Ahhhh, the business cycle, etched so very deep into the collective mind of Wall Street. The business cycle, so very important, so very fundamental, that there is even a category of stocks known as "cyclicals." And conventional wisdom states, "Don't get caught with a cyclical when the business cycle goes south! Cyclical stocks do terribly in the trough of the business cycle. So if you see even a hint that the down side of the cycle is coming, get out, get out. Run for the hills. It's gonna be baaaad. Oh so very, very baaaaaad."
And what could be more cyclical than steel. Sure, when the good times role, we need steel, out of which to build cars and beautiful office towers. But when the business cycle turns south, we don't need very much steel anymore. And then, per conventional wisdom, there is a competitive frenzy between the steel companies and they start going under and fools who have been crazy enough to invest in steel lose all there money. And that's baaad. Oh, so very baad.
Perhaps it is this type of thinking that has caused analysts to rate AK Steel (NYSE:AKS) at a collective 3.2, where 1 is a strong buy, 5 is a strong sell and the average stock is ranked at about a 2.4. AK Steel has had a rating of about a 3.2 during its entire climb from a little over 2, to 72.
Well, the analysts sure missed the boat on that one. You would have thought that one of them would have had the guts to issue a buy recommendation. But for the most part, not a one of them did. And this has been a fabulously lucrative stock for those who bought, despite the disapproval of the analysts.
And perhaps it is that sort of business cycle thinking that in the last few days has slammed AKS from a high of 70.54 on Monday, June 30 all the way down to a closing price of 52.79, today, July 3rd. Yes, that is a drop of 25% in a little less than four short days. The new orders information released by the Census Bureau showed a very small drop in steel orders from April to May and the auto makers announced dismal sales figures and wham, did AK Steel ever get hit hard. And why not? If this the beginning of a trough in the business cycle for steel, which will represent a harrowing descent for the steel companies, it makes perfect sense.
I am convinced, however, that structural changes in the world economy will continue to boost the fortunes of AK Steel. Sure, it could go down further in this crazy, skittish environment. But, hey, although its course over the next month or two is unpredictable, eventually the fundamentals of the situations will translate to an increased stock price. And what are these structural changes? Well, I discussed four of them in a Marketocracy Marketscope article of April 2005. Now I can think of at least 10:
- Fossil fuels are being depleted: This is a structural change that will not be reversed. The greater the depletion of fossil fuels the deeper we will have to go to get them out. The greater the complexity of the extraction process, the more steel typically will have to be used. Rather than just drilling down a mile or two and pumping it out, we must drill down a mile or two in a first well, and then drill a bunch of wells around it to inject water or gas or steam to get that oil out. And we must drill more wells, deeper, into smaller pockets of oil and gas. This all takes more and more steel.
- The huge U.S. trade deficit is not sustainable. We must start to make progress at closing this massive deficit, which is running at about $2,500 per American per year. To do this the dollar must fall. Perhaps not today, or tomorrow, but eventually. As it falls, American steel producers become more competitive with foreign producers. We should also note that the domestic steel industry's nightmare days came at a time when the dollar was worth about 20% more than the Euro. Those dark days are not coming back.
- The high price of petroleum means that it costs more to ship steel from overseas. As the United States is a net steel importer, this benefits domestic steel producers because it drives up the price of competing imported steel.
- The high price of petroleum means that petroleum exporting countries are going on a building spree, using a great deal of steel. The Saudis are planning huge new cities. The steel for these cities comes from all over, and it drives up the international price.
- The high price of natural gas is making alternative means of electricity production increasingly feasible. That means steel supports for windmills and steel structure for solar facilities (a square mile of pivoting mirrors translates to a lot of steel structure).
- The high price of petroleum creates an advantage for railroads over trucks. This means the railroads will expand their rail network, which is made of steel.
- The Chinese government used to encourage steel exports, now they discourage them, to keep the steel in China.
- The agricultural boom means more spending on agricultural structures, made of steel.
- The high price of gold, silver, copper and other metals means that more steel will be needed for mining equipment, mine structural supports and processing facilities.
- Our continuing efforts to fight pollution mean that we will use more steel for sewage treatment facilities and pollution control equipment.
So that is ten structural changes that will cause steel to continue to prosper. U.S. Steel (NYSE:X) is good also, but AK Steel, with its 3.2 analyst rating and its recent 25% price plunge, is the underdog that I love. It may take another two months for it to bottom out, or it may have hit bottom already. There is just no telling with investor psychology. But I foresee that this stock has some more strength and will be moving back up, before too long.
Disclosure: I own AK Steel, myself, and I also own some in my mFolio portfolio.