About the Steel Industry
Given the unique combination of strength, formability and versatility in steel; it is deployed across various industries including construction, transport, electrical appliances, food packaging and others. 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 products are wire rods, beams, reinforced bars and merchant bars.
The steel industry in today’s world is considered as the backbone of the economy and is often indicative of economic progress, as it plays a critical role in infrastructural and overall economic development. World crude steel production went up from 851 megatons (Mt) in 2001 to 1,548 Mt in 2012. However, despite its size, the steel industry remains relatively fragmented and is highly cyclical and intensely competitive.
Within the Zacks Industry classification, the steel industry falls under the broader Basic Materials sector (one of 16 Zacks sectors). We rank all of the more than 250 industries in the 16 Zacks sectors based on the earnings outlook for the constituent companies in each industry. This ranking is available in the Zacks Industry Rank.
The way to look at the complete list of 250+ industries is that the outlook for the top one-third of the list (Zacks Industry Rank of #85 and lower) is positive, while the outlook for the bottom one-third (Zacks Industry Rank #170 and higher) is negative.
We have three Steel related industries: Steel Pipes, Steel Producers and Steel Specialty. The Steel Pipes industry currently retains a Zacks Industry Rank #118, placing it in the middle one third of the 250+ industry groups. The Steel Producers industry is featuring in the bottom 1/3rd of all Zacks industries with a Zacks Industry Rank #235, followed by the Specialty Steel industry, with a Zacks Industry Rank #249. Looking at the exact location of these Steel industries, one could safely say that the outlook is on the ‘Negative’ side.
Please note that the Zacks Rank for stocks, which is at the core of our Industry Outlook, has an impressive track record going back years, verified by outside auditors, to foretell stock prices, particularly over the short term (1 to 3 months). The rank along with Expected Surprise Prediction (ESP) (Read: Zacks Earnings ESP: A Better Method) helps in predicting the probability of earnings surprises.
Industry Performance So Far
After witnessing sturdy growth for most part of the last decade, the steel industry suffered a setback due to the recession in 2008 as consumers utilized existing inventories rather than buying new stock. The industry witnessed a turnaround in late 2009 and continued to grow thereafter, in sync with the global economic recovery.
Demand for steel benefited from growth in the developing economies that helped counter the sluggishness in developed economies. Asia, particularly China, continued to be the principal growth driver. Demand for steel products, nonetheless, remained below the pre-recession levels.
However, China’s economic growth has been subdued compared to the robust levels over the last decade. The economic slowdown in 2012 unfavorably impacted infrastructure and construction spending. Concerns surrounding China’s growth and the European debt crisis remain overhangs on the sector’s outlook.
Global Production Numbers in 2012
World crude steel production was a record 1,548 Mt in 2012, outperforming the 2011 level by 1.2%. Production in Asia improved 2.7% to 1,012 Mt. China retained its leadership position, yielding almost 46% of the global output at 716.5 Mt. Production in Japan, the second largest producer, remained flat year over year at 107.2 Mt. The United States held the third position, producing 88.6 Mt of crude steel, up 2.5% annually and accounting for 6% of the total global output. Production in Europe and South America were somber, declining 2.7% and 3.1%, respectively.
In Jan 2013, world crude steel production edged up 0.8% annually to 125 Mt. China’s crude steel production was 59.3 Mt, up 4.6% year over year. Japan produced 8.9 Mt of crude steel, an increase of 2.7%. The U.S produced 7.3 Mt of crude steel in Jan 2013, a 5.8% year-over-year decline.
Industry Capacity & Demand/Consumption Dynamics
The average capacity utilization ratio in 2012 was 78.8% compared to 80.7% in 2011. World crude steel capacity utilization ratio further decreased to 71.2% in Jan 2013 from 73.2% in Dec 2012, and also dipped 5.5 percentage points from Jan 2012.
Global apparent steel consumption increased 1.7% in 2012, down sharply from 7.4% growth in 2011. Region wise, apparent steel consumption decreased 9% in Europe, edged up 2% in China and increased 7% in the United States in 2012 on a year-over-year basis.
Steel prices are generally volatile, in line with the highly cyclical nature of the global steel industry. Rising raw material prices have a direct impact on steel prices as higher raw material prices induces a corresponding increase in steel prices.
However, in the wake of lower demand, it becomes increasingly challenging to pass on raw material price hikes to consumers. Overcapacity, glut in cheaper Chinese steel imports, economic conditions, shifts toward other substitutes significantly impact steel prices.
Steel prices improved in the first half of 2012, but declined in the back half due to a glut in imports, oversupply in the market from zealous steelmakers, weak demand in Europe and tempering growth in Asia. A sustained downside in steel prices will materially and adversely affect margins of the steel companies.
The overall negative tone of Zacks Industry Rank for the Steel industry reflects this underwhelming earnings outlook. We believe that the eventual pricing recovery will need a reviving economy, stabilization in the Euro-zone and a rebound in construction activity in the developing countries, in particular China, India and South Korea.
Raw Material Trends
The primary inputs for the steel industry are iron ore and coking coal, as well as coke, scrap, alloys and base metal. The industry also uses large volumes of natural gas, electricity and oxygen for its steel manufacturing operations.
In the first half of 2012, prices were more or less stable before plummeting to a three-year low in September. Nonetheless, prices have been on the rise based on aggressive restocking drive by Chinese steel mills. However, average iron ore prices in 2012 were much lower than the previous year.
The iron ore industry is highly concentrated with only three major players, Vale S.A. (VALE - Analyst Report), Rio Tinto Plc (RIO - Analyst Report) and BHP Billiton Ltd. (BHP - Analyst Report), having significant pricing power. Iron ore prices are expected to slump in 2013 due to the economic uncertainty in China.
Mergers and acquisitions (M&A) have remained an important growth strategy in the steel industry providing additional steel capacity, production efficiency and economies of scale. However, consolidation was minimal in 2012, given the current economic uncertainties in the developed economies as well as a slowdown in the emerging regions.
In 2012, a landmark development was the merger of Japan's largest and world's sixth-largest steel maker Nippon Steel Corporation with 27th-ranked Sumitomo Metal Industries to form the world's second largest steel firm - Nippon Steel & Sumitomo Metal Corporation . With a combined capacity of 46.1 million tons, the merger is targeted to generate savings in the face of increasingly intense global competition.
We expect M&A activity to remain slow in 2013 until prices stabilize and the industry strikes a balance between supply and demand. Going forward, the abatement of the Euro-zone crisis, recovery in the U.S. and Chinese economy will determine the fate of such deals.
How Well Did Steel Stocks Fare?
Reflecting on the recently reported fourth quarter results of the steel companies in our coverage -- ArcelorMittal (MT - Analyst Report), U.S. Steel Corp. (X - Analyst Report), Nucor Corp. (NUE - Analyst Report) and AK Steel Holding Corp. (AKS - Analyst Report) -- we see revenues were constrained across the board due to a drop in average steel prices. All the steel players have been plagued by weak steel demand, oversupply in the U.S. steel industry and increased steel imports in the domestic market, which have affected steel prices, hurting margins in the process. The weak global conditions are a deterrent factor for volumes.
Given the scenario in Europe, ArcelorMittal, the world's largest steelmaker in terms of volume, announced its plans in Jan 2013 to permanently close its plant in Liege, Belgium, owing to the slack demand. These plans, however, faced protests from the country's leaders. In response, ArcelorMittal has agreed to stall its restructuring programs through June until the European Union Commission publishes its plan to revive Europe's steel industry.
German heavy industry giant ThyssenKrupp also announced plans to layoff more than 2,000 employees out of a total workforce of 27,600 at its Steel Europe division, thus generating cost savings of 500 million euros ($671 million).
Looking Ahead in 2013
The U.S. steel market down remains plagued by oversupply and increased imports. Although Chinese steel production growth, which was responsible for causing the glut to some extent, has somewhat slowed down; supply in the steel market still overshadows demand. We expect continued increase in steel imports, volatility in steel pricing, the European debt crisis and its potential global impact, and sluggish growth in the emerging markets to be deterrents for the steel industry.
Let’s have a look at the performance of the major consumer markets. Historically, the automotive and construction markets have been the largest consumers of steel, consuming more than half of the total steel produced. The industry caters to large automakers such as General Motors Company (GM - Analyst Report), Ford Motor Co. (F - Analyst Report), Toyota Motor Corporation (TM - Analyst Report) and Honda Motor Co. Ltd. (HMC - Analyst Report).
The automotive sector registered significant growth in 2012. The momentum was carried forward in 2013 with auto sales in January increasing 15% with the seasonally adjusted annual rate (SAAR) at 15.3 million vehicles. This was the third straight month of above 15 million SAAR.
This performance creates the perfect start to achieve the consensus expectation of 15.3 million vehicles to be sold in 2013, up from 14.5 million vehicles sold in 2012. The robust growth rate in the sector has been fueled by strong pent-up demand, rising credit availability, launch of several redesigned and fuel-efficient vehicles and rebound in consumer confidence, thanks to a growing belief that the housing market is recovering.
Another major market -- the Construction sector -- remained an overhang on the steel companies’ earnings. However, in 2012, there have been evident signs of upturn in construction activity. The architecture billing index (ABI), an economic indicator that provides an approximate nine- to twelve-month glimpse into the future of non-residential construction spending activity, after remaining negative through most of 2012, climbed back into the positive territory in Aug 2012 and remained stable till then.
Construction activity for 2013 has kicked off on a promising note with ABI at 54.2, up sharply from 51.2 in December. This has been the strongest growth witnessed in five and a half years. This momentum is expected to persist and conditions are expected improve, albeit at a slow and steady rate.
The American Institute of Architects projects a 5% increase in spending in 2013 for non-residential construction projects, on the back of higher construction of commercial facilities, particularly for hotels followed by industrial construction spending.
The residential housing sector is also showing signs of strong momentum with housing starts and housing permits at highest levels in more than four years as record-low mortgage rates, rising rents and reduced prices of properties are luring buyers. In Jan 2013, housing starts spiked 24% year over year to a seasonally adjusted annual rate of 890,000. Building permits were at a seasonally adjusted annual rate of 925,000, 35% higher than the year-ago figure.
The steel industry will thus benefit from the strong momentum in the automotive markets. The turnaround in the so-far faltering construction sector will definitely provide a much-needed impetus to the sector. The outlook for other key markets -- transportation, energy, industrial and agricultural sectors also remains favorable.
To Sum Up
In 2013, the steel industry will continue to face headwinds in the form of overcapacity and surge of imports. Global steel demand is expected to improve gradually in 2013 compared to the 2012 levels. Growth in the United States will be supported by the Federal Reserve attempts to sustain the U.S economy’s momentum, an improving labor market, strong momentum in the auto sector and recovery in construction markets.
Emerging and developing economies will continue to drive growth. In China, government pro-growth policies, rising loan growth and a renewed focus on infrastructure spending will induce demand. Prices could potentially stabilize on the back of a rebound in construction activity in other developing countries, in particular India and South Korea.
Steel selling prices will improve hand-in-hand with improved demand across most regions, due to higher raw material prices and an end to the destocking that was observed during the fourth quarter of 2012. In addition to raw materials prices, the sustainability of higher steel prices will continue to depend on an increase in sustainable real demand, and no further worsening of the Euro-zone debt crisis.