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On Jul 2, we downgraded metals processor Reliance Steel & Aluminum Co. (RS - Analyst Report) to Underperform. Our view takes into account softness in the non-residential construction market and the weak pricing environment.  

Why the Downgrade?

Reliance Steel had a lackluster first-quarter 2013 (reported on Apr 25) with both revenues and earnings missing the Zacks Consensus Estimate. Weak demand and lower pricing led to a double-digit decline in revenues.

Healthy momentum across automotive, energy and heavy equipment was somewhat masked by lingering weakness in the non-residential construction market. The company expects economic challenges to continue into the second quarter.

Following the release of the first quarter results, the Zacks Consensus Estimate for 2013 for Reliance Steel has gone down roughly 11% to $4.90 per share.

Cause for Concern

Reliance Steel, which currently has a Zacks Rank #5 (Strong Sell), remains challenged by weak steel industry fundamentals and contends with soft steel and metals pricing environment. In addition, raw material prices are expected to remain volatile.

The steel industry remains affected by overcapacity that continues to outpace demand. There is not enough demand for steel products due to weakness in construction end markets, resulting in excess supply. Contributing toward this inventory glut are production ramp ups by domestic steel producers and rapid growth in Chinese production.

We also remain concerned about the non-residential construction market (Reliance Steel’s largest end market), which continues to be the weakest link. While there has been a modest recovery of late, demand remains significantly below the peak levels achieved in 2006.

Other Stocks to Consider

While we prefer to stay away from Reliance Steel, other companies in the metals industry having a favorable Zacks Rank are NSK Ltd. (NPSKY), Kaiser Aluminum Corporation (KALU - Snapshot Report) and Northwest Pipe Co. (NWPX - Snapshot Report). While NSK and Kaiser Aluminum hold a Zacks Rank #1 (Strong Buy), Northwest Pipe retains a Zacks Rank #2 (Buy).

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