Reliance Steel is true to its name
With just-in-time inventory management and an array of products, Reliance Steel & Aluminum (RS) is a reliable supplier to its customers. Investors also look for companies that they can rely upon for superior and stable performance.
We’ll now look at the reliability of Reliance Steel & Aluminum as an investment proposition.
An all-weather friend
The steel industry is associated with huge swings in profitability and margins, which reflects the trends in business cycles. Steel companies lose profits as the economy dips into a recession. When economic activity grows, steel company stocks once again become the flavor on Wall Street. So timing your investment becomes an ultimate necessity if you want to own steel companies. But timing the market every time is not possible, even for the seasoned fund managers.
The chart above shows the operating margins of Reliance Steel across business cycles. As you can see, the margins have been relatively stable when compared to other steel service centers as well as steel mills. The key point to note is that in cyclical upturns, like we saw in the period of 2004–2007, Reliance Steel tends to have lower margins as compared to steel mills. But this gets compensated in the higher margins in the periods of slowdown as we see today.
Why Reliance Steel enjoys stable margins over steel mills
Steel mills like ArcelorMittal (MT), United States Steel Corporation (X), and Nucor Corporation (NUE) have high operating and financial leverage. This means that they have high fixed costs, which hurt their profits in slowdowns. In times of high growth, these fixed costs get distributed among higher units of production. So, these companies are able to post better margins.
Reliance Steel, on the other hand, has a business model that doesn’t involve higher leverage. Also, as you have seen, it’s able to complete customer orders in little time. This helps create a flexible business model. These factors help the company to post stable margins across business cycles.
In the next part of the series, we’ll analyze other key financials of Reliance Steel.
Please note that the steel industry can also be accessed through the SPDR S&P Metals and Mining ETF (XME).