Executive Summary / Key Takeaways

• Worthington Steel (WS) is transforming from a traditional carbon flat-rolled steel processor into a high-value, technology-driven partner, strategically focusing on the rapidly growing electrical steel and tailor welded blank markets.
• Recent financial performance reflects market headwinds, including lower volumes and unfavorable steel price dynamics leading to inventory holding losses, particularly impacting Q3 FY2025 results ($13.8M net earnings attributable to controlling interest, $0.27 EPS).
• Despite near-term uncertainty, significant capital investments in electrical steel expansions in Mexico and Canada are on track, with substantial capacity already secured by customer commitments, signaling strong future growth potential in high-margin areas.
• The company's differentiated technology, such as licensed ablation for tailor welded blanks and expertise in electrical steel laminations, provides a competitive moat, enabling price differentiation and access to new, higher-value automotive and infrastructure applications.
• Management is cautiously optimistic for the second half of calendar year 2025, anticipating market recovery driven by potential macroeconomic improvements and the ramp-up of new automotive programs, while actively mitigating risks through continuous operational transformation and disciplined capital allocation.

Setting the Scene: A Value-Added Steel Processor's Foundation

Worthington Steel, Inc. (WS) stands as a prominent value-added metals processor in North America, tracing its roots back nearly 70 years to the foundational principles established by John H. McConnell. For decades, the company operated as the steel processing arm of Worthington Enterprises, Inc., building extensive capabilities in transforming flat-rolled steel. A pivotal moment arrived on December 1, 2023, with the completion of its spin-off into a standalone, publicly traded entity. This separation sharpened the company's focus, allowing for dedicated strategic execution within the dynamic steel processing landscape.

WS operates primarily within a single reportable segment, but its business model is multifaceted, encompassing both direct sales, where it manages material ownership risk, and toll processing, providing fee-based services on customer-owned steel. This operational flexibility allows the company to adapt to varying demand dynamics. The core of its offering lies in processing steel to precise customer specifications, serving a diverse array of end markets including automotive, construction, heavy truck, agriculture, and energy.

The company's strategic direction is now clearly defined by three pillars: focused investments in the high-growth electrical steel market, pursuing margin-accretive growth through disciplined capital expenditures and selective acquisitions, and leveraging "transformation," its system of continuous improvement, to enhance operational efficiency and reduce costs. This strategy aims to elevate WS beyond traditional commodity processing, positioning it as a preferred partner delivering highly technical, customized solutions.

Technological Differentiation and Innovation

At the heart of Worthington Steel's strategy is its commitment to technological differentiation, particularly in specialized areas like tailor welded blanks and electrical steel laminations. These capabilities represent a significant competitive moat, enabling the company to offer solutions that provide tangible benefits to customers and command higher margins.

In the realm of tailor welded blanks (TWB), WS utilizes advanced processes, including newly licensed ablation technology. This technology is a key differentiator, allowing the company to process a wider range of automotive applications, such as pillars, rails, cross car beams, and door rings. Management estimates this technology opens up new product opportunities within the existing welded blank market by approximately 30%. The tangible benefits for automotive manufacturers include critical weight reduction, improved crash performance, and optimized material utilization – factors of increasing importance in vehicle design. The equipment for this technology is currently being installed and tested, with customer interest and orders already being received.

The electrical steel market represents a core strategic focus and a significant growth driver. WS, through its Tempel operations and recent strategic moves, is a global producer of electrical steel laminations used in electric motors (for automotive and industrial applications) and transformer cores. This market is experiencing robust growth, fueled by global electrification trends, the surge in electric and hybrid vehicles, and the critical need to modernize and expand electrical infrastructure to support demands from areas like AI and data centers. Management highlights a substantial 2-year backlog for transformers and projects the need for power to grow at over 6% per year for the next 15 years, directly driving demand for their products. WS is well-positioned to capitalize on the shift to hybrids, supplying specialty steel for transmissions and laminations for traction motors.

The company is actively investing in expanding its electrical steel capacity. In Mexico, where it produces laminations for industrial motors and electrified vehicles, the first five new presses have been installed and are undergoing testing, with production expected to begin late in calendar year 2025. The company intends to install approximately 10 presses in this facility and has already secured enough orders to fill three of the initial five presses at full production. In Canada, the expansion project focuses on transformer cores, with construction progressing towards operational readiness by early calendar year 2026. Impressively, WS has already secured enough new business to fill 50% of this planned new capacity, demonstrating strong customer demand ahead of commissioning.

Further strengthening its position, WS is acquiring a controlling stake (52%) in Sitem Group, a leading European electrical steel lamination manufacturer, with closing expected in early fiscal 2026. This acquisition is strategic, not only expanding WS's European footprint but also providing access to Sitem's world-class tool and die making capabilities and expertise in press automation, which WS plans to leverage across its global electrical steel plants.

The "so what" for investors is clear: these technological capabilities and strategic investments are positioning WS in higher-margin, faster-growing segments compared to traditional flat-rolled steel processing. The ability to offer differentiated, value-added solutions allows for greater pricing power and less exposure to the volatile commodity steel market, contributing to a stronger competitive moat and enhancing long-term profitability and growth prospects.

Competitive Landscape and Market Positioning

The steel processing industry is characterized by fragmentation and intense competition, with players vying for market share based primarily on price, product quality, and delivery capabilities. Worthington Steel operates within this environment, competing with a range of players from large integrated steel mills with processing arms to smaller, specialized processors. Key publicly traded competitors in the broader steel and processing space include Nucor (NUE), Steel Dynamics (STLD), Cleveland-Cliffs (CLF), and U.S. Steel (X).

While these larger players often benefit from scale and integrated production (particularly EAF-based producers like NUE and STLD known for cost efficiency), WS differentiates itself through its focus on value-added processing and technical expertise. Unlike mills primarily selling standard steel products, WS specializes in transforming steel into highly customized components. This focus on technical solutions and customer-specified requirements allows WS to carve out a distinct position, particularly in demanding sectors like automotive and specialized construction.

WS's competitive advantage is rooted in its processing capabilities and technological offerings like tailor welded blanks and electrical steel laminations. These are areas where its specialized know-how and investment in advanced equipment provide an edge over competitors who may lack these specific capabilities or the same depth of expertise. For instance, the ability to produce complex tailor welded blanks using ablation technology allows WS to serve applications that competitors might not, enabling price differentiation even when base steel prices are low, as evidenced by TWB's ability to raise prices to recover costs in Q1 FY2025 despite dipping HRC prices.

In the electrical steel market, while some integrated mills like Cleveland-Cliffs (CLF) are involved in electrical steel production and even moving into transformer manufacturing, WS's focus remains on being the expert in laminations and cores. Management views potential moves by mills into downstream areas not as a disruption, but as a validation of market growth, emphasizing that their strength lies in partnering with transformer manufacturers who are the experts in their field. This partnership approach, coupled with strategic expansions and acquisitions like Sitem, positions WS to capture growth in this specialized, high-margin segment globally.

Customer relationships, particularly with major automotive OEMs like the Detroit Three (representing 32% of net sales year-to-date FY2025), are critical. WS's ability to consistently meet demanding quality and delivery standards, as recognized by awards from customers like General Motors (GM) and John Deere (DE), reinforces its position as a trusted partner. While larger mills compete on scale and cost, WS competes on value, technical solutions, and reliability, aiming to be the preferred value-added processor.

However, WS is not immune to competitive pressures. The fragmented nature of the industry means competition on price remains a factor, and larger competitors' scale can offer cost advantages in certain product areas. Furthermore, the cyclicality of end markets impacts demand for all players. WS's strategy of focusing on high-value niches and leveraging technology is a direct response to these dynamics, aiming to mitigate the impact of commodity price volatility and differentiate itself from more commoditized offerings.

Financial Performance: Recent Trends and Drivers

Worthington Steel's recent financial performance reflects the interplay of its strategic initiatives, market dynamics, and the inherent volatility of the steel industry. For the nine months ended February 28, 2025, net sales totaled $2,260.4 million, a decrease of $259.2 million or 10.3% compared to the prior year period ($2,519.6 million). This decline was primarily driven by lower volumes (direct tons down 5%, toll tons down 6%) and lower direct selling prices (down 6%).

Gross margin for the nine months ended February 28, 2025, was $261.6 million (11.6% of net sales), down $47.2 million from $308.8 million (12.3% of net sales) in the prior year period. This decrease was mainly attributable to lower direct volume, which unfavorably impacted gross margin by an estimated $34.6 million, and unfavorable direct spreads. Direct spreads were significantly impacted by estimated inventory holding losses of $31.2 million in the current year period, compared to zero estimated losses in the prior year period, representing a $31.2 million unfavorable swing.

Operating income for the nine months ended February 28, 2025, was $80.6 million, a decrease of $46.6 million from $127.2 million in the prior year period. Beyond the gross margin impact, selling, general, and administrative (SGA) expenses increased by $12.0 million to $172.7 million. This rise was attributed to higher wage and benefit costs, incremental costs associated with operating as a standalone public company, a $2.5 million increase in bad debt expenses, and $3.3 million in professional fees related to the Sitem Group Transaction. Impairment of assets also contributed $7.4 million in the current year period, including a $1.3 million write-off of an in-process R&D intangible and a $6.1 million charge related to the WSCP Cleveland facility consolidation. Restructuring expense added $0.9 million from the TWB voluntary retirement program. Notably, Separation costs, which totaled $19.5 million in the prior year period, were zero in the current period following the spin-off finalization.

Equity in net income of unconsolidated affiliate, primarily from Serviacero Worthington, decreased significantly to $0.4 million for the nine months ended February 28, 2025, down $15.3 million from $15.7 million in the prior year period. This decline was driven by lower volume, lower direct spreads (affected by inventory holding gains in the prior year not realized in the current period), and unfavorable foreign currency exchange impacts from the Mexican peso.

Net earnings attributable to controlling interest for the nine months ended February 28, 2025, were $55.0 million ($1.09 per diluted share), compared to $101.5 million ($2.05 per diluted share) in the prior year period. The effective income tax rate for the nine months ended February 28, 2025, was 18.7%, lower than the 21.9% in the prior year period, primarily due to a $4.4 million net tax benefit related to pre-acquisition matters at Tempel.

Liquidity remains a key focus post-separation. The company's primary sources of liquidity include cash balances, operating cash flows, and access to its $550 million senior secured revolving credit facility. As of February 28, 2025, cash and cash equivalents stood at $63.3 million. Outstanding borrowings under the Credit Facility were $110.0 million, resulting in net debt of $49.0 million. The available borrowing capacity under the Credit Facility was $217.1 million.

Cash flow from operations was robust, providing $176.4 million for the nine months ended February 28, 2025, up from $163.9 million in the prior year period. This improvement was largely driven by a $48.7 million increase in cash from net operating working capital accounts, benefiting from the reduction in average steel prices, and $12.8 million in distributions received from Serviacero Worthington. Investing activities used $83.8 million, primarily for capital expenditures totaling $84.9 million, reflecting the significant investments in the electrical steel expansions in Mexico and Canada. Financing activities used $69.5 million, including $23.9 million in dividends paid to shareholders. The company declared a quarterly cash dividend of $0.16 per common share payable in June 2025.

The financial performance in the most recent periods highlights the sensitivity to steel price volatility (inventory impacts) and end-market demand fluctuations (volume impacts), alongside the costs associated with strategic growth initiatives (CapEx, M&A fees, standalone costs). Despite these pressures, the company's operating cash flow generation and balance sheet position appear adequate to support its ongoing operations and strategic investments.

Strategic Growth and Future Outlook

Worthington Steel's outlook is anchored in its strategic pillars, particularly the expansion into high-growth electrical steel markets and the application of continuous improvement. Management expresses cautious optimism for the near term, acknowledging ongoing market uncertainty, but is more optimistic about the second half of calendar year 2025 as clarity is expected to improve.

A key driver of this optimism is the anticipated recovery in core end markets. While North American vehicle production forecasts for calendar year 2025 suggest a relatively flat year at around 15.3 million units, management sees potential upside from lower interest rates and inflation. Crucially, they expect a significant Detroit Three OEM customer, whose production cuts impacted recent volumes, to return to a more normal build schedule later in the calendar year. Furthermore, WS's commercial teams have successfully secured new automotive programs and increased market share, which are expected to ramp up over the next several quarters, contributing positively to future volumes.

The construction market is viewed as a tale of two halves in calendar 2025, with flatness expected in the first half followed by momentum building in the second half, benefiting from potential interest rate cuts. The heavy truck market, though currently slow, is showing signs of improvement and is expected to exhibit GDP-type growth for the rest of calendar year 2025, potentially accelerating into 2026 due to regulatory requirements. The agriculture market, however, is expected to remain soft for a while.

Execution of the electrical steel strategy remains central to the growth narrative. The expansions in Mexico and Canada are progressing on schedule, with production expected to commence in late calendar 2025 and early calendar 2026, respectively. The significant portion of new capacity already secured by customer commitments underscores the strong market demand validating these investments. The pending Sitem acquisition in Europe is also expected to close in early fiscal 2026, further solidifying WS's global footprint in this high-margin area.

Financially, the company anticipates estimated inventory holding gains of approximately $20 million to $25 million pre-tax in the fourth quarter of fiscal 2025, a direct benefit from the recent increase in hot-rolled coil prices driven partly by tariffs. This highlights the potential for positive impacts from market price movements, although volatility remains a risk.

Capital expenditures for fiscal year 2025 are projected to be approximately $125 million, an increase from previous estimates, reflecting accelerated spending on the Canada expansion, the addition of a new press in China to support new business, and upgrades to IT systems (ERP, shop floor, data warehouse) at Tempel to enhance future process improvements through transformation. Estimated annual maintenance capital needs are between $35 million and $40 million.

The "transformation" initiative is an ongoing process aimed at driving continuous improvement across operations and corporate functions. Examples shared, such as significant reductions in payroll process time (80%), PC distribution time (15%), and IT contractor hiring tasks (30%), demonstrate the potential for efficiency gains, cost savings, and improved workflow, which are expected to contribute to the bottom line over time.

Overall, the outlook is one of strategic investment and operational optimization aimed at capitalizing on anticipated market improvements and the long-term growth trends in electrical steel, while leveraging differentiated technology and continuous improvement to enhance profitability and shareholder value.

Risks and Considerations

While Worthington Steel is strategically positioned for growth, several risks and challenges could impact its performance and the realization of its investment thesis.

A primary risk is the inherent cyclicality and volatility of the steel industry and its raw material prices. Fluctuations in the price of flat-rolled steel, particularly hot-rolled coil, directly impact the company's material costs and selling prices. While WS employs derivative instruments to manage some price risk, significant swings can lead to substantial inventory holding gains or losses, as seen in recent quarters, impacting gross margins. The consolidation among steel suppliers could also pose risks to raw material availability and pricing.

End-market demand fluctuations are another significant factor. The automotive industry, being the largest end market, is sensitive to macroeconomic conditions, interest rates, and consumer spending. Unexpected production cuts by key customers, as experienced in Q2 and Q3 FY2025, can directly and negatively impact volumes and profitability, particularly affecting the absorption of fixed costs. Demand in other markets like construction, heavy truck, and agriculture is also subject to economic cycles and specific industry dynamics.

Execution risk is associated with the company's strategic growth initiatives. Successfully completing and ramping up production at the electrical steel expansions in Mexico and Canada on time and on budget is critical. Integrating the acquired Sitem Group and realizing expected synergies also presents execution challenges. Failure to achieve planned operational efficiencies or secure anticipated volumes for the new capacity could impact future financial performance.

Foreign currency exchange rate fluctuations pose risks, particularly for operations in Canada, Mexico, China, India, and Germany. Changes in exchange rates can impact reported earnings and cash flows through both translation and transaction exposures. Devaluation of foreign currencies can be particularly challenging if price increases cannot fully offset the impact.

Financial difficulties or bankruptcy filings of customers, suppliers, or joint venture partners, although managed through credit monitoring, remain a potential risk that could lead to bad debt expenses or supply chain disruptions.

Tariffs and trade restrictions can impact raw material costs, import competition, and export markets. While management anticipates minimal direct impact on its localized sourcing strategy, reciprocal tariffs or broader trade conflicts could introduce uncertainty and affect end-market demand or supply chain stability.

Other risks include potential disruptions to operations from adverse weather, equipment failures, labor shortages, or civil unrest, as well as risks related to cybersecurity breaches, changes in environmental regulations, and shifts in healthcare or tax laws.

These risks highlight the importance of the company's operational flexibility, risk management strategies, and the successful execution of its transformation initiatives to mitigate potential negative impacts and navigate the dynamic market environment.

Conclusion

Worthington Steel is navigating a pivotal period, leveraging its nearly 70-year history and recent spin-off to sharpen its focus as a differentiated, value-added metals processor. While recent financial results have been impacted by challenging market conditions, including volatile steel prices and fluctuating end-market demand, the underlying narrative is one of strategic transformation towards higher-growth, higher-margin opportunities.

The core investment thesis rests on WS's ability to capitalize on its technological edge, particularly in tailor welded blanks and the rapidly expanding electrical steel market. Significant capital investments in new capacity in Mexico and Canada, coupled with strategic acquisitions like Sitem, underscore a clear commitment to these high-value segments, which are poised for growth driven by global electrification and infrastructure needs. The substantial portion of new capacity already secured by customer commitments provides a degree of confidence in the future volume ramp-up.

Despite near-term headwinds and market uncertainty, management's cautious optimism for the latter half of calendar 2025 is grounded in expectations for macroeconomic improvements and the ramp-up of new business. The company's continuous improvement initiatives, or "transformation," are expected to yield ongoing operational efficiencies and cost savings, further supporting profitability.

While risks such as commodity price volatility, demand cyclicality, and execution challenges persist, WS's differentiated product offerings, strong customer relationships, and disciplined approach to capital allocation and operational improvement position it to navigate these challenges. The company's strategic pivot towards specialized, technology-driven solutions provides a compelling path for long-term value creation, distinguishing it within the broader steel industry landscape.