The Steel Industry: A Snapshot
Steel is the one of the world’s most essential materials and is present everywhere around our lives. It is used in almost every sphere like buildings, vehicles or even a tin can that preserves food. The steel industry has often been considered an economic indicator, as it has always gone hand in hand with 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 coupled with its highly cyclical and intensely competitive nature.
As urban population increases globally, so will the need for steel to build skyscrapers and public-transport infrastructure. Emerging economies will also continue to be a major driver of demand as these necessitate a huge amount of steel for urbanization and industrialization. The demand for steel will thus remain strong for years to come.
This positive long-term backdrop notwithstanding, the industry’s near- to medium-term outlook is a function of the health of the global economy, which is far from favorable at present.
The Steel Industry: Story So Far
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 into 2013, hinder the industry’s prospects.
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 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%. In the first three quarters of 2013, world crude steel production increased 2.7% year over year to 1,186 Mt. China retained its leadership position, yielding almost 50% of the global output at 587 Mt, an 8% annual rise.
Production in Japan, the second largest producer, increased 1.4% year over year to 82 Mt. The United States held the third position, producing 65 Mt of crude steel, a 4% annual decline. Production in Europe and South America were a dampener, declining 4% and 1.2%, to 124 Mt and 34 Mt, respectively. In Asia, production increased 5.9% to 795 Mt and rose 6.8% to 19 Mt in the Middle East.
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 2% increase in 2012, the World Steel Association projects global steel usage to rise 3.1% in 2013 to 1.475 Mt. This is based on the premise of an expected recovery in global steel demand led by emerging economies. However, the Eurozone crisis remains an overhang.
China’s steel usage in 2013 is estimated to grow 6%, following 2.9% growth in 2012 triggered by the government’s stimulus measures focused on infrastructure. High inflation and structural problems will constrain the usage of steel in certain sectors in India and therefore lead to a tepid 3.4% rise in 2013 after a 2.6% improvement in 2012. After a decline in 2012, steel usage in Japan is expected to witness a tad 0.1% improvement due to government stimulus measures.
In the U.S. market, steel consumption is projected to be up a meager 0.7%, falling from the 7.8% 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 2.8% in 2013 versus 3.1% increase in 2012. In Brazil, investment in infrastructure coupled with modest re-stocking process will lead to apparent steel use growth of 3.2% in 2013.
In Europe, the gloomy economic outlook will continue to pull down demand by 3.8% in 2013. However, this is an improvement from the decline of 9.5% in 2012.
Things Look Better in 2014
The overall scenario is expected to improve in 2014. World steel demand is expected to increase 3.3% to 1,523 Mt driven by a further pickup in global steel demand with the developed economies increasingly contributing to growth. Even though risks within the developed world are expected to dwindle, there will remain some uncertainty in the developing countries due to unresolved structural issues, political instability and volatile financial markets.
China’s steel usage is expected to lose steam and grow 3% over the 2013 projections, as the government’s efforts to rebalance the economy will hold back investment activities. India on the other hand will pick up pace and grow 5.6%, fueled by accelerated attempts to implement structural reforms. Japan’s recovery will be short lived as steel demand is projected to dip 1.6% due to a new consumption tax, manufacturing production relocation from Japan and inflating energy prices.
In 2014, steel use in the U.S. is projected to rise 3% fuelled by the improving global economy and the automotive, energy and residential construction sectors. Central and South America is expected to grow 5% in 2014. Brazil’s steel consumption is expected to grow 3.8% in 2014. However, Europe is expected to recover a modest 2.1% 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 induce 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.
The cost of iron ore is crucial for the global economy as it affects the price of steel. In the first half of 2012, iron ore prices were more or less stable before plummeting to a three-year low of $88.50 per ton in September last year. The price was dragged down by low buying activity due to a weak economic environment. It recovered by the end of 2012 due to aggressive restocking driven by Chinese steel mills.
In the first quarter of 2013, iron ore prices attained a high of $160 per ton, aided by strong steel production in China, seasonally weaker supply of the seaborne iron ore and increased demand growth from steel end-consumers, particularly the Chinese construction sector. However, iron ore prices remained volatile in the second quarter with an average price of $137.4 per ton in April, $124.7 per ton in May and then down to an average price of $114.5 per ton in June. The volatility owed much to the uncertain outlook for steel demand in China.
The picture has changed as iron ore prices entered a bull market in the third quarter, averaging a healthy $133 per ton as sentiment improved across the Chinese metals sector. Chinese steel producers replenished their inventories after two quarters of de-stocking. Steel production surged due to the stimulus aimed at stabilizing the country’s economy. With inventories of iron ore at low levels, increased demand from the steel industry triggered a rise in demand for iron ore.
In the next few years, a wave of new supply of iron ore is slated to hit the market as large players such as BHP Billiton Ltd (BHP - Analyst Report), Vale S.A. (VALE - Analyst Report) and Rio Tinto plc (RIO - Analyst Report) are going gung ho with their expansion. Once the stocking cycle is over and iron ore supplies hit the market, prices are expected to go down.
Consolidation & Divestitures, Expansion Plans
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 was 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.
ThyssenKrupp AG (TYEKF), 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. ThyssenKrupp also completed the sales of its Tailored Blanks business, the market leader in laser-welded blanks for the automotive industry to Chinese steel producer Wuhan Iron and Steel Corporation in July 2013.
After incurring two consecutive years of record losses, ThyssenKrupp is undergoing radical restructuring in which it is trying to sell assets to slash debt and refocus the group on its core European business.
For over a year ThyssenKrupp has been trying to sell its loss-making Steel Americas business, which comprises steel slab plant in Brazil and a processing mill in Alabama for over a year. ThyssenKrupp has faced a succession of costly write-downs since its decision to build the plants. The sale would allow the company to focus on its core Steel Europe and engineering assets. According to latest reports, the company now intends to completely exit its American steel operations while expanding its operations in Brazil.
The long-term growth potential in Brazil remains strong. Infrastructure work will boost steel demand in the nation as the FIFA World Cup is slated to be held in Brazil in 2014 and Rio de Janeiro will host the summer Olympics in 2016. As mentioned earlier, apparent steel use is projected to rise 3.2% in the region in 2013.
ArcelorMittal also recently announced its plans to restart an expansion project at its Monlevade and Juiz de Fora sites in Brazil. The project expansion is expected to increase the annual production capacity from 3.75 million tons to 4.9 million tons.
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.
What’s in Store from the Major Consumer Markets
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 Co. (GM - Analyst Report), Ford Motor Co. (F - Analyst Report), Toyota Motor Corp. (TM - Analyst Report) and Honda Motor Co. Ltd. (HMC - Analyst Report).
The automobile sector has performed impressively this year, buoyed by economic recovery and escalating demand in the U.S. and Asia. Average age of vehicles on U.S. roads reached an all-time high of 11.4 years in Aug 2013, leading to high replacement demand for cars.
The robust growth rate in the sector has been fueled by strong pent-up demand, easier car financing, launch of several redesigned and fuel-efficient vehicles, improving employment rates and rebound in consumer confidence, thanks to an increasing belief that the housing market is recovering.
The construction sector has been showing signs of upturn in construction activity. The architecture billing index (ABI), an economic indicator, which provides an approximate 9- to 12-month glimpse into the future of non-residential construction spending activity, was at 54.3 in September despite uncertainty regarding the federal government shutdown. This also marked a year of steady non-residential billings growth.
The strength in recent readings in the ABI signals an impending healthy upturn in non-residential activity. The American Institute of Architects projects a 2.3% increase in spending in 2013 for non-residential construction projects with next year’s projection at 7.6% increase.
The residential housing sector is also showing signs of strong momentum in 2013 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. However, the partial government shutdown in October and confusion over a debt default had increased uncertainty in the construction sector.
The Fed made no changes to its stimulus program during the September FOMC meeting, which coupled with the lifting of the government shutdown, sparked optimism about builder and consumer sentiment bouncing back. However, all eyes will now be on the outcome of the FOMC meeting today and it remains to be seen whether Fed would consider a small taper. The market is hoping that the Fed will not spring any surprise this time and leave the stimulus in place, at least for the next few months.
The steel industry will 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.
Sector Level Performance in Q2 and Q3 So Far
Looking Back at Overall Q2 Results - Looking at results of all the companies in the Basic material sector, earnings dipped 9.9% in the second quarter, deteriorating from the 1.6% decline in earnings witnessed in the first quarter of 2013. However, revenues for the sector went down 1.4% in the second quarter, worsening from the flat sales in the first quarter.
Top & Bottom Line, So Far So Good - We are in the midst of the third quarter earnings season. In the basic material sector, 45.8% of the companies have reported to date. Earnings increased 26.8%, reversing the 7.6% decline recorded in the second quarter by these companies who have reported so far. Revenues went up 5.4%, faring much better than the 2.9% dip in the second quarter.
Earnings Beat - Of the companies reported, the Basic Material sector had a beat ratio (percentage of companies coming out with positive surprises) of 81.8% compared with the 54.5% beat in the second quarter. Even though results are looking better at the moment than the previous quarter, it is too early to cheer.
Q3 & Beyond: What Zacks Predicts
The Basic Material sector is one of the sectors experiencing material negative estimate revisions, largely reflecting the overall negative tone of guidance provided by companies. 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 for volumes.
Quarterly Numbers: Keeping aside the preliminary numbers, earnings for all the companies in the Basic Material sector are expected to rise 2.4% in the third quarter and revenues are expected to edge up 0.9%. However, it is expected to improve in the fourth quarter as earnings are expected to increase 8.7% and revenues are expected to rise 1%.
In the first quarter of 2014, the sector’s earnings are expected to rise 9.5% despite a meagre 2.5% rise in revenues. In the second quarter of 2014, earnings are projected to surge 19.5%, while revenues are expected to increase by 1.9%.
Yearly Numbers - In 2013, the sector’s earnings are expected to dip 0.4%, while revenues are expected to grow 0.7%. In 2014, earnings growth is projected at 18.3% and revenues at 3.8%.
For more information about earnings for this sector and others, please read our ‘Record Earnings, But Outlook is Uncertain' report.
Industry Ranking: Overall Negative
Within the Zacks Industry classification, the steel industry falls under the broader Basic Materials sector (one of 16 Zacks sectors). We rank all of 259 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 producers industry features in the top 1/3rd with a Zacks Industry Rank #69. However, the steel-pipe and tubes producers with a Zacks Industry Rank #206 and the steel specialty industry with a Zacks Rank #220 make it to the bottom one third. This indicates that the overall outlook is skewed to 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) helps in predicting the probability of earnings surprises.
To Sum Up
Steel has been out of favor of late. However, revival in global economy’s growth rate could brighten the outlook for the steel industry. Manufacturing activity in China grew at its fastest pace in seven months in October. The preliminary HSBC China Manufacturing Purchasing Managers' Index for October increased to 50.9 from September's final reading of 50.2 as the government readies a series of key economic reforms. This adds further evidence to China's ongoing growth rebound.
On the flip side, manufacturing numbers out of Europe were disappointing. The purchasing managers' index for the Euro zone declined to 51.5 in October from 52.2 in September. As per preliminary financial data, the U.S. Manufacturing Purchasing Managers Index fell to 51.1 in Oct, the lowest since October 2012, from 52.8 in September. This is mainly due to the 16-day U.S. government shutdown that has slowed overall U.S. growth slightly in the fourth quarter of 2013.
Overall, global economic and political uncertainty, complicated by political issues in the U.S., will continue to be a headwind for the industry in the fourth quarter of 2013. Things will look up thereafter as the impact of the U.S. government impasse wears off. Pricing will also remain near the current low levels for the remainder of the year.
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 major industry trends are strategic cost reduction, vertical integration and capital optimization.
Global steel demand is expected to improve gradually in 2013 and thereafter in 2014. Growth in the United States will be supported by strong momentum in the auto sector and recovery in construction markets. Efforts of the Chinese government to rebalance its economy will contribute to the domestic and global steel demand. India will also stoke steel demand in the future, thanks to a rising middle class along with increased urbanization.
Steel selling prices will improve hand-in-hand with improved demand across most regions along with higher raw material prices. 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.