This Small Cap Steel Company Will Continue to Improve Profitability Via Acquisitions

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Worthington Industries’ (NYSE: WOR) robust performance and continued successful efforts at improving and growing its business strengthen my optimism on the shares. Worthington has been one of the most active companies in steel space through the downturn acquiring new businesses and divesting underperforming ones, implementing a strategic restructuring of its core Steel Processing business and buying back a substantial amount of its shares. I expect these efforts to continue looking forward.

Acquisition of Westerman Companies

Recently, Worthington has announced the acquisition of Westerman Companies, an Ohio-based producer of large oil & gas tanks and nuclear storage cylinders. I believe this acquisition further diversifies the Company's revenue stream in the Pressure Cylinders segment (about 35% of FY13 pro forma sales). In my view, the purchase does not completely satisfy Worthington's desire for exposure in targeted large LPG tank market and cryogenics markets. However, I believe the acquisition will offer a platform for eventual penetration given Westerman's technological capabilities to produce much larger cylinders than legacy Worthington Industries which I see as a huge positive for the company.

Exposure to Alternative Fuels

With the directive to grow and expand its exposure to alternative fuels, I would not be surprised to see the company announce further deals in the alternative markets pipeline over the next 6-12 months to further accelerate growth. I am looking forward to 1Q13 (August) EPS call in late September to get more visibility on the company's strategic growth endeavors for the Pressure Cylinders business.

ISM Steel Survey Supports Inventories Level

The August ISM Steel Survey continues to reflect American manufacturing's scaled-back expectations for the US economy as well as increasing uncertainty, driven largely by worries about the Eurozone crisis and a slowing China. The good news in the month’s report was about inventories; Report has indicated that increased numbers of respondents have inventories below one months' supply on hand and this number of respondents has been the highest since last September.

The Company’s Valuation

The company has several competitors in steel space with market cap lie in the range of $1 - $3 billion including SunCoke Energy (NYSE: SXC), Commercial Metals (NYSE: CMC) and Steel Dynamics (NASDAQ: STLD). The following chart summarizes the Expected EPS growth, ROE and Forward P/E of Worthington and its peers:

<table> <tbody> <tr> <td> <p><span>Company</span></p> </td> <td> <p><span>Expected Annual Growth for next 5 years</span></p> </td> <td> <p><span>ROE</span></p> </td> <td> <p><span>Forward P/E</span></p> </td> </tr> <tr> <td> <p><span>Worthington</span></p> </td> <td> <p><span>6.7%</span></p> </td> <td> <p><span>16.67%</span></p> </td> <td> <p><span>9.39</span></p> </td> </tr> <tr> <td> <p><span>SunCoke energy</span></p> </td> <td> <p><span>9.5%</span></p> </td> <td> <p><span>14.57%</span></p> </td> <td> <p><span>12.25</span></p> </td> </tr> <tr> <td> <p><span>Commercial Metals</span></p> </td> <td> <p><span>6.33%</span></p> </td> <td> <p><span>5.67%</span></p> </td> <td> <p><span>9.72</span></p> </td> </tr> <tr> <td> <p><span>Steel Dynamics</span></p> </td> <td> <p><span>9.59%</span></p> </td> <td> <p><span>7.04%</span></p> </td> <td> <p><span>8.42</span></p> </td> </tr> </tbody> </table>

The company discounted valuation seems justified on relative basis as the expected EPS growth is relatively less. Steel Dynamics seems relatively cheap as it is trading at a forward P/E of just 8.42 and expected EPS growth of 9.59% is highest. However, I think Steel Dynamics has been an inconsistent performer in the past which should retract prudent investors to put it on their portfolio. Worthington’s stock performance has closely tracked the company’s ROE over the last several years. The company currently has the highest ROE among its peers which I believe will provide some edge to its valuation in near term.

I believe Worthington currently presents a more balanced risk/reward outlook relative to other steel stocks. Worthington is starting to enjoy the fruits of its labor following several quarters of successful integration and progress with its transformation program. I believe the company is only now beginning to show its true earnings power. Furthermore, I believe this incremental earnings power has been underestimated by the Street and will likely continue to pay dividends not yet in consensus estimates. The company's non-steel processing operations have grown increasingly attractive in recent months as these operations have provided a growing level of earnings support despite the uncertain macro environment. Also, in my view, Worthington will continue to improve profitability via acquisitions and realigned segments. Thus, I recommend buying it.


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