Steel Stocks Set To Rebound On Recovery

Includes: PKX
by: Roger S. Conrad

In April 2011, hot rolled steel sold for $900 per tonne on global markets. Today, that price is under $700.

Meanwhile, demand for the two principal commodity inputs used to make steel remains robust. The price of metallurgical or “coking” coal is less than 10 percent off its peak, while the price of iron ore is down just 1.5 percent. Electricity prices also have been strengthening in many areas of the world.

Steel demand is still strong by any measure, with global demand expected to increase 6.5 percent this year. That’s down, however, from 8 percent growth in the first quarter of 2011 and well off last year’s torrid 15 percent growth rate. And industry executives are anticipating a further slowdown into 2012.

The upshot is what some are calling a “steel trap,” in which producers’ profits are caught between weakening selling prices and high costs. Steel stocks across the board have already reacted to the threat. Some have already crashed as much as 50 percent from their highs earlier this year. The so-called conventional wisdom argues that these losses will eventually match the magnitude of 2008’s steep declines.

These sky-high levels of fear notwithstanding, 2011 is definitely not 2008. Today, neither of the two biggest markets for steel–China and the US–are in recession. US economic growth remains sluggish and jagged by historical standards. But China, now the source of nearly half the world’s steel demand, is still growing its economy by at least 9 percent each year.

Moreover, China’s preliminary manufacturing Purchasing Managers Index, announced this week, rose above 50 for the month of October. A reading of more than 50 indicates an expansion of manufacturing activity and suggests an expanding economy. That pretty much dispels the threat that China is headed for a “hard landing” due to government attempts to cool economic growth and tamp down inflation. This is hardly the first time investor perceptions have underestimated the world’s second-biggest economy.

Demand in Asia and the rest of the developing world remains the key to global steel prices, and by extension the health of steel producers. In the near-term, pricing will continue to be affected by general economic concerns. But for long-term, prices and demand for this essential element of economic growth will remain robust. That’s very good news indeed for the handful of companies that dominate the industry.

At this point, the prices of most steel stocks have already reacted to the threat of further global economic turmoil, if not an outright recession. As a result, the bar of expectations is quite low and there’s a lot of room to beat expectations and send these stocks markedly higher.

Until actual demand growth for steel does bottom out, however, some steel producers will fare better than others. Those firms that can control their costs most effectively will gain market share and productive capacity at the expense of those who can’t.

When the recovery comes, all steel stocks will benefit. The best-positioned companies, however, will further their advantage over the industry’s weakest names. Meanwhile, as long as the slump continues, they’ll hold their own.

Far and away, the world’s strongest steel stock is the world’s No. 3 producer POSCO (NYSE:PKX). The South Korean firm produces hot-rolled, cold-rolled and stainless steel for steel pipes, ships and automobiles. As Jim fink pointed out in his article, "Posco Earnings Disappoint: Global Steel Demand in Trouble?" the company has faced some difficulties in 2011, but it remains one of the best steel producers in the world, with modern low-cost production, a high-quality product mix, and a nearly debt-free balance sheet.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.