As many readers will know, I am fond of the metals and mining space right now (despite the run-up). JPM just put something out on the integrateds, here is the summary:
While the integrated steel stocks (AKS, MT and X) have meaningfully outperformed the minimills and overall market since mid-November (up 40% on average vs. a 16% gain for the minimills and 4% increase for the S&P 500), we think the integrateds still have more room to run, and are raising our estimates and price targets for AKS, X and MT (co-covered with our European steel analyst Jeff Largey). Our increased estimates are to largely capture the recently announced price hikes and to reflect our belief that even a modest improvement in demand from current levels could push prices meaningfully higher given the severe supply constraints. For AKS, we are raising our Dec. 2010 price target to $34 from $29, moving our 2010E EPS to $2.30 from $1.74, and introducing 2011E EPS of $3.65. For X, we are raising our Dec. 2010 price target to $75 from $55, upping our 2010E EPS to $4.00 from $3.45, and introducing 2011E EPS of $9.45. Finally, for MT, we are raising our Dec. 2010 price target to $55 from $45, leaving our 2010E EPS unchanged at $3.40 and introducing 2011E EPS of $5.50.
Higher raw material costs = Higher steel prices. Over the past month, the key raw material costs for steel (iron ore, met coal, and scrap) have all seen strong gains and are likely to push global steel prices higher, limit imports into the U.S. and encourage exports. Scrap prices have rebounded by roughly 25% since their mid-November lows, and look set to increase by another 15% due to seasonal supply constraints, strong exports, and low inventory levels at the mills. Additionally, as more integrated production comes on line, we think they will use a higher percentage of scrap in their basic oxygen furnaces in order to push scrap prices higher and therefore minimill costs higher as a way to pressure hot-rolled prices higher.
Steel prices rebounding. After dropping to a recent low of $500/ton in late November and early December, producers have announced a series of price hikes for the beginning of the year which should take hot-rolled sheet prices to $550-580/ton for February. Order activity has improved, driven by consumers attempting to get ahead of these price increases, filling inventory holes, and from restocking as well as modest improvements in demand. Given the increased demand, cost pressures and still tight supply situation, we think the announced price increases will stick and expect to see more announced before the spring.
This could just be the beginning. As we commented in our report on November 16 (Steel: Time to buy the integrated steels – Adding AKS and X to the Focus List and removing Nucor (NYSE:NUE)), when (not if) steel demand increases, we expect steel sheet prices to rise rapidly given the severe constraints throughout the supply chain, driven by limited imports, record low inventories, and minimills already running at high levels. We believe we could see hot-rolled sheet prices jump past $750/ton in this scenario. In addition to pricing leverage, the integrateds should see significant earnings improvement from even a modest increase in demand as we believe they are primed to capture almost all of the incremental volume which should materially improve their fixed cost absorption.
I am still a fan of X as an integrated steel and like both their bonds and their equity.
Disclosure: No positions in the above named companies.