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Commercial Metals to Gain on Favorable Demand Amid Cost Woes

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On May 17, we issued an updated research report on Commercial Metals Company (CMC - Free Report) . The company is poised to gain from favorable key markets, acquisitions and growth in the United States and Poland. However, cost inflation and higher interest expenses are likely to constrain margins in the near term.

Strategic Growth Initiatives Drove Q2 Results

Commercial Metals delivered adjusted earnings per share of 29 cents in the second quarter of fiscal 2019 (ended Feb 28, 2019), which marked year-over-year improvement of 13%. The bottom line also surpassed the Zacks Consensus Estimate of 25 cents. Despite seasonal factors and unprecedented rainfall levels which impacted construction activity in many of its markets, the company delivered improved results thanks to the execution of various strategic growth initiatives.

Higher Steel Demand to Drive Growth

Strong bid activity has led to significant growth in the company’s backlog. Continued strength in global demand for steel has led to increased margins across the company’s segments. Additionally, spending in construction activity in the United States continues to rise. Market conditions in the United States and Poland suggest continued economic growth, which is anticipated to translate into improved long-product steel demand.

Focused Investment in Growth

Capital expenditures were $67 million in the fiscal second quarter, while capital spending for fiscal 2019 is likely to be in the range of $170 million to $225 million. The ramp-up of production volumes at the micro mill in Durant, OK, is progressing well. The facility had increased shipments during the second quarter of fiscal 2019 and is generating higher-than-expected returns aided by the strong rebar demand and improved metal margins.

Construction is well on track at the Arizona micro mill where the company has invested in a second spooler to produce hot spooled rebar. The facility will likely start producing spooled material during the fourth quarter of fiscal 2019. Commercial Metals has started construction on expanding the finished goods production capacity by approximately 400,000 metric tons at its Polish facility. The investment will allow the facility to fully utilize the existing melt capacity, and continue expansion into higher-margin wire rod and merchant product. The project is likely to close by the end of fiscal 2020.

Acquisition to Drive Growth

On Nov 5, 2018, 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. In the fiscal second quarter, the acquired assets added $383.6 million to the company’s revenues and $32.9 million to operating income.

The acquisition will add more than 2 million tons of rebar capacity, as well as approximately 800,000 tons of fabricated steel capacity. Additionally, the company will have an expanded geographic presence in the largest construction regions in the United States. This buyout is anticipated to be accretive to earnings and cash flow within the first year of transaction. The company has already developed execution plans to deliver synergies with expectations to exceed $40 million in the coming quarters.

Few Headwinds Remain

Inflationary pressure on manufacturing costs owing to tight labor market and consumable raw material prices will dent the company’s margins. Furthermore, its debt to equity ratio has shot up, in order to fund the acquisition of certain U.S. rebar steel mill and fabrication assets from Gerdau S.A. Consequently, higher debt levels and interest expense remain concerns for Commercial Metals. Seasonal factors might also result in lower shipment rates at the company’s facilities in third-quarter fiscal 2019.

Share Price Performance

Shares of Commercial Metals have plunged 35.2% over the past year compared with the industry’s decline of 38.1%.

Zacks Rank and Stocks to Consider

Commercial Metals currently carries a Zacks Rank #3 (Hold).

A few better-ranked stocks in the Basic Materials space are Israel Chemicals Ltd. ICL, Arconic Inc. ARNC and Arch Coal Inc. ARCH, each carrying a Zacks Rank #2 (Buy), at present. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Israel Chemicals has an expected earnings growth rate of 13.51% for 2019. The company’s shares have gained 13.5% in the past year.

Arconic has an estimated earnings growth rate of 31.62% for the current year. The stock has appreciated 19% in a year’s time.

Arch Coal has a projected earnings growth rate of 16.7% for the ongoing year. Its shares have rallied 13% over the past year.

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