Continued Chinese Oversupply Of Steel Makes Steelmakers A Risky Investment

Includes: AKS, MT, NUE, RIO, X
by: Zvi Bar

China, the world's largest steel producer, has been ramping up its steel exports in 2012, and Chinese steel exports have reached their highest level in two years. This is occurring at a time when there is already significant oversupply for decreasing global steel demand, and the trend appears bad for most steelmakers.

China has flooded the international steel market before, and the move was bearish for the domestic and international ex-China steelmakers, with some going bankrupt from the last glut. This current move comes at a time that steel prices in China are at a two year low, while the nation's production rate is at or near record highs. China's prior exporting policy indicates that China will probably continue to ramp up steel exports to at least the extent its domestic demand continues to decrease, plus any further growth in its steel production.

Generally, publicly traded steel companies have not performed well through the last several quarters. This is because steel supply has grown, while demand has declined. Issues including Asian and U.S. economic slowing, and the continuing European Union's sovereign and bank debt problems have dramatically reduced demand for steel as well as several other industrial metals, such as copper.

Europe appears to be the most concerning present factor. On July 25, ArcelorMittal (MT), a large steelmaker operating out of Luxembourg, posted a 28 percent drop in Q2 profit. The company also reported the sale of a 48.1% stake in international engineering company Paul Wurth Group to SMS Holding GmbH for 300 million euros. The company has pledged to reduce its debt, which now totals about $22 billion. ArcelorMittal ADR shares are down about 22.3 percent since the start of 2012, not counting dividends, and are down about 57 percent over the last 12 months.

This decline in ArcelorMittal is not an isolated incident within the industry, and domestic steelmakers have not been immune. AK Steel (AKS) has declined by about 40 percent since the start of 2012 and 65 percent over the last 12 months. Likewise, US Steel (X) has declined by about 30 percent YTD and 60 percent over the last 12 months. Nucor (NUE), which is the largest U.S. steel producer, has performed far better, but has still declined by about six percent YTD and nine percent over the last 12 months.

Similarly, Rio Tinto (RIO), a large and highly diversified international metals and minerals miner, has fallen by about 11 percent YTD and 40 percent over the last 12 months, as demand for resources has fallen, while resource supplies have generally grown.

Chinese supply has an overwhelming affect upon the market and could easily continue to be a problem for the foreseeable future. China's total steel production is considerably greater than the total production coming out of India, Japan, Russia and the United States, the next four largest producers. The inevitability here is that continued oversupply and potentially reducing prices should require non-Chinese steelmakers to shutter plants for the short term. The alternative would be selling steel at a loss in order to maintain or possibly gain market share, but that strategy will only keep a steelmaker solvent for so long.

Despite some significant recent declines amongst the steelmakers, it appears unlikely that the source of their woes will not soon go away and that business may get worse in the second half of 2012. European demand will likely remain weak, while Chinese production will likely remain strong. This will likely cause multiple steelmakers to report disappointing results and further reduce their estimates in the coming quarters.

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