Worthington Steel (WS) Q1 FY2027: Interest Eats Half of Adjusted EBIT

Worthington Steel (WS) reported fiscal 2027 first-quarter results for June through August 2026 on October 6, 2026, and its first quarter consolidating Klöckner & Co showed debt costs arriving before cash returns [1][2]. Earlier research on the company asked three questions: whether Klöckner could support consolidated profit, whether the legacy business's gross margin gains came from processing spreads rather than steel prices, and whether working capital release could outrun quarterly interest. This quarter's answers were that Klöckner showed no sign of demand-driven deterioration but was not reported separately, that legacy gross margin growth came mainly from inventory holding gains, and that deleveraging had not yet started [1][2]. Financing costs did not exceed the pro forma level, but cash flow has not turned positive, and the synergy and debt-reduction targets only start counting once the control agreement takes effect.

Worthington Steel is a North American flat-rolled carbon steel processor that processes coils to customer specifications and earns a processing spread, with automakers as its largest customer group; on direct sales it bears steel price risk, while on toll processing it only charges a fee [3]. On June 3, 2026, the company acquired about 62% of German metals distributor Klöckner, which contributed roughly two-thirds of consolidated sales this quarter [1].

Change 1: Interest absorbed about half of adjusted EBIT

Net interest expense was $38.8 million in the quarter, compared with $2.9 million a year earlier [1]. Adjusted EBIT rose to $78.5 million, yet adjusted EPS fell from $0.77 to $0.57, which management attributed to higher interest after the acquisition [1][2]. After acquisition expenses and the remeasurement loss on previously held shares, net loss from continuing operations attributable to the company was $7.0 million [1].

The interest level itself did not exceed pro forma expectations. Excluding a $1.6 million charge for unamortized costs of the former credit facility, interest was about $37.2 million, below the pro forma quarterly average of about $40.3 million [1][4]. Total debt of $2,196.4 million at quarter end was below the pro forma figure of about $2,356 million, but this mainly reflects the financing structure and the replacement of existing debt, not repayment from operating cash [1][5].

Change 2: Working capital kept absorbing cash

Operating cash flow was −$6.0 million in the quarter, capital spending was $63.0 million and free cash flow was −$69.0 million [1]. Receivables, inventories and payables together absorbed a net of about $54.6 million [1]. Management did not give a specific attribution, but noted that steel prices remained high at quarter end and supply stayed tight, which is consistent with working capital absorbing cash while prices rise [2]. The prior-year quarter was also −$6.3 million, so part of the negative figure is seasonal [1].

The sources of debt reduction have not yet contributed cash. Net debt was $1,948.2 million at quarter end, and the company will report a leverage ratio only once it has a full year of Klöckner results [1][2]. The company targets net leverage below 2.5x within 24 months after the DPLTA (domination and profit and loss transfer agreement) becomes effective, along with about $150 million of additional working capital reductions [6].

Update: Klöckner profit is not reported separately, and synergies start later

Klöckner was consolidated for about 90 days and contributed $1,772.7 million of net sales, with its gross margin reduced by an approximately $43 million inventory fair value step-up [1]. That step-up is a one-time cost created by acquisition accounting, and the company also declined to provide segment data [2]. Based on the difference between consolidated and legacy adjusted EBITDA, Klöckner contributed about $35.9 million, or about $78.9 million after adding back the step-up, but this basis cannot be reconciled with Klöckner's past euro-denominated figures [1].

The synergy target is unchanged, but its delivery starts later. About half of the roughly $150 million of annual EBITDA synergies is expected in the first full year after the DPLTA becomes effective, with about $50 million of one-time costs in the first 12 months [2][6]. The DPLTA requires approval at the October 23 shareholder meeting and registration, and cannot become effective before January 1, 2027 [1][6].

Update: Legacy gross margin growth came from inventory gains

Legacy Worthington Steel net sales were $953.9 million, up 9% year over year, and direct tons rose 3% [1]. Gross margin increased by only $2.0 million: volume added $7.6 million, inventory holding gains rose from $5.6 million to $12.1 million, pricing was −$0.2 million and manufacturing expenses rose $11.1 million [1]. Those holding gains reverse when steel prices fall, and excluding them, legacy gross margin fell by about $4.5 million year over year. Management said the spread of about $200 per ton will only show up from the January contract season, and it expects second-quarter inventory holding gains of $10 million to $15 million [2].

Conclusion

The quarter shows that the acquisition expanded the growth base, while profit conversion and cash generation are temporarily lagging debt costs; inventory gains could also reverse if steel prices fall [1][2]. The second quarter is the first full consolidated quarter, and whether operating cash flow turns positive, net debt declines and the DPLTA takes effect on schedule will determine whether the deleveraging view improves or weakens further.

Sources

[1] WS 8-K filed 2026-10-07 · Q1 FY2027 results release (Exhibit 99.1), 2026-10-06, Worthington Steel earnings release, https://www.sec.gov/Archives/edgar/data/1968487/000196848726000032/ws-ex99_1.htm [2] WS Q1 FY2027 earnings call 2026-10-07, 2026-10-07, earnings call transcript, https://ir.worthingtonsteel.com [3] WS 10-K filed 2026-07-30 · business description and customers, 2026-07-30, Worthington Steel annual report, https://www.sec.gov/Archives/edgar/data/1968487/000196848726000026/ws-20260531.htm [4] WS 8-K/A filed 2026-08-19 · pro forma combined statement of earnings, nine months ended February 28, 2026, 2026-08-19, Worthington Steel pro forma combined financial information, https://www.sec.gov/Archives/edgar/data/1968487/000119312526356964/d417231dex992.htm [5] WS 8-K/A filed 2026-08-19 · pro forma combined balance sheet, 2026-08-19, Worthington Steel pro forma combined financial information, https://www.sec.gov/Archives/edgar/data/1968487/000119312526356964/d417231dex992.htm [6] WS 8-K filed 2026-10-07 · Q1 FY2027 investor presentation (Exhibit 99.2), 2026-10-06, Worthington Steel investor presentation, https://www.sec.gov/Archives/edgar/data/1968487/000196848726000032/ws-ex99_2.htm