BMO reiterates Reliance Steel stock rating on defense contracts

AMI Metals (a Reliance Steel subsidiary) won U.S. government contracts totaling up to $2.9B, which BMO estimates could boost 2027 EBITDA by ~4–5% (LTM EBITDA $1.33B). Reliance beat Q4 2025 estimates with EPS $2.96 vs $2.80 and revenue $3.5B vs $3.43B. Despite the contract and earnings beat, JPMorgan downgraded to Neutral (PT $330) and BMO downgraded to Market Perform (PT $320) citing margin pressure and higher-than-expected expenses, tempering near-term upside.

Analysis

A shift in a supplier's revenue mix toward aerospace/defense creates a two‑tier effect: higher reported margins at the contract level but a contemporaneous rise in working capital, QA/certification costs and program management overhead. Expect the P&L improvement to phase in unevenly — gross margin can move sooner than free cash flow because inventory build and billing cadence lag contractual awards.

Competitors focused on commodity steel volumes are the implicit losers: customers with higher certification requirements will consolidate around trusted, qualified vendors, compressing available high‑margin TAM for undifferentiated mills. Conversely, prime contractors benefit from lower supply‑chain execution risk, but that reduces their optionality to drive down supplier pricing over time, which could blunt their margin tailwind on long programs.

Key near‑term catalysts are program flow schedules, pricing pass‑through mechanics and any disclosure around warranty/indemnity terms — each will re‑rate earnings quality on a 1–4 quarter cadence. The largest tail risk is political or legal reversal that converts option volumes to write‑offs; consider that optionality gives upside but caps visibility, making volatility the primary market inefficiency to exploit.

Key Decisions for Investors

• Long RS (size 2–4% portfolio) with a hedged collar: buy shares and purchase 9‑month 10% OTM puts financed by selling 3‑month 5% OTM calls. Timeframe 12–18 months. R/R: captures multi‑quarter margin re‑rating while limiting downside from adverse contract timing or expense surprises.
• Buy a defined‑risk options spread on RS: purchase a 12‑18 month ATM call and sell a 25–35% OTM call to fund cost (calendar/vertical spread). Timeframe 12–24 months. R/R: asymmetric upside if optional volumes convert, limited premium paid if consensus remains cautious on margins.
• Pair trade to isolate mix premium: long RS / short STLD (equal notional) for 6–12 months to capture premium for defense/aerospace certification exposure versus commodity steel cyclicality. Timeframe 6–12 months. R/R: long captures contract conversion; short cushions commodity demand softening risk.
• Tactical LMT idea: if geopolitical headlines continue to cool, sell short‑dated defense vol (e.g., short 1–3 month LMT calls) and use proceeds to buy 9–12 month LMT calls on dips. Timeframe 3–12 months. R/R: collects premium from headline volatility while keeping longer‑dated upside exposure to sustained defense budget realism.