Steel Industry Stock Outlook - December 2017

Steel is not only the world's most important engineering and construction material, but is also utilized in countless products given the metal's combination of high strength and a relatively low production cost. Consequently, it is considered a crucial element of economic growth.

Both advanced and developing economies are exhibiting stronger economic momentum this year, which bodes well for the steel industry. Further, President Trump’s plans for colossal infrastructure spending — one of his key campaign promises — will be a catalyst for American steel makers as it is likely to have a beneficial effect on the U.S. steel industry given the expected increase in steel consumption.

So it is safe to say a lot of hopes rest on the President. Notably, Trump’s aggressive trade policies are also anticipated to provide more protection to the U.S. steel industry. Moreover, the industry continues to benefit from the sustained healthy demand in the automobile and construction sectors.

Steel Production Expands at a Solid Pace

Per the World Steel Association’s (“WSA”) data available til October 2017, global steel production surged a healthy 5.6% to 1410 metric tons (Mt) on a year-over-year basis propelled by higher output across all regions. Steel production in Asia was at 975 Mt in 10 month-period, an increase of 6.0% year over year. North America’s crude steel production registered a 4.1% rise to 96.5 Mt while the EU produced 140.8 Mt of crude steel, rising 3.7% year over year.

Steel production in the C.I.S. was at 85.2 Mt, a 0.4% rise year over year. China, the world’s largest steel maker which accounts for around half of the global production, delivered a 6.1% rise in steel production during the first 10 months of the year.

Concerns about China’s slowdown had dealt a massive blow to the global steel industry over the last couple years, with overcapacity and lower steel prices denting the margins of Chinese steel producers. Efforts have been undertaken to reduce overcapacity and upgrade production in China's steel industry to negate these factors.

To mitigate the impact of rebalancing, the Chinese government issued a number of mini stimulus measures. This led to a short-term boom in infrastructure investment and the housing market, working in favor of the steel industry. Consequently, China’s steel demand grew 1.3% in 2016 and the industry continues to witness strong steel demand so far in 2017.

The country’s steel exports slumped 31% for the first 11 months of 2017, per data released by the General Administration of Customs. Notably, November marks the 15th consecutive month in which Chinese steel exports have registered a yearly decline. Positive rulings in trade cases (resulting in levy of heavy tariffs) against China is contributing to a decline in Chinese steel exports.

Further, China’s actions to reduce excess steel supply are also expected to lend support to steel prices in 2017. The world’s largest steel producer has pledged to cut steel production capacity by around 50 million Mt in 2017 to tackle pollution and curb excess supply.

Cheap Imports Continue to Hinder Growth

U.S. steel mills remain impacted by depressed capacity utilization and a surge of unfairly traded imports. The domestic market continues to be inundated with cheap imports from overseas producers, especially China. According to a recent report from the American Iron and Steel Institute (AISI), total and finished steel imports for the first 10 months of 2017 shot up 19.4% and 15.4% year over year, respectively. Year to date, finished steel import market share is estimated at 28%.

American steel makers including Nucor Corp. (NUE), United States Steel Corp. (X), AK Steel Holding Corp. (AKS), Steel Dynamics Inc. (STLD) and ArcelorMittal USA, a part of ArcelorMittal (MT), have been bearing the brunt of high levels of cheap imports. This has resulted in declining orders, idling of mills and layoffs across the board. Consequently, U.S. steel makers continue to actively press the U.S. regulators to stop unfair trade practices and enforce new trade laws to rescue the crisis-hit American steel industry.

Industry Positioning – Mixed Bag

The Zacks Industry Rank relies on the same estimate revisions methodology that drives the Zacks Rank for stocks. The way to look at the complete list of industries is that, we put our X industries (all 265 of them) into two groups: the top half (i.e., industries with the best average Zacks Rank) and the bottom half (the industries with the worst average Zacks Rank).

In the last 10 years, using a one week rebalance, the top half beat the bottom half by a factor of more than 2 to 1. Click here to know more: About Zacks Industry Rank

Within the Zacks Industry classification, the Steel producers, Steel-pipe and tube and Steel specialty industries are grouped under the Basic Materials sector (one of 16 Zacks sectors). The steel specialty and steel-pipe and tube and industry, with a Zacks Industry Rank of #53 and #111, respectively, remain in the top half. However, the Steel producers industry occupies a space in the bottom half of the Zacks classified industries with a Rank of #183.

Sector Level Earnings Trend — Positive

Per the Zacks Industry classification, the steel industries are grouped under the broader Basic Materials sector. Earnings from the sector participants on the S&P 500 Index increased 2.6% in the third quarter. Per our projections, earnings for the Basic Materials sector are anticipated to surge 27.3% in the fourth quarter of 2017. For full year 2017, the sector is expected to log impressive growth in earnings of 22.5%. In 2018, earnings growth will remain strong with projections of 16.5%.

Mixed Performance

The Steel Specialty industry’s rise of 27.9% in the past year has outperformed the S&P 500’s gain of 18.3% in the past year. However, both the Steel Producers industry and steel-pipe and tube industries have underperformed the S&P 500 with a 9.4% gain and 9.1% dip, respectively.

What Lies Ahead?

The WSA forecasts global steel demand to expand 7% in 2017. Steel consumption in China is expected to go up 12.4% this year as closure of most of its outdated induction furnaces are expected to lead to a jump in steel use. Global steel demand barring China is projected to rise 2.6% in 2017.

A cyclical upturn in steel demand this year has been backed by strong economic momentum across advanced and developing economies. The U.S. economy is exhibiting strong fundamentals on the back of improving business confidence as well as improved consumer spending. Steel demand in the United States is expected to rise 4.8% this year.

Moreover, Eurozone’s economic recovery continues apace, as evident from recent upbeat economic data. The region’s recovery is backed by declining unemployment along with strengthening business and consumer confidence. The WSA sees steel demand in the European Union to go up 2.5% in 2017. This augurs well for companies like ArcelorMittal, which generates almost half of revenues from this region. United States Steel also has a significant presence in Europe.

Demand in emerging and developing economies (barring China) is also expected to rise 2.8% this year. Developing economies are gaining from an upturn in the world economy and economic reforms across several countries including India and Brazil.

Steel demand in Japan is on the rise aided by government stimulus package, improving exports and preparations for the 2020 Olympic games. India is anticipated to act as the next growth engine, given its progressing construction and manufacturing sectors along with rapid urbanization and structural reforms.

Meanwhile, the automotive and construction industries will continue to be the mainstays of the steel industry. Projection of earnings growth, favorable Zacks Rank also instills investor confidence in the space.

Some Stocks in Focus

Despite a low ranking now, earnings growth expectation going forward instills optimism for the industry. Investors can consider the following steel stocks that are backed by a solid Zacks Rank and healthy growth projections.

Carpenter Technology Corp. (CRS) can be a solid addition to one’s portfolio. The stock currently sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Carpenter Technology has an expected earnings growth of 107.78% for fiscal 2018 and 27.67% for fiscal 2019.

We also recommend stocks such as POSCO (PKX) and SSAB AB (SSAAY), both carrying a Zacks Rank #2 (Buy).

POSCO has an expected long-term EPS growth rate of 5%. It has an expected earnings growth rate of 134.76% for the current fiscal and 5.73% for the next. SSAB AB has a projected earnings growth rate of 133.33% for 2017 and 28.57% for 2018.

However, we suggest staying away from or getting rid of Zacks Rank #5 (Strong Sell) stocks such as Thyssenkrupp AG (DE:TKAG) (TYEKF) and Universal Stainless & Alloy Products, Inc. (USAP). Both stocks have been witnessing downward estimate revisions lately.