Olympic Steel is Overlooked and Undervalued

I anticipate that Olympic Steel (ZEUS) will reach a price of $22 in the next month and a long term price of $30. I believe this is the case because the stock is undervalued from a fundamental perspective, oversold, and is a part of a sector that I expect will excel over the next year.

Potential risks of this investment are the possibility that the steel sector does not recover from its last month in which it has experienced significant losses. If steel does not succeed neither will Olympic Steel. Throughout the article I will express my reasons as to why I feel that the steel industry will succeed and Olympic Steel will not only benefit alongside its sector but in fact exceed it. Another potential risk is that since Olympic Steel is a fairly unfollowed stock there are very few analyst estimates regarding the future growth and EPS of the stock. This leads to estimates that could have a very high variation from what the actual consensus expectation may be. However, I feel that this is not an issue as we can look at Olympic Steel’s financials and its significant growth throughout the last year and understand that this stock is built to continue its growth into the foreseeable future.

On May 31, 2018, President Donald Trump imposed 25% tariffs on Chinese steel imports. Since then profits throughout the steel industry have increased significantly and Olympic Steel (ZEUS) is no exception to this. However, since May 31, Olympic Steel’s stock price, which currently stands at $18.90, has decreased by 20%. It appears that this stock, and its low volume of approximately 65k per day, is being overlooked.

The Company

Olympic Steel, headquartered in Cleveland, Ohio, focuses on selling and distributing processed carbon, steel and aluminum across the Americas. The company features a strong management team consisting of people who have been in steel for many years. Recently, CFO Rick Marabito was promoted to CEO. He takes over for Michael Siegal who will continue with the company as Chairman. This move was in the works for a long time and was executed at this time due to Olympic’s strong financial standing which led to a smooth transition.

Steel Sector

President Trump’s tariffs on steel imports forces the US to provide its own steel and this naturally increases the demand of US manufacturers. Other aspects of the United States’ trade war with China have encouraged companies to build new manufacturing facilities in the US as opposed to abroad. As growth in the US continues to climb so will the demand for steel and the services of companies such as Olympic Steel.

Why Zeus is Undervalued

Olympic Steel features some very attractive statistics which show that the stock is undervalued. ZEUS’ P/E ratio is 5.97 which is well below the industry average of 13.5. The stock’s EV/EBITDA multiple is 8.84 which is also below the industry average. Both these values signify that Olympic Steel’s high earnings may not be accurately portrayed by its current valuation. Zeus’ high level of earnings can be paired with a very productive last 3 quarters on the top line. There has been an uptrend in both Total Revenue and Total Operating Income over this time period. All of these factors have led to an EPS growth rate this year of 160%. However, over this same time period the stock price has decreased. This screams that there is a gross underestimate in terms of valuation. To further prove this undervaluation one can look at what Eddy Elfenbein from Crossing Wall Street calls “The World’s Simplest Stock Valuation Multiple”:

(Growth Rate/2 + 8) · EPS = Fair Value

Olympic Steel’s next 5 year growth rate is 34.29% and its average estimate for next year’s EPS is 2.2. When we plug this into our stock valuation multiple we get:

(34.29/2 + 8) · 2.2 = $55.32

This valuation is clearly far above our current stock price of $18.90. Although this is a very crude valuation multiple, a 66% difference between the current price and our fair value is a significant enough difference to determine that the stock is grossly undervalued.

Technical Analysis

Not only does Olympic Steel impress on the fundamental level it is also promising from a technical perspective.

Screen Shot 2018-10-18 at 8.35.02 PMOver the last month the stock price has decreased from $22 to a bottom of $18.10. This is not the first time that Olympic Steel has taken a large hit over roughly the same time span. As you can see above I have annotated three other occasions just this year in which ZEUS has faced a very similar sell-off and in each instance the stock has recovered with strength. The Relative Strength Index (RSI) is currently 38 (anything below 40 is commonly considered oversold) which further emphasizes the case that the stock is oversold right now and should rebound. It is clear that the stock has already begun this rebound due to its bounce off of support just three days ago.

 Concession

A possibly worrying sight is the fact that the 200-day moving average has recently crossed above the 50-day moving average. This occurrence, which many know as “the death cross” may scare many as it signals a recent buck in the upward trend but I believe that the stock will gain momentum once again in the next month as it climbs up following its bounce off support. I believe this “death cross” will be short-lived and a bullish “golden cross” is in the not so distant future.

Another facet of Olympic Steel that many may see as a reason to stay away from the company is that although the balance sheet boasts a strong current ratio of approximately 4, inventory accounts for over 60% of current assets. Inventory has increased steadily over the past three quarters and could mean that Olympic Steel is struggling to sell its product. However, total revenue has increased over this time period as well which signals that this increase in inventory may simply be a result of an increased demand.

Conclusion

Due to the technical analysis conducted earlier I see this stock getting back up to a price of $22 over the next month leading up to earnings. In the long-term I think Zeus’ fundamental strength will take over and the stock will reach a price of $30+ due to its significant current and future growth that has not been accounted for in the share price. Earnings on November 8th may be the catalyst necessary to shoot ZEUS even higher and break the trend of fluctuating between the $18-$24 channel.

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