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The Steel Industry: A Snapshot
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 is an economic indicator, as it plays a critical role in infrastructure and overall economic development. World crude steel production has grown from 851 megatons (Mt) in 2001 to 1,548 Mt in 2012. However, despite its size, the steel industry remains relatively fragmented, 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 260 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 page.
The way to align the ranking and outlook from the complete list of Zacks Industry Rank for the 260+ companies is that the outlook for the top one-third of the list (Zacks Industry Rank of #87 and lower) is positive, while the outlook for the bottom one-third (Zacks Industry Rank #174 and higher) is negative.
The steel–pipe and tube industry producers industry features in the bottom 1/3rd with a Zacks Industry Rank #198, followed by steel producers with a Zacks Industry Rank #224. The steel specialty industry is near the bottom of the list with a Zacks Rank #248. This indicates that the overall outlook is on the ‘Negative’ side.
Please note that the Zacks Rank for stocks, which are at the core of our Industry Outlook, has an impressive track record, 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 Way to Find Earnings Surprises) helps in predicting the probability of earnings surprises.
What's Denting the Steel Industry?
After witnessing sturdy growth for most of the initial phase in the last decade, the steel industry suffered a setback due to the recession in 2008 as consumers utilized existing inventories rather than buying new stocks. 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 countries. Asia, particularly China, continued to be the principal growth driver. Demand for steel products, nonetheless, remained below pre-recession levels.
In 2012, the continuing Euro-zone sovereign debt crisis, economic stagnation or slow growth in developed economies and a cooling of emerging market economies took a toll on the industry. Growth in the Chinese economy, which in recent years has been one of the main demand drivers for steel, slowed. These challenging economic conditions continued to hinder the steel industry in the first quarter of 2013.
Furthermore, overcapacity has been a perennial problem. Stiff competition in the United States from cheaper imports and from domestic producers with new or expanded facilities or under-utilized existing facilities continues to result in a significant oversupply of steel compared to demand.
Global Production Numbers
World crude steel production was a record 1,548 Mt in 2012, outperforming the 2011 level by 1.2%. From Jan through May 2013, world crude steel production has increased 2.1% year over year to 658 Mt. China retained its leadership position, yielding almost 49% of the global output at 325 Mt, an 8% annual rise.
Production in Japan, the second largest producer, increased 1.3% year over year to 45 Mt. The United States held the third position, producing 36 Mt of crude steel, a 7% annual decline. Production in Europe and South America were a dampener, declining 6% and 5%, to 70 Mt and 18.8 Mt, respectively.
Through the Jan-May timeframe, world crude steel production attained the highest figure in 2013 so far in May, at 136 Mt and a 2.6% annual increase.
The average capacity utilization ratio in 2012 was 78.8% compared with 80.7% in 2011. Despite the global rise in supply in 2013, total capacity utilization continues to be low. World crude steel capacity utilization ratio in 2013 was the lowest in Jan at 71.2%. Even though it has rebounded; it has remained stubbornly at the 80% level since then. It also continues to decline on year-on-year comparisons.
Steel Consumption & Forecasts
Following a 1.2% increase in 2012, the World Steel Association projects global steel usage to rise 2.9% in 2013 to 1.454 Mt. This is based on the premise of an expected recovery in global steel demand by the second half, led by emerging economies. However, the Eurozone crisis remains an overhang.
China’s steel usage in 2013 is estimated to grow 3.5% to 66.8.8 Mt, following 1.9% growth in 2012. India’s steel consumption will accelerate as monetary easing is expected to support investment activities to 5.9% in 2013 after a 2.5% growth in 2012. After a decline in 2012, no improvement is expected for Japan with a projected dip in steel usage of 2.2% to 62.6 Mt due to contracting shipbuilding and automotive sectors despite a positive boost from the construction sector.
In the U.S. market, steel consumption is projected to be up 2.7%, falling from the 8.4% climb last year due to continuing fiscal concerns. Last year, improvement in the automotive and energy sectors and recovery in the construction sector had boosted steel demand.
In Central and South America, apparent steel use is expected to rise by 6.2% in 2013 versus 2.6% increase in 2012. In Brazil, investment in infrastructure coupled with the end of the recent de-stocking process will lead to apparent steel use growth of 4.3% in 2013.
In Europe, the gloomy economic outlook will continue to pull down demand by 0.5% in 2013. However, this is an improvement from the decline of 9.3% in 2012.
Things look better in 2014. The overall scenario is expected to improve in 2014. World steel demand is expected to increase 3.2% to a record of 1,500 Mt driven by a further pickup in global steel demand with the developed economies increasingly contributing to growth.
China’s steel usage is expected to grow 2.5% over the 2013 projections, aided by government stimulus measures. India will pick up pace and grow 7%, triggered by reform measures and initiatives to improve the foreign direct investment.
In 2014, steel use in the U.S. is envisioned at over 100 Mt, an expected annual rise of 2.9% fueled by the improving construction sector. Central and South America is expected to grow 4.3% to 52 Mt in 2014. Japan is still expected to underperform with a 0.6% dip due to the end of fiscal stimulus and structural factors. However, Europe is expected to recover a modest 3.3% in 2014.
Steel Prices - Drivers & Trends
Steel prices are generally volatile, owing to 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. Furthermore, overcapacity, glut in cheaper Chinese steel imports, economic conditions and shifts toward other substitutes significantly impact steel prices.
Steel prices had shown improvement in the first half of 2012, but started declining in the latter half due to a glut in imports, oversupply in the market from zealous steelmakers, weak demand in Europe and tempering growth in Asia. The scenario continues to be the same in 2013 as well.
A sustained downside in steel prices will materially and adversely affect the margins of steel companies. We believe that the recovery in pricing momentum will be driven by 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, iron ore prices were more or less stable before plummeting to a three-year low below $100 per ton in September. It recovered by the end of 2012 due to aggressive restocking drive by Chinese steel mills.
However, it remained well below the Feb 2011 record high near $200 per ton. Prices peaked to $150 per ton range in Jan and Feb this year, but dropped to a low of $113 per ton in May in tandem with changing sentiment over China’s economic growth and steel output.
Chinese demand for iron ore is growing at a slower rate, while supply of iron ore is growing significantly. Iron ore prices are expected to slump in 2013 due to the economic uncertainty in China.
Consolidation & Divestitures
Mergers and acquisitions (M&A) have remained an important growth strategy in the steel industry, leading to 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 deal 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.
Despite the considerable scope for consolidation in the steel sector, companies are holding back and instead focusing on conserving cash. They are waiting for a stronger and more sustainable economic upturn to spur a wave of consolidation. They are instead focusing on shedding unproductive operations, cutting costs and restructuring.
ArcelorMittal (MT - Analyst Report), the world’s largest steel producer, kicked off 2013 with the sale of its 15% stake in iron ore mines in Canada for $1.1 billion to a consortium that included South Korean steelmaker POSCO (PKX - Analyst Report) and Taiwan-listed steelmaker China Steel. The divestiture is in line with the company’s effort to get rid of production overcapacity in Europe as well as to reduce its debt.
ArcelorMittal had earlier planned to permanently close its plant in Liege, Belgium, due to slack demand. However, this faced protests from the country's leaders. Currently, the government of Belgium's Wallonia region is considering whether to nationalize ArcelorMittal’s steelworks.
ThyssenKrupp, one of the top 20 steel producing companies in the world and the biggest steelmaker in Germany, completed the sale of its stainless steel operations Inoxum to Finland’s Outokumpu for $3.7 billion in Dec 2012. The company is seeking to reposition itself to become a more diversified industrial company after incurring two consecutive years of record losses.
The company is also on track to sell its Steel Americas assets -- a plant in Brazil and one in the U.S. ThyssenKrupp has faced a succession of costly write-downs since its decision to build the plants. Following these transactions, sales from steel will account for only 30% of ThyssenKrupp’s sales (down from 40%) with the balance 70% from capital goods and materials and logistics services.
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.
Sector Level Earnings Performance in 1Q13
Looking at the overall results of the Basic Material Sector, earnings dipped 1.8% in the first quarter of 2013, a disappointing performance compared with the 13.2% rise in the fourth quarter of 2012. Total revenue decreased 2.1% in the first quarter versus a 1.3% increase in the fourth quarter of 2012.
Revenue performance was weak across all 16 sectors covered by Zacks, but was particularly pronounced in the Basic Material sector. Nevertheless, the Basic Material sector had a beat ratio of 69.6%. Beat Ratio is the percentage of companies coming out with positive surprises.
All 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 affected steel prices, hurting margins in the process. The weak global conditions are a deterrent factor for volumes.
Expectations for 2013
Earnings for the sector are expected to dip 4.5% in the second quarter. Estimates for the second quarter in the Basic Material sector underwent sharp downward revisions as the first quarter earnings season progressed, largely reflecting the overall negative tone of guidance provided by companies. However, it is expected to improve in the second half.
For the third quarter, earnings are expected to rise 15.9% and accelerate further by 23.2% in the fourth quarter. Revenues are expected to rise 0.1% in the second quarter, 2.6% in the third and 2.1% in the fourth quarter.
For more information about earnings for this sector and others, please read our 'Earnings Trends' report.
A Look at the Major Consumer Markets
The U.S. steel market remains plagued by oversupply and increased imports. Although Chinese steel production, 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 increases 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 the headwinds for the steel industry.
Let’s have a look at the performance of 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 and Honda Motor Co. Ltd. (HMC - Analyst Report).
The automotive sector registered significant growth in 2012. The momentum was carried forward in 2013 as well. From January to May, 15.2 million seasonally adjusted annual rate (SAAR) vehicles were sold on an average. Barring April, sales were recorded at above 15 million SAAR for all the months in 2013.
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 an increasing belief that the housing market is recovering.
Another major market -- the construction sector -- has been showing signs of upturn in construction activity. The architecture billing index (ABI), an economic indicator that provides an approximate 9- to 12-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.
In 2013, after a solid run, the ABI reverted into negative territory in April, but bounced back in May with a score of 52.9. This is a positive sign for construction sector and suggests that April’s dip was temporary. This momentum is expected to persist and conditions are expected to improve, despite 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. It also projects a 7.2% increase of spending in 2014.
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 May 2013, housing starts spiked 29% year over year to a seasonally adjusted annual rate of 914,000.
Building permits were at a seasonally adjusted annual rate of 974,000, 21% higher than the year-ago figure. It is worth mentioning that building starts had touched 1 million in March, a feat not witnessed since June 2008.
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 boost 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. The steel companies are going through a restructuring process, which will have a positive impact on operations in the medium- and long-term. Some of the major industry trends are strategic cost reduction, vertical integration and capital optimization.
Global steel demand is expected to improve gradually in 2013 compared with 2012 levels. Growth in the United States will be supported by strong momentum in the auto sector and recovery in construction markets. Concerns surrounding China’s growth and the European debt crisis remain overhangs on the sector’s outlook.
Efforts of the Chinese government to rebalance its economy will contribute to the domestic and global steel demand. Although China is the dominant market in the steel sector, India is also increasing its presence, due to rise in its domestic steel demand. The rising middle class population along with increased urbanization will fuel steel demand in the future.
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 material 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.