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Commercial Metals Rides on Improving Markets, Debt Rises

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On Nov 13, we issued an updated research report on Commercial Metals Company (CMC - Free Report) . Improvement in key end markets, rising scrap prices, and favorable macroeconomic and market conditions in both the United States and Poland bode well for the company. However, losses in the Americas Fabrication segment and higher debt levels remain concerns.
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Upbeat Fiscal 2018 Results
 
For fiscal 2018, Commercial Metals reported adjusted net income of $176 million or $1.49 per share in fiscal 2018 compared with net income of $67 million or 57 cents in fiscal 2017. The company witnessed record levels of shipments of steel products from its operations in the United States and Poland in fiscal 2018. In fiscal 2018, ferrous prices have increased approximately 19% while non-ferrous prices have risen 11%. 
 
Poised for Better Fiscal 2019 Despite Weak Q1
 
The first quarter is typically a slightly slower period for the company as construction work begins to wind down before the onset of winter months and the beginning of the holiday season. Further, the company lost shipping days in certain markets due to heavy rains in Texas, and impact of hurricanes Florence and Michael. Further, higher manufacturing costs due to a tight labor market, consumable raw material prices and an extended planned outage in Polish operations is likely to dent margins in the first quarter of fiscal 2019.
 
Nevertheless, the company anticipates improved results in fiscal 2019 backed by continued momentum in demand for construction steel and strong economic environment. The Zacks Consensus Estimate for fiscal 2019 is at $2.25, projecting year-over-year growth of 51%. 
 
There have been improvement in farm equipment manufacturing activity, construction and energy related spending. Moreover, strong bid activity has led to significant growth in the company’s backlog. Further, leading indicators of macroeconomic and market conditions in both the United States and Poland suggest continued economic growth. This is likely to translate into improved long product steel demand. The imposition of tariff under Section 232 for additional import duties for steel mill and aluminum products should level the field for Commercial Metals against imported rebar and merchant bar products. The company can now effectively compete on a global basis.
 
Acquisition of Certain Assets of Gerdau Positive, Debt Levels a Concern
 
On Nov 5, the company completed the acquisition of certain U.S. rebar steel mill and fabrication assets from Gerdau S.A., a producer of long and specialty steel products in the Americas, for $600 million. With this, the company’s global melt capacity will go up to approximately 7.2 million tons. The company will also have an expanded geographic presence in the largest construction region in the United States. The buyout is expected to be accretive to earnings and cash flow within the first year.
 
However, the company’s debt to equity ratio has gone up to 76% as of Aug 31 to fund the acquisition. Higher debt levels and the consequent interest expense remain concerns.
 
All Segments Poised for Growth Except Americas Fabrication
 
The company’s top-line is benefiting from the increase in global investment in infrastructure, spurred by improvement in the construction and energy sectors. Notably, this has led to an environment of increased pricing of raw materials, including scrap prices. This increase in scrap prices has favorably impacted year-over-year average selling prices in the company’s Americas Recycling, Americas Mills, and International Mill segments.
 
The Americas Mill segment will continue to gain from improving construction activity and lower imports. The Americas Recycling segment is benefiting from strong demand for ferrous scrap, and an increasing price environment for both ferrous and non-ferrous material. At the International Mill segment, strong market conditions will continue in Poland which will aid results. In Poland, steel consumption was a record 13.5 million metric tons in 2017, increasing for the fourth year in a row. 
 
However, increase in scrap prices has adversely impacted the Americas Fabrication segment (that generated 25% of fiscal 2018 revenues), as projects that included in the backlog were carrying lower selling prices. Consequently, these were unable to offset rising rebar substrate and production costs. The segment incurred loss in fiscal 2018 due the lower priced backlog.
 
 
Shares of Commercial Metals rose 8% against the industry’s drop of 2% in the past year.
 
The company currently carries a Zacks Rank #3 (Hold).
 
Stocks to Consider
 
Some better-ranked stocks in the basic materials space are CF Industries Holdings, Inc. (CF - Free Report) , KMG Chemicals, Inc. and The Mosaic Company (MOS - Free Report) .
 
CF Industries has an expected long-term earnings growth rate of 6% and a Zacks Rank #1 (Strong Buy). The company’s shares have gained 40% in the past year. You can see the complete list of today’s Zacks #1 Rank stocks here.
 
Mosaic has an expected long-term earnings growth rate of 7% and a Zacks Rank #1. The company’s shares have rallied 61% over a year’s time.
 
KMG Chemicals has an expected long-term earnings growth rate of 28.5% and a Zacks Rank #2 (Buy). Its shares have risen 50% in the past year.
 
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