Steel: The Measure of Economic Progress
Steel can be rightly termed the basic building block of modern society given its usage in almost every sphere -- ranging from buildings, vehicles, machines or even a tin can that preserves food. The industry’s fortunes are dependent on the growth of its user industries, namely, automobiles, consumer durables and infrastructure. The volume of steel consumed has thus been the barometer for measuring development and economic progress.
Increasing modernization in the 21st century has led to a doubling of global steel production from 851 Mt (million tons) at the turn of the century to 1,607 Mt in 2013. The size notwithstanding, the industry remains relatively fragmented. It is also highly cyclical and intensely competitive.
In the past two years, the continuing Euro-zone problem, economic stagnation or slow growth in developed economies and a cooling of emerging economies took a toll on the industry. Growth in the Chinese economy, which in recent years has been one of the main demand drivers for steel, slowed down. Overcapacity has also been a perennial problem. Stiff competition in the United States from cheaper imports and from domestic producers with new or expanded facilities continues to result in significant oversupply of steel compared to demand.
However, as urban population increases worldwide, so will the need for steel to build skyscrapers and public-transport infrastructure. Emerging economies will also continue to be a major driver of demand due to the huge amount of steel required for urbanization and industrialization. The demand for steel is thus expected to remain strong in the years to come.
Global Production: Up in 2013, Starts 2014 on a Tepid Note
As mentioned above, world crude steel production was 1,607 Mt in 2013, reflecting a 3.5% annual climb, led by increase in Asia and the Middle East that helped counter the declines elsewhere. China was once again the leading producer of steel, contributing a record 48.6% of the global output at 779 Mt, a 7.5% annual rise. Production in Japan, the second largest producer, increased 3% year over year to 111 Mt.
The United States held the third spot, producing 87 Mt of crude steel, which declined 2% annually. India commanded the fourth position with a production of 81 Mt, up 5% year over year. Production in Europe declined 1.8% year over year to 165.6 Mt of crude steel in 2013. Even though production in Europe declined in for the full year, the fourth quarter registered the first positive year-over-year movement since the fourth quarter of 2011.
However, the steel industry sputtered in the New Year with world crude steel production declining 0.4% to 130 Mt in January. China was a drag with a 3.2% decline due to the slowdown in industrial activities during the Chinese Lunar New Year holidays. Japan increased 6.1% while production in India remained flat. Production in the U.S was down 0.5%. Europe outshined the other regions with a 7.3% rise in production, continuing the positive momentum witnessed in the fourth quarter of 2013.
Capacity Utilization Below 80%
The average capacity utilization ratio in 2013 was 78% compared with 76% in 2012. Despite the global rise in supply in 2013, total capacity utilization remained stubbornly below the 80% level throughout the year. The crude steel capacity utilization ratio in Jan 2014 was 74.4%, 2.5 percentage points lower year over year, but up 0.2 percentage points sequentially.
Steel Prices - Drivers & Trends
Steel prices are generally volatile owing to the highly cyclical nature of the global steel industry. Rising raw material prices have a direct impact on steel prices. Furthermore, overcapacity, a glut in cheaper Chinese steel imports, economic conditions and shifts toward other substitutes significantly impact steel prices.
This was what affected steel prices in 2013. The oversupply of steel due to imports from China in the market outstripped demand. Add to this, the situation in Europe and tempering growth in Asia, kept prices in check. The lower steel prices have affected margins of major steelmakers including ArcelorMittal (MT), United States Steel Corp. (X), Nucor Corp. (NUE) and AK Steel Holding Corp. (AKS) for major part of the year.
A sustained downside in steel prices will materially affect the margins of steel companies. We believe that the recovery in pricing momentum will be driven by a reviving economy, stabilization in the Euro-zone and a rebound in construction activity in the developing countries, in particular China, India and South Korea.
Raw Material Trends
The primary inputs for the steel industry are iron ore and coking coal, as well as coke, scrap, alloys and base metal. The industry also uses large volumes of natural gas, electricity and oxygen for its steel manufacturing operations.
The cost of iron ore is crucial as it directly affects the price of steel. Iron ore prices had an overall good run in 2013 thanks to Chinese demand. China is currently the largest producer of steel and consequently the largest consumer of iron ore, accounting for around 60% of the global seaborne market.
Recently, in Feb 2014, iron ore price has fallen below the level of $120 a ton for the first time since July last year. This was triggered by reports that the Chinese government and banks are intending to curb lending to the property market and cut down steel capacity. China's property sector consumes almost 45% of the country’s steel and thus is a key driver of iron ore prices. After a strong spell last year, demand for steel will moderate as the Chinese government targets the real estate sector.
In the next few years, a wave of new supply of iron ore is slated to hit the market as large players such as BHP Billiton Limited (BHP), Vale S.A. (VALE), Rio Tinto plc (RIO) and Fortescue Metals Group Limited (FMG.AX) are going gung ho with their expansion plans to augment iron ore production capacity. Brazil and India will also step up their exports. In case this excess supply is not matched by adequate demand, it will expose the market to the risk of a decline in prices. On top of this, a less bright outlook for China's economy will put iron ore prices under threat. We believe the fate of iron ore prices now mainly hinges on Chinese demand.
Consolidation & Divestitures
Mergers and acquisitions (M&A) have remained an important growth strategy in the steel industry, leading to additional steel capacity, production efficiency and economies of scale. However, consolidation was minimal in the past two years, given the economic uncertainties. Companies focused on conserving cash, shedding unproductive operations, cutting costs and restructuring.
ArcelorMittal, the world's largest steelmaker by volume, sold its 15% stake in iron ore mines in Canada for $1.1 billion to a consortium that included South Korean steelmaker POSCO (PKX) and Taiwan-listed steelmaker China Steel. The divestiture is in line with the company's effort to get rid of production overcapacity in Europe as well as to reduce its debt.
Despite its strategy of growing through acquisitions, ArcelorMittal had suspended M&A activity in 2008 and 2009. After the notable acquisition of Baffinland Iron Mines in 2011, ArcelorMittal resumed acquisitions in Nov 2013 by announcing the acquisition of ThyssenKrupp Steel USA from ThyssenKrupp AG (TYEKF) through a joint venture partnership with Nippon Steel & Sumitomo Metal Corporation (NSSMY). The acquisition will complement ArcelorMittal’s existing operations in the United States and strengthen its product offering.
ThyssenKrupp, one of the top 20 steel producing companies in the world and the biggest steelmaker in Germany, is undergoing a radical restructuring in which it is trying to sell assets to slash debt. The sale of the loss-making Steel Americas business will allow the company to focus on its core Steel Europe and engineering assets.
We expect M&A activity to remain slow in 2014 until prices stabilize and the industry strikes a balance between supply and demand. Going forward, the abatement of the Euro-zone crisis, recovery in the U.S. and Chinese economy will determine the fate of such deals. M&A activity is expected to go up in the Indian steel industry. The country has become the world’s third largest steel consumer and has the prospects to take the second spot.
Q4 Scorecard, Sector-wise
Top and Bottom Line, So Far So Good: We are in the last leg of the fourth quarter earnings season. 92% of the companies in the sector have already reported their financial results. Earnings increased 30% while revenues edged up 1.4%. In fact, the basic materials sector has displayed an upbeat beat ratio (percentage of companies coming out with positive surprises) this quarter.
Major surprises came up during this reporting season, leading to a rekindled interest in the so far faltering steel sector. After incurring losses through the major part of 2013, some notable steel names like United States Steel and AK Steel Holding returned to profit, delivering solid earnings surprises of 203.85% and 80%, respectively.
Projections for 2014 and 2015
Taking into account all the companies yet to report fourth-quarter results, earnings of the Basic Material sector are expected to increase 21.4% in the quarter. For 2014, earnings at the sector are expected to grow at a rate of 1.6% in Q1, then 16.5% in Q2 and 12.4% in Q3. Overall, in 2014, the sector’s earnings are projected to grow 10.5%. In fiscal 2015, the growth will accelerate further to 15.4%.
Industry Ranking: Overall Negative
Within the Zacks Industry classification, the steel industry falls under the broader Basic Materials sector (one of 16 Zacks sectors). We rank all of 260 industries in the 16 Zacks sectors based on the earnings outlook for the constituent companies in each industry. This ranking is available in the Zacks Industry Rank page.
The way to align the ranking and outlook from the complete list of Zacks Industry Rank for the 260+ companies is that the outlook for the top one-third of the list (Zacks Industry Rank of #87 and lower) is positive, while the outlook for the bottom one-third (Zacks Industry Rank #174 and higher) is negative.
The steel producers, steel specialty industry and the steel-pipe and tubes producers are currently in the bottom tier with a respective Zacks Industry Rank #202, #254 and #256. This indicates a bearish outlook for the industry.
Please note that the Zacks Rank for stocks, which are at the core of our Industry Outlook, has an impressive track record, verified by outside auditors, to foretell stock prices, particularly over the short term (1 to 3 months). The rank along with Earnings ESP helps to predict the probability of earnings surprises.
What’s in Store for the Industry?
The overall scenario is expected to improve in 2014. Steel demand will grow in the U.S. on the back of an improving global economy and the strong momentum in the automotive markets. The turnaround in the construction sector will definitely provide a much needed boost to steel.
China's steel usage is however expected to lose steam due to government's ongoing attempt to restructure the economy away from exports and towards domestic consumption. A slowdown in the real estate market and weaker infrastructure investment growth is likely to lead to slower growth in steel demand during 2014.
India on the other hand will pick up pace. Demand in Japan will also increase due to rebuilding activity in the major earthquake affected areas. Tokyo is also gearing up to host the 2020 Olympic Games.
Macroeconomic conditions in the Euro-zone began to stabilize in 2013. The momentum has continued into 2014. After two years of contraction, steel demand is likely to improve thanks to a rise in demand from the automobile sector and recovery in the construction sector.
Overall, with the global economy gradually on the mend and activities picking up in automotive and construction, prospects look bright for the steel industry this year. The World Steel Association expects continued recovery in steel demand in 2014 and projects global steel usage to increase 3.3% in 2014. Improving demand is also expected to perk up steel prices.