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Steel Industry Stock Outlook - Jan 2017

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The steel industry is currently reeling from the economic slowdown in China, and the continued weakness in the manufacturing sector and the glut of foreign steel imports into the U.S., despite sustained demand from the automobile and construction sectors.

Per the World Steel Association’s data available til Nov 2016, global steel production edged up 0.4% to 1468 metric tons (Mt). China, the world’s largest steel maker, delivered a 1.1% rise in steel production during the time period. Economic slowdown in China has dealt a massive blow to the global steel industry. Overcapacity and lower steel prices are hurting margins of Chinese steel producers. To negate these factors, efforts have been undertaken to reduce overcapacity and upgrade production in China's steel industry.

China’s economy grew at an annual rate of 6.7% in the third quarter of 2016, unchanged from the prior two quarters. China official steel PMI dropped to 47.6 in December, following two months of gains, with output contracting sharply owing to production curbs implemented by regulators on environmental concerns.

According to the World Steel Association’s short range outlook published in October, steel demand decline in 2016 will be less severe than previously expected. To mitigate the impact of rebalancing, the Chinese government issued a number of mini stimulus measures to  boost infrastructure spending. However, the rebound in the real estate market is limited and not sustainable as inventory levels remain very high. Consequently, the construction sector will be deterrent for steel demand and manufacturing sectors have only limited room for recovery. Steel demand in China is projected to decline 2.0% in 2017.

Additionally, the steel industry is challenged by waning investments, turbulence in the financial market and geopolitical conflicts in many developing regions. Given the industry’s 10% exposure to the energy sector, lower oil prices have weighed down prices of steel as well. Steel demand from energy companies continues to be weak due to declining capital expenditure budgets. United States Steel Corp. (X - Free Report) , which is the biggest supplier to energy companies in North America, along with AK Steel Holding Corporation (AKS - Free Report) and ArcelorMittal (MT - Free Report) , remains affected by the slowdown.

U.S. steel mills remain impacted by depressed capacity utilization and a surge of unfairly traded imports. The domestic market continues to be inundated with cheap imports from overseas producers, especially from China. American steel makers including Nucor Corporation (NUE - Free Report) , United States Steel, AK Steel, Steel Dynamics Inc. (STLD - Free Report) and ArcelorMittal USA, a part of ArcelorMittal, have bore the brunt of high levels of cheap imports. This has resulted in declining orders, idling of mills and layoffs across the board.

Consequently, U.S. steel makers continue to actively press the U.S. regulators to stop unfair trade practices and enforce new trade laws to rescue the crisis-hit American steel industry. Consequently, steel market conditions have been recovering lately, driven by favorable developments on steel trade cases in the recent past. Moreover, steel prices have rebounded partially of late, helped by punitive trade actions that led to levy of tariffs on imports.

Sector Level Earnings Trend

Within the Zacks Industry classification, the steel industry falls under the broader Basic Materials sector (one of the 16 Zacks sectors). The sector put up a 4.7% year-over-year increase in earnings on the scoreboard for the third quarter.

Though sector growth will remain in negative territory in the fourth quarter, a dip of 0.8% projected for the quarter is not that steep compared to the third quarter. The sector will decline 0.6% in the first quarter of 2017. The earnings graph will enter the positive territory and log growth of 9.2%, 6.9% and 15.9% in the second, third, and fourth quarters of 2017, respectively.

Industry Ranking

Within the Zacks Industry classification, the “steel producers,” “steel-pipe and tube” and “steel specialty” industries are grouped under the Basic Materials sector (one of 16 Zacks sectors). We rank all of the 255 industries under 16 Zacks sectors based on the earnings outlook for the constituent companies in each industry. This ranking is available on the Zacks Industry Rank page.

The way to align the ranking and outlook from the complete list of Zacks Industry Rank for the 255+ companies is that the outlook for the top one-third of the list (Zacks Industry Rank of #85 and lower) is positive, the middle one-third (Zacks Industry Rank between #86 and #170) is neutral, while the outlook for the bottom one-third (Zacks Industry Rank #171 and higher) is negative.

The “steel producers” and “steel-pipe and tube” industries are currently in the top tier both with respective Zacks Rank of #20 and #84, which translates into a positive outlook. The “steel specialty” industries, on the other hand, are relegated to the bottom tier with a Zacks Rank #244, exhibiting a negative outlook.

What Lies Ahead?

The World Steel Association expects global steel production to edge up 0.5% in 2017. Continued weakness in investment globally is hindering a stronger steel demand recovery. However, a better-than-expected forecast for China, along with continued growth in emerging economies, will aid the global steel industry resume a positive growth path in 2017.

The U.S. steel industry continues to face the threat of cheaper imports in the wake of a stronger dollar and lower oil prices. Steel market conditions in the U.S. have improved of late, driven by favorable developments on steel trade cases in the recent past. Steel prices recovered partially on the back of punitive trade actions that led to levy of tariffs on imports. U.S. steel producers continue to actively press the U.S. regulators to stop unfair trade practices and ensure a fairer and more competitive market for American steel makers and workers.

China will remain a hindrance as uncertainty persists related to the impact of government measures aimed at stabilizing the decelerating economy. The International Monetary Fund projects China’s growth to slow down further to 6.5% in 2017.

Meanwhile, India is anticipated to act as the next growth engine, given its progressing construction and manufacturing sectors, rapid urbanization and structural reforms. The European economy, on the other hand, is on a slow road to recovery. Steel demand in the EU is expected to go up in 2017. This is a positive for companies like ArcelorMittal, which generates almost half of its revenues from this region. United States Steel also has a significant presence in Europe.

Although the steel industry will remain under pressure for some time, it is certainly expected to grow thereafter on the back of the automotive and construction industries. At this juncture, we recommend stocks such as AK Steel, Steel Dynamics, and MRC Global Inc. (MRC - Free Report) , which sport a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here. AK Steel, Steel Dynamics and MRC Global, have delivered an average positive earnings surprise of 170.80%, 10.12% and 83.27% respectively over the past 4 quarters.

However, we suggest staying away from or getting rid of Zacks Rank #5 (Strong Sell) stocks such as ThyssenKrupp AG and Aperam (APEMY - Free Report) .