2013 is starting out to be what will likely be a good year for some steelmakers, coming off of last year's tough operating environment for most steel producers worldwide. Last year, there was excess steelmaking capacity and supply in certain regions, and these factors are continuing to impact the industry this year. This particularly impacts steelmakers with operations in the eurozone. Decreased steel prices for most of the year, reduced demand, and higher iron ore prices impacted many producers worldwide. But conditions have changed.
Prospects for growth, and the state of the economy in different countries and regions are impacting local demand for steel. Most importantly, when one compares the prospects for the steel industry in the United States, Europe and China, conclusions can quickly be reached. Prospects for steelmakers with operations in the United States are basically OK, the prospects for China's steelmakers are very good, and the prospects for steelmakers in Europe are dismal.
Ultimately the steel industry is about the financial performance of companies, valuations, and whether a company is overvalued or undervalued, whether a company is a "buy," "hold," or "sell." A quick look at current valuations of some U.S. and Chinese steelmakers enables an investors to quickly make his or her own determination.
The following are P/Es of three steelmakers with U.S. operations:
- ArcellorMittal (MT) is not profitable, but its shares are trading at a forward P/E for the year-ending December 31, 2013 of 21.37.
- Nucor Corp. (NUE) is profitable and its shares are trading at a P/E of 30.45.
- United States Steel (X) is not profitable, but its shares are trading at a forward P/E for the year ending December 31, 2013 of 16.79.
The following are the P/Es of three steelmakers with Chinese operations:
- China Industrial Steel (CDNN.OB) is profitable and its shares are trading at a P/E of 4.63.
- Sutor Technology Group (SUTR) is profitable, and its shares are trading at a P/E of 4.62.
- China Gerui Advanced Materials Group (CHOP) is profitable and its shares are a trading at a P/E of 2.96.
While ArcellorMittal, Nucor and United States Steel are substantially larger companies and have larger stock market capitalizations than their Chinese peers, it's difficult to make the argument that their shares should be trading at a P/E 4 to 5 times higher than the P/Es of Chinese steel producers. When one looks at the lack of profitability of both ArcellorMittal and United States Steel, and their forward P/Es, rather than actual P/Es, it's even more difficult to justify their current share prices and valuations.
Without taking into consideration the growth prospects for China's economy compared to the growth prospects for the U.S. economy, the Chinese steelmakers could be considered to be substantially undervalued.
A Quick Look at Three Steelmakers with U.S. Operations
I recently wrote at Seeking Alpha about ArcelorMittal , the world's largest global steelmaker. The company has significant operations in the United States. But, the global steel industry is fragmented, and ArcelorMittal accounts for only about 6% of global steel volume. Even though the company is considered to be a global producer, the company has substantial U.S. operations. The company posted a loss of over $700 million for the third quarter of 2012, and is facing numerous problems. These include the difficulty of permanently closing European steel mills and dealing with Europe's huge steelmaking overcapacity. ArcelorMittal is also facing a challenge in trying to reduce its substantial debt to regain its investment grade status. It would be hard to see ArcelorMittal as a buying opportunity now. The company doesn't have a current P/E because of its lack of profitability, but its forward P/E for the year ending December 31st of this year is a very aggressive 21.37. But I don't see how ArcelorMittal will achieve anywhere close to that level of profitability this year.
Nucor Corp., the second largest U.S. steel manufacturer, which I also wrote about here at Seeking Alpha, was able to remain profitable, and posted a profit of $110.3 million for the third quarter of 2012. The company's P/E is 30.45.
United States Steel Corp. is an integrated steel producer. The company manufactures a wide range of value-added steel sheet and tubular products for the automotive, appliance, container, industrial machinery, construction, and oil and gas industries. The company doesn't have a current P/E because of its lack of profitability, but its forward P/E for the year ending December 31st of this year is 16.79, which I also view as being very aggressive.
A Quick Look at Three Steelmakers with Chinese Operations
Sutor Technology Group manufactures and distributes finished steel products and welded steel pipes. The Company converts steel manufactured by other companies to finished steel products, including hot-dip galvanized steel, pre-painted galvanized steel, acid-pickled steel, cold-rolled steel and welded steel pipe products. Sutor Technology, for the first quarter of its fiscal 2013 year, the quarter ended September 30, 2012, posted a minimal net income of $1.8 million. The company's P/E is 4.62.
China Industrial Steel produces and sells steel billet, steel plate and steel bar primarily for the domestic Chinese market. The Company has four production lines on approximately 1,000 acres in Handan City in Hebei Province. The company's steel plate, steel wire and steel bar are primarily used in the construction of buildings and in large scale infrastructure projects, including roads and bridges. The company's steel plate is also utilized by the ship building industry, and in the construction of pipelines. An additional company product is steel billet, a semi-finished product, which is utilized as a raw material by other steel manufacturers. China Industrial Steel reported revenues for the first nine months of 2012 of $492 million, and income of $7.9 million. The company's P/E is 4.63.
China Gerui Advanced Materials Group is a value-added, steel processor. The Company produces specialized cold-rolled steel products, which are not standardized, commodity items. Instead, the company manufactures specialized products based on specific customer requirements. The company's customers include companies involved in food and industrial packaging, construction and household materials, electrical appliances, and wire manufacturers for the telecommunications industry. China Gerui Advanced Materials , for the nine months ended September 30, 2012, reported revenue of $202 million, with a net income of $26.67 million. The company's P/E is 2.96.
Prospects for Steelmakers in the United States
Positive factors for steelmakers in the United States include the gradually improvement of the U.S. economy, improvement in residential and commercial construction, and the resolution of the fiscal cliff. The upcoming battles in the U.S. Congress over the federal budget and an increase in the government's borrowing limits are putting the country's economic recovery and growth at risk. These factors also raise concerns regarding the prospects for U.S. steelmakers.
Last year the demand for steel in the United States increased by 8%. In 2013 the U.S. demand for steel will likely increase at an even greater rate. This increased demand will likely have a positive impact for U.S. steelmakers including United States Steel , ArcelorMittal , and Nucor .
Despite a general global steel glut and soft prices globally, prices for steel in the United States started to firm up last month. Factors that led to the increased demand and increased steel prices included the strong U.S. automobile market, some shortages related to mill outages, and increased demand from regions that use steel drilling pipe for oil and gas exploration. The U.S. steel industry will also benefit from a recovery in the construction industry, as U.S. real estate continues to generally improve. With residential construction increasing, a recovery of non-residential construction will likely be beneficial for the steel industry. Historically, the recovery of non-residential construction has lagged the recovery of residential construction by 9 to 12 months.
Iron ore and metallurgical coal prices are likely to decline this year, after last year's run up in prices, which is also beneficial for U.S. steelmakers.
Prospects for Steelmakers in China
Any discussion of the global steel industry quickly brings one to China, a country which accounts for approximately 46% of global steel output. China is also the largest consumer of steel in the world. While the prospects for the U.S. industry are good, the prospects for China's steel industry are even more positive.
China's massive infrastructure stimulus program, which was announced in September of last year, has already had an impact on steel demand and prices. The stimulus program included transportation facilities, highways and ports and is estimated at over $150 billion.
China's economy grew at a 7.9% rate in the fourth quarter of last year, and the country's industrial production increased by 10.3% in December.
The improvement of China's economy is leading to an increased demand for steel, and an increase in steel prices and should be reflected in the bottom line of most Chinese steel producers.
The Market for Steel in the Europe
With European financial and economic problems no longer front page news, there is a general consensus that the euro zone will stay intact. But the euro zone's structural problems remain. These include high levels of unemployment, flat or negative economic growth, and unsustainable levels of government borrowing. All these factors affect Europe's steel industry.
It is estimated that demand for steel in Europe will decrease by up to 4% this year, following a decrease of 3% last year. European steelmaking overcapacity will continue to be a problem, and will haunt steel makers with European operations including AccelorMittal and ThyssenKrupp. There are definitely political issues for steelmakers in Europe. Due to a number of factors, including steel mills being large employers, there will be political and perhaps legal actions by governments to keep steel mills open. This has most recently impacted ArcelorMittal's operations in France.
A fair conclusion is that steelmakers with any European operations should be avoided by investors. This includes ArcelorMittal .
A More In Depth Look at China Industrial Steel
China Industrial Steel (CDNN.OB) produces and sells steel billet, steel plate and steel bar primarily for the domestic Chinese market. The Company has four production lines on approximately 1,000 acres in Handan City in Hebei Province.
The company's steel plate, steel wire and steel bar are primarily used in the construction of buildings and in large scale infrastructure projects, including roads and bridges. Steel plate is also utilized by the ship building industry, and in the construction of pipelines. The Company also manufactures and sells steel billet, a semi-finished product, which is utilized as a raw material by other steel manufacturers. The company also is a major producer of reinforcing bar (rebar), so as construction in China strengthens, China Industrial Steel should be a beneficiary.
China Industrial Steel is definitely a smaller capitalization company, with a stock market capitalization of $56 million. The company has a current P/E of 4.63.
The company's revenues for the first nine months of this year were $475 million, with a net income of $2.8 million. The revenues and net income were substantially down from the comparable period of 2011, reflecting the overall softness of the Chinese economy earlier this year.
As the Chinese economy continues to improve, it's also a possibility that China Industrial Steel returns to, or exceeds its 2011 levels of revenues of $823 million and net income of $45.8 million.
China Industrial Steel can be considered an orphan stock, with minimal trading activity and minimal attention from investors. But, this is likely to change as U.S. investors are able to see an improvement in the company's financial results as the Chinese economy improves, and with it the country's steel industry. As investor attention becomes focused on China Industrial Steel, it's also possible that the company could be a beneficiary of the similar impact on its share price as happened with another Chinese orphan stock I started writing about here at Seeking Alpha in September, Asia Carbon Industries (ACRB.PK). Today Asia Carbon's shares reached a recent high of $.32, up from $.13 a few weeks ago.
Investors should carefully evaluate the risk of investing in United States Steel and ArcellorMittal, as both companies are not profitable, and ArcellorMittal has lost its investment grade status.
Investing in smaller-capitalization companies, as well as investing in companies in emerging markets, including China, is not suitable for all investors, and can be risky. It's important that investors thoroughly perform their own due diligence and analyze the potential risk.
The companies discussed above include major global steel producers. It also includes smaller capitalization companies with Chinese operations. But the Chinese companies, whose shares trade in the U.S. are all U.S. reporting issuers, and subject to the reporting requirements of the U.S. Securities and Exchange Commission, so U.S. transparency and disclosure is available to investors.