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  • OUTLOOK FOR U.S STEEL INDUSTRY & STOCKS 0 comments
    Jan 11, 2012 1:24 PM | about stocks: X, NUE, STLD

    Sources: Credit Suisse, JP Morgan

    Outlook for US Steel industry & Stocks

    The steel industry as well as steel stocks is known for its cyclical nature of business. In the last few months, raw material and steel prices have rebounded causing steel stocks to move higher too. The end market for the steel companies is construction, automobile, ship building and oil related industries.  The key drivers for the US steel industry are as follows:

    • The GDP growth rate as it impacts the activity in the end markets of steel producers. The construction sector consumes 55% of finished steel products; thus a pick up in the new activity in residential and non-residential construction will be a major catalyst for steel prices. Investors should follow the real estate vacancy rates closely. The residential market is expected to pick up; however, the key will be the recovery in non-residential commercial market which, in normal times, accounts for 40% of total steel demand.
    • The cost of labor, raw materials (iron ore, coal, scrap) and energy (gas, electricity).  In the last few months raw material prices have risen: seaborne iron ore prices are up by 15%, scrap prices are up by 6% and HRC prices are up by 15%.
    • Scrap prices: JP Morgan research has shown that scrap supply tightens in winter and this leads to higher prices of steel and steel stocks.
    • Inventory levels: The month’s supply of steel inventories tends to co-relate with steel prices. Credit Suisse research shows that inventories (NYSE:MOS) have built up in 31 out of the last 34 years during the month of December, by an average of 11%. However, a stronger Q1 is expected and higher shipments will bring down the months supply below the historical average of 2.5 MOS.
    • Production capacity and utilization rates. Steel production is on the decline globally which will bode well for steel prices and steel stocks.

    Historically steel companies don’t make money if steel prices are below $600/ton. The recent rise in steel prices to north of $750 will help the bottom line of U.S steel producers. For the same reason Steel stocks are up 30% from their recent lows. The recent announcement by AKS to raise the steel prices by $50/ton, a 7% increase, shows the end demand is growing and can cause steel stocks to move much higher.

    While analyzing this industry, one should also keep in mind the seasonal nature of this business. Few sell side analysts have analyzed historical seasonal price moves in steel stocks and their results show they have a tendency to move up 10% in the month of December.

     

    Below we will analyze three opportunities in the U.S steel industry.

    US Steel Corp(NYSE:X)

    Whenever a portfolio manager or an individual wants to have a play on cyclical steel industry or bet on U.S or global growth, the first names that comes to mind is US Steel. Current forecasts for its earnings for 2011 are only 20c. This is compared to average earnings of $8.75 during 2004-07 (JP Morgan calculation). If one is slightly bullish on U.S economics, especially construction activity, he can assume X will have annual earnings per share of more than $4. The reason is its high fixed cost structure that benefits more in booming times, in our view. Even using a lower range of X’s historical price earnings ratio of 10x, the stock should be trading north of $40 vs. current price of $23. However, expecting earnings per share of $4 or higher is highly dependent on a recovery in the non-residential construction market. This makes X a buy but with risks attached such as decline of steel prices hitting margins more than the competitors, higher energy costs and a decline in U.S & European industrial production activity.

    NUCOR CORP (NYSE:NUE)

    Nucor Corp, another US based steel company, has recently announced bullish results for Q3. Though, the company has a history of giving conservative guidance, and their better outlook for next year reflects stabilization in the order book, stronger pricing and demand trends. They have witnessed improvement in the real demand of automotive and heavy equipment end markets. JP Morgan has an overweight rating on the stock with a target price of $46. They think it’s an innovative company in the industry and has always come out of down cycle as a stronger and more diversified company. NUE has the most flexible cost structure in addition to a stronger balance sheet than competitors. The stock is trading at a P/E 10x and an EV/EBITDA of 6x. This is also the best dividend play in the steel universe, with a dividend yield of 4%.

    STEEL DYNAMICS, INC (STLD, STLD US)

    Steel dynamics is a U.S steel manufacturer which has initiated impressive cost cutting measures. Currently, it’s operating at below normal utilization. When the end demand picks up, an expected scenario for 2012, its margins will expand and will help the stock trade higher. JP Morgan has a price target of $18, which was derived using an EV/EBITDA of 6.2x, a slight premium to its historical average of 5.8x. They believe that the current stock price is not truly reflecting the earnings power of STLD. There primary end market is non-residential construction, which is still down 60% from the pre-crisis levels. As demand picks up in this market, STLD will be the primary beneficiary.

     

     

     

     



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