The steel industry in the United States has been singled out as a bright spot in the global steel industry, with U.S. Steel Corp. (NYSE:X), Nucor Corp. (NYSE:NUE) and AK Steel Holding Corp. (NYSE:AKS) being key beneficiaries. I've written extensively here at Seeking Alpha about two of these companies, U.S. Steel and Nucor.
ArcelorMittal (NYSE:MT), as the world's largest global steelmaker, also has significant U.S. operations. I've written about ArcelorMittal as well. The company is continuing to face significant challenges with its European operations, with its high level of debt and its credit downgrade.
None of these four U.S. steelmakers, Nucor, U.S. Steel, AK Steel and ArcelorMittal have benefited from the recent run-up of the U.S. equity markets to record highs.
The future of steelmakers with major European operations is bleak. But compared to the European steel industry, the prospects for steelmakers with U.S. operations is promising. But, as I've stated here at Seeking Alpha, neither steelmakers in the U.S., nor Europe come anywhere close to the prospects for Chinese steelmakers.
The Steel Industry is Ultimately All About Economic Growth, Which Brings Us to China
The real future of the global steel industry is all about China, and this is the reason that I'm bullish on the future for Chinese steelmakers.
Steel is a basic building block of a country's economy. The construction and auto industries are big users of steel. The development of a country's infrastructure, and the building of port facilities and transportation systems are also big users of steel.
I like to use a basic approach in evaluating the prospects for steel demand within a country, or in the case of Europe, for the euro zone. If a country's economy is growing, there will likely be an increasing demand for steel. If a country has negative economic growth, as is the case with many European economies, or low economic growth, as is the case in the U.S., the demand for steel will be low.
My conclusion is that China will be engine of the world's global economic growth for at least the rest of the decade. This leads me to be positive as to the outlook for China's steelmakers. For me, current and future growth metrics make a compelling bullish argument for investing in China's steel industry.
The Chinese government has indicated that its economy will grow at a rate of 7.5% this year. But, some economists, including those at DBS Bank, are projecting growth at 9%. My own projections are that China will finish 2013 somewhere in between the two estimates, in an amount slightly in excess of 8%. In recent years China's economy has outperformed the country's official growth projections, which leads credence to my estimates as well as those of DBS.
But regardless of whether China's growth is 7.5%, 9% or somewhere in between, China's economy will grow at a significantly faster rate than that of the euro zone or the United States.
The euro zone contracted .6% during the fourth quarter of last year, and a consensus of economists is that its economy will contract .3% for the first quarter of this year. What's important to realize is that these projections were made before the Cyprus financial crisis. It's likely that fallout from the Cyprus crisis will negatively impact euro zone growth, contributing to the region's negative growth. It is estimated that demand for steel in Europe will decrease by up to 4% this year, following a decrease of 3% last year. Negative growth is bearish for steelmakers with significant euro operations.
While the prospects for steelmakers in the U.S. are considerably better than those with European operations, prospects for America's producers significantly less than that for China's. Despite a recovering housing market in certain U.S. geographical markets, the U.S. stock market reaching recent new highs, and increased consumer confidence, the U.S economy has not substantially improved. It was recently leaked that the International Monetary Fund (NYSE:IMF) will soon be decreasing its growth rate for the U.S. for this year to 1.7%, down from its previous projection of 2%. This growth estimate is not at all bullish for U.S. steelmakers.
China and Its Steel Industry
When evaluating investment opportunities, my recent modus operandi has been that China will be the engine of global growth for at least the remainder of this decade. Despite what I view as bumps in the road over the past year or so, I am convinced that China's growth is on the rise. This can be seen from the country's stunning economic growth, even since the Global Financial Crisis of 2008. It can also be seen in the rising standard of living in major Chinese cities, the growing consumer economy, and massive infrastructure modernization programs.
With China's continuing fast pace of growth, the upside for investors is also potentially huge. But there are issues in China investing. These include the country's environmental issues, issues regarding disparity of wealth and income, high levels of corruption and the lingering effects on the country's economy from the Global Financial Crisis. But, since the 2008 crisis, I've been impressed with the Chinese government's ability to take action, respond and react to problems and challenges as they occur.
China's steel industry has recently reached a new high level of production. In February, China's output of crude steel rose 9.8% to 2.21 million metric tons, on a daily average basis. This was a significant increase from the previous record of 2.5 million tons set in January, and also substantially up from the 1.86 million tons produced in December.
This increased demand for steel in China was a confirmation of increased growth in industries that consume steel, including real estate development and automobiles. China's National Bureau of Statistics indicated that the county's investment in fixed assets, including factories, real estate and infrastructure rose 21.2% in January and February, compared to a year earlier. The Chinese Association of Automobile Manufacturers also reported that China's auto market, a big user of steel, started the year with January automobile sales of 2,034,500 units, an increase of 12.41% over sales in December and a staggering increase of over 46% compared with January 2012.
As I've written about here at Seeking Alpha, there will likely be a consolidation of China's steelmakers, due to a number of factors, including production overcapacity. It's also likely that smaller mills, those that are big polluters, or those who are not energy efficient, will be closed.
It's always difficult to determine who will be the acquirers and who will be acquired, but I believe that Chinese steelmakers whose shares are listed in the United States are well positioned to be the acquirers for a number of reasons. These reasons include their enhanced access to private equity capital in the U.S. and globally, their ability to utilize their shares as potential currency for acquisitions, and their high level of transparency due to their Securities and Exchange Commission (SEC) filing requirements and the significant scrutiny that they're facing from their auditors.
Three Chinese steelmakers that have been, and continue to be on my radar screen are China Industrial Steel (OTCPK:CDNN), Sutor Technology Group (NASDAQ:SUTR), and the value-added steel producer, China Gerui Advanced Materials Group (NASDAQ:CHOP).
A Comparison of Chinese and American Steelmakers
Let's take a look at the P/Es and recent trading history of several U.S. steelmakers and the global steelmaker, ArcelorMittal (US), which has significant U.S. operations:
U.S. Steel closed today at $19.96. There is no P/E as the company is not profitable, but the forward P/E for the year ending December 31, 2014 is 8.95.
Nucor Corp. closed today at $45.99. The company's P/E is a staggering 29.11.
Now let's take a look at the Chinese steelmakers:
China Industrial Steel closed today at $.57. The company's P/E is 3.48.
Sutor Technology Group closed today at $1.55. The company's P/E is 5.93.
China Gerui Advanced Materials Group closed today at $1.95. The company's P/E is 2.55.
For me the decision is simple. I'd rather own a steelmaker in an economy that is growing. This makes China, with its annual growth rate of more than 7.5% far more attractive to me than a steelmaker in the shrinking euro zone economy, or a steelmaker in the U.S. whose economy is likely to only grow no more than 2% this year.
I would also rather own a steelmaker that is profitable. This makes the Chinese steelmakers with their low P/Es very attractive. It also makes the American steelmakers who maybe will be profitable almost two years from now, the year ending December 31, 2014 as a potentially worrisome investment.
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 risks.
The companies discussed above include major global steel producers. Investors should be concerned about ArcelorMittal due to its problems in Europe, high debt levels and unprofitable operations. Investors should also be concerned regarding the prospects for U.S. steelmakers who are not profitable.
Companies discussed also include 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.
Disclosure: I am long OTCPK:CDNN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.