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By Stuart Burns

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Recent second quarter upbeat results for steelmakers such as ArcelorMittal (NYSE:MT) and Tata Steel (OTC:TATLY) should not be seen as a revival in the steel industry’s fortunes.

A Bloomberg report breaks down Tata Steel’s latest results advising profitability has doubled from about $98 million for the quarter last year to $186 million for the same second quarter this year.

But delve a little deeper and it becomes clear that although EBITDA earnings rose slightly from 10.6% of revenue to 11.4%, it was solely on the back of cost-cutting and a one-off tax gain from the group’s operations in the Netherlands.

In 2012 the group incurred a charge of 1.9bn Rupees, but this year gained a rebate of 4.15bn Rupees. Sales fell year-on-year by 3% as the market destocked due to demand weakness and, in anticipation falling iron ore prices, would reduce finished steel prices.

Europe is now showing some signs of recovery as re-stocking gets underway and prices have begun to firm a little, but steel producers remain vulnerable to any rise in interest rates as net debt is high – three times expected earnings at ThyssenKrupp (OTCPK:TYEKF) and more than four times at Tata, according to an FT article.

The industry remains plagued by overcapacity, estimated by Nomura at some 400 million tons and although Europe cut capacity by about 5% over the last year, China continues to add it. As a result of the (at best) breakeven position of many of China’s steel mills and wider overcapacity position of Asian steelmakers, European producers’ recovery is vulnerable and could be short-lived, according to Moody’s, the rating agency.

Moody’s is expecting Asian steelmakers’ profitability to decline in the second half of this year, with demand rising no more than 2-3% through June 2014 due to de-stocking in the region. Mills have little pricing power due to overcapacity, and raw material costs remain higher than expected in spite of overcapacity in iron ore and coal supplies.

The only bright spot for Asian producers is the continued strength of Chinese demand and the hope, the faintest hope, that Beijing’s efforts to cut excess production capacity across a range in industries will eventually begin to curb steel capacity. Steel production, though, is facing such oversupply that state-enforced closures are unlikely to have any meaningful impact in the next 12 months.

Meanwhile, Asian and European consumers can look forward to a relatively benign pricing environment for the foreseeable future.

Source: European Steel Mills' Profitability Rises - But Not Prices