Global uncertainty weighs on steel industry stocks

World steel production has increased since April 2009 due to a moderate rise in demand. But global growth could slow in 2012.

By Zacks.com Dec 1, 2011 6:08PM

Overview

The world steel industry is concentrated in structure, with a few producers accounting for the lion’s share of sales.

 

Historically, the automotive and construction markets have remained the largest consumers of steel, absorbing more than half of the total steel produced. Large automakers such as General Motors Company (GM), Ford Motor Company (F), Toyota Motor Corporation (TM) and Honda Motor Company (HMC) depend upon the steel industry.

 

Other steel consuming industries include appliances, agricultural implements, converters, containers, energy, electrical equipment and industrial machinery.

 

Steel products are classified into four broad categories: flat steel products, long steel products, scrap and semi-finished products. Flat products include plates, hot-rolled strip and sheets and cold-rolled strip and sheets. The long steel product category comprises wire rods, beams, reinforced bars and merchant bars. The products under both these categories are rolled from steel slabs, which are considered as unfinished or semi-finished products that are generally not sold.

 

Production

World crude steel production has continued to show a steady increase since April 2009 on the back of a moderate rise in demand and the resumption of work at idled facilities. China has emerged as a major producer and consumer of steel.

 

According to the World Steel Association, world crude steel production was 124 million metric tons in September 2011, up 9.7% year over year. ArcelorMittal (MT) -- a leader in all major global carbon steel markets, including automotive, construction, household appliances and packaging, with leading R&D and technology -- produced 90.6 million tons of crude steel in 2010, representing approximately 6% of world steel output. In the first nine months of 2011, the company produced 70.2 million tons of crude steel.

 

Growth trends

With the global economy picking up in late 2009, the steel industry started seeing signs of improvement. However, given its economic sensitivity, we expect global steel demand to improve gradually, in line with the recovery in the user industries, especially automotive and residential construction.

 

According to World Steel Association, in the first half of 2011, the worldwide demand for steel has remained on the improving trend line. This is despite a series of anticipated and unanticipated negative developments: the ongoing euro area sovereign debt crisis, the earthquakes in Japan , the political/social unrest in some countries of the MENA region leading to the related surge in oil prices and the tightening of government monetary measures in many emerging economies.

 

Today the global economy is facing increased uncertainty over the ongoing turmoil in the financial markets and how it will affect the real economy. The WSA’s current forecast for 2012 assumes that developing economies continue to drive global growth and the policy response to the European sovereign debt crisis prevents increased volatility in the equity and financial markets.

 

A look at some companies

Here, we will discuss the recent results of a few companies, whose results were aided by higher selling prices and increased shipments, and their growth expectations.

 

ArcelorMittal (MT) reported diluted net earnings of 19 cents per share in the third quarter of 2011, much below the Zacks Consensus Estimate of 51 cents and last year’s 89 cents per share. Total steel shipments in the third quarter of 2011 were 21.1 million metric tons compared with 20.5 million metric tons in the year-ago quarter.

 

Quarterly revenues increased 22.6% year over year to $24.2 billion from $19.7 billion in the year-ago quarter and decreased 3.6% sequentially from $25.1 billion. Sales were down sequentially primarily due to lower average steel selling prices (-1.7%) and lower volume of shipments (-4.9%).

 

The company’s EBITDA in the second half of 2011 is expected to exceed the level achieved in the comparable period of 2010. The company expects shipments in fourth quarter 2011 to be lower sequentially, reflecting economic uncertainties leading to customers adopting a “wait and see” approach.

 

Higher iron ore and coal volumes will continue to be a positive underlying driver. The company’s iron ore and coal production is expected to increase by 10% and 20% respectively, by the end of 2011 as compared with 2010.

 

In light of the recent market uncertainty, the company is focusing on core growth capital expenditure. This will result in postponement of some planned steel investments. Accordingly, full-year 2011 capital expenditure is expected to be below the previously targeted level of $5.5 billion.

 

Our long-term recommendation on ArcelorMittal remains Outperform, though it has a Zacks #3 Rank (Hold).

 

The commercial metals company AK Steel Holding (AKS) posted its third-quarter 2011 results, delivering a net loss of $3.5 million or $0.03 cents compared with a net loss of $59.2 million or $0.54 cents during the year-ago quarter. However, results were below the Zacks Consensus Estimate of $0.00 cents per share.

 

Net sales, as reported by the company, were $1,585.8 million on the shipments of 1,368,800 tons versus $1,575.9 million and 1,465,800 tons in the prior-year quarter. Net sales also missed the Zacks Estimate of $1,662 million. Average selling price for the third quarter of 2011 was $1,158 per ton, up 8% year over year, but down 2% sequentially.

 

Value-added shipments for stainless/electrical increased to 229.3 tons compared with 226.9 tons in the prior-year quarter. Value-added shipments for Coated, Cold-rolled and Tubular product decreased to 577.2, 278.3 and 32.4 tons, respectively, compared with 624.4, 322.5 and 33.2 tons, respectively, in the year-earlier quarter.

 

Non-value-added shipments including Hot-rolled increased to 222.6 tons from 213.6 tons in the year-earlier quarter. Non-value-added shipments including secondary products decreased to 29.0 tons from 45.2 tons in the prior-year quarter.

 

AK Steel currently retains a Zacks #3 Rank (short-term Hold rating). Our long-term recommendation also remains Neutral.

 

Allegheny Technologies Inc. (ATI) also earned $70.6 million or 63 cents per share (excluding acquisition related expenses of $8.3 million, net of tax) in the third quarter of 2011 up from $1.0 million or 1 cent in the same quarter of 2010. Results exceeded the Zacks Consensus Estimate of 61 cents.

 

Sales in the quarter increased 28% to $1.35 billion, driven by higher shipments for most high-value products, higher raw material surcharges and increases in average base selling prices for many products. However, sales were lower than the Zacks Consensus Estimate of $1.39 billion.

Segment operating profit surged 157% to $161.8 million, or 12.0% of sales, from $63.0 million, or 6.0% of sales, in the third quarter of 2010.

 

Allegheny expects to continue to benefit from its new alloys and products, diversified global growth markets and differentiated product mix over the next 3 to 5 years. Demand is expected to be strong for its mill products and highly engineered forged and cast components from the aerospace market.

 

Strong growth is also expected from the oil and gas/chemical process industry for its titanium-based alloys, nickel-based alloys and specialty alloys, and tungsten products.

 

We currently have a Neutral long-term recommendation on the stock, which is the same as reflected in the Zacks #3 Rank (Hold) rating.

 

Nucor Corporation (NUE) reported net earnings of $181.5 million, or 57 cents per diluted share (excluding special items) in the third quarter of 2011, beating the Zacks Consensus Estimate of 51 cents per share. This was a significant increase from $23.5 million, or 7 cents per diluted share (excluding special items) reported in the year-ago quarter. Nucor’s third-quarter earnings exceeded those of last year's quarter, but they declined from the second quarter of this year on lower steel prices and significantly lower metal margins.

 

Consolidated sales surged 27% year over year to $5.25 billion, beating the Zacks Consensus Estimate of $4.86 billion. The growth was attributable to an increase of 24% in average price per ton and a rise of 3% in shipments (to 5.8 million tons) to outside customers. The company’s end-markets such as automotive, heavy equipment, energy and general manufacturing demonstrated strength compared to 2010 but showed very little improvement compared with the first half of 2011.

 

Steel mill shipments grew 9% to 4.2 million tons during the quarter. The average scrap and scrap substitute cost per ton accelerated 27% to $449.

 

Although Nucor expects to see only slight improvement in demand in its non-residential construction markets through the end of 2011, it remains optimistic about its combined construction businesses (steel mills and downstream facilities) and anticipates that it will continue to operate profitably.

 

Nucor expects fourth-quarter earnings to be below its third-quarter level. The company expects margin compression in the sheet market in the fourth quarter of 2011. Furthermore, the company forecasts a smaller compression in plate margins due to imports. The magnitude of margin compression will be favorably impacted by expected lower scrap costs through the quarter.

 

The company has a Zacks #3 Rank (Hold) Rank on its stock.

 

Zacks Recommendation

Prospects for 2012 have remained mildly positive despite high levels of uncertainty surrounding the outlook for end-users in the EU. Activity in the manufacturing sectors and in construction will continue to grow, albeit in the case of the manufacturing industry at a significantly slower pace than in 2010 and 2011.

 

Particularly in the first half of 2012, real steel consumption is forecast to grow only modestly. From mid-2012 onwards improving end-user fundamentals should result in a modest acceleration in consumption growth.

 

In China, the government’s expansionary economic policies, easy credit and construction initiatives have thus far sustained demand. But with China attempting to rein in its overheated property sector and engineer a soft landing for its economy, steel demand will most likely soften noticeably in the coming months. This relatively uncertain Chinese outlook, coupled with a still tentative recovery in the developed world, is expected to weigh on prices.

 

In the short term, we are neutral on steel manufacturers like AK Steel (AKS), U.S. Steel (X) and Nucor (NUE).

 

AK Steel’s cost structure is higher than its peer group due to a greater reliance on external supply of raw materials such as carbon scrap, purchased slabs, iron ore and purchased coke. Iron ore is the key raw material in steel manufacturing operations.

 

However, industry giants with integrated business models like U.S. Steel and ArcelorMittal have an edge over their peers. Both steel makers have substantial captive sources of iron ore and coal and source about 75%–80% of their coke and iron ore requirements from owned and/or operated facilities.

 

This article was condensed from the full report.

 

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