suppliers.
Investors should also track the company’s balance sheet ratios. We’ll look at these in detail in our next part.