Reliance Steel Slips to Neutral

We are downgrading our recommendation on Reliance Steel & Aluminum Co. ( RS - Analyst Report ) to Neutral following its mixed second-quarter 2012 results. Earnings of $1.44 per share topped the Zacks Consensus Estimate by 3 cents. Revenues climbed 8% year over year to $2.21 billion, but missed the Zacks Consensus Estimate of $2.24 billion.

Revenue growth was driven by higher sales volume and strength across a host of industries, especially oil and natural gas. Moving ahead, the company expects the economic challenges to sustain through the third quarter. The pricing environment is expected to remain uncertain for certain metals it sells.

Reliance Steel has tremendous earnings capacity with its broad and diversified product base, along with a wide geographic footprint that positions it well in the industry. The company continues to evaluate and execute additional growth projects and is well placed to leverage the strong momentum across a number of end markets.

The company’s expansion initiatives and strategic acquisitions should drive growth this year and beyond. The acquisitions of McKey and National Specialty Alloys (“NSA”) have enabled Reliance Steel to improve its product offerings and expand into newer markets.

Reliance Steel, in April 2012, wrapped up the acquisition of all the assets of the Worthington Steel Vonore plant from Worthington Industries Inc. ( WOR - Snapshot Report ) . The acquisition, which complements the company’s existing portfolio, will expand its presence in the Southeastern regions of the U.S. Moreover, the recent acquisition of the assets of Airport Metals marked Reliance Steel’s first foray of into the Australian market.

In addition, Reliance Steel remains committed to offer incremental returns to its shareholders. The company recently boosted its quarterly dividend by 67% to 25 cents a share.

However, we are concerned about the non-residential construction market (the company’s largest end market), which continues to be the weakest link. In addition, raw material prices are expected to remain volatile.

Reliance Steel also contends with falling steel and metals prices. The company is experiencing a declining pricing trend for most of the metals it sells. Prices for alloy aluminum, carbon steel products and stainless steel fell in the second quarter. All these factors lead us to tread with caution.

Our recommendation on the stock is in sync with a short-term Zacks #3 Rank (Hold).