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Steel Industry on the Mend: Good Time to Buy Stocks

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Steel is used in every important industry ranging from energy, construction, automotive and transportation, infrastructure, packaging and machinery. Expectations of increased infrastructure-related spending in the U.S. has pushed steel company stocks to new highs, particularly following the November election.

While some people are legitimately concerned about the industry’s steel industry’s performance lately, there are plenty of reasons to be optimistic about the broader steel industry, both in the short and long term. Here, we discuss some of the key reasons and what investors in the steel sector can look forward to in the coming months and years.

Construction Sector Remains a Pillar of Strength

Amid a volatile U.S. stock market, aftermath of Brexit and volatile oil prices, the homebuilding market remains a pillar of strength for the economy along with the steel industry. The housing and construction sector is the largest consumer of steel, accounting for almost half of the total consumption. Positives like an improving economy, modest wage growth, low unemployment levels, low interest rates, positive consumer confidence and a tight supply situation raise optimism about the sector’s performance.

The US Architecture Billings Index (ABI), an economic indicator that provides an approximately 9 to 12 month glimpse into the future of non-residential construction spending activity, has been at 50 or better for 20 of the last 24 months indicating reliable, manageable, sustainable growth in architectural activity. The American Institute of Architects (AIA) anticipates spending in the non-residential building sector to climb around 6% in 2017. Nucor Corporation NUE and Commercial Metals Company CMC are the leading steel suppliers to the non-residential construction sector.

The Dodge Momentum Index grew 2.9% in December to 136.7 from its revised November reading of 132.8. It is a monthly measure of the first report for non-residential building projects in planning, which have been shown to lead construction spending for non-residential buildings by a full year. The Index is currently at an eight-year high after its steady 2016 climb.

Over the long haul, as the urban population increases worldwide, the need for steel to build skyscrapers and public transport infrastructure should see an uptrend as well. Emerging economies will continue to be major demand drivers owing to the huge amount of steel required for urbanization and industrialization. Hence, demand for steel is expected to remain strong in the years to come. Companies like United States Steel Corp. X, ArcelorMittal (MT - Free Report) , Nucor Corporation and Steel Dynamics Inc. STLD would benefit from the momentum in construction.

Automotive Sector in Top Gear

The automotive sector, which is the second-largest steel consumer, is showing significant promise despite threats from other materials. Besides giving a boost to the already rising U.S. auto sales, cheap oil has backed a recovery in the European auto market. The rising sales trend is anticipated to persist on the back of falling fuel prices, low interest rates, enhanced job security, rising wages and household wealth, improving consumer confidence, residual pent-up demand, attractive deals and vehicle launches.

Moreover, the high average age of light vehicles on U.S. roads is resulting in large replacement demand for cars as well as car parts. The average age is estimated to rise to 11.5 years by 2017 and 11.7 years by 2019 from 11.4 years at the end of 2013, according to forecasts by IHS Automotive. This will benefit auto parts manufacturers and retailers.

The auto industry in Asian countries, particularly China and India, are also projected to flourish over the next five to seven years. China is the biggest and fastest growing auto market in the world in terms of number of vehicles sold. With automakers cashing in on strong demand, steel is expected to get a proportional boost in the years to come. ArcelorMittal and AK Steel Holding Corporation AKS generate a large portion of their revenues from auto companies.

Indian Steel Sector to Be a Major Driver

India, currently the fourth largest producer of steel in the world, is expected to record exponential growth in the future. This will be fueled by increasing urbanization and projected growth in the infrastructure, automobile and real estate sectors.

The country’s comparatively low per capita steel consumption and the anticipated rise in consumption due to increased infrastructure construction, along with the thriving automobile and railways sectors, offer huge scope for growth. In fact, as per the World Steel Association, steel demand in the sub-continent is projected to grow 4% in 2017 backed by its reforms to boost consumption and infrastructure investment.

Steady Growth in Developed Economies

Developed economies are expected to witness a stable recovery momentum, albeit at a slow pace. Steel demand in these regions will grow 1.1% in 2017. In the EU, steel demand recovery remains on track backed by resilient consumption and a mild recovery in construction. In the U.S., an improving job market and a strong housing sector will support growth in steel demand.

Imposing Anti-Dumping Duties

U.S. steel companies have been hammered by a tide of cheap imports over the past few years that largely contributed to the slump in steel prices. Low costs of production have allowed overseas producers to sell their products at cheaper rates, leading to an industry-wide price decline.

Big U.S. steel producers U.S Steel, AK Steel, Nucor, Steel Dynamics and ArcelorMittal USA retaliated by filing anti-dumping petitions in Jul 2015 with the U.S. International Trade Commission (“USITC”) and the DOC, alleging illegal dumping of cold-rolled steel that is used to make automotive products and appliances, among others. The regulator found that imports of cold-rolled steel flat products have caused or threatened to cause material injury to the U.S. steel industry and thus imposed hefty anti-dumping duty and countervailing duty on these imports.

In a similar development, earlier this month, The USITC made its final determinations on anti-dumping and countervailing duty investigations on imports of certain hot-rolled steel flat products by seven countries (Australia, Brazil, Japan, South Korea, the Netherlands, the U.K. and Turkey) into the American market. Hot-rolled steel is used in appliances, automotive products, heavy machinery, machine parts, commercial construction and transportation equipment.

As a result of the USITC’s affirmative findings, the DOC will now issue countervailing duty orders on imports of hot-rolled steel products from Brazil and South Korea and anti-dumping duty orders on imports from Australia, Brazil, Japan, South Korea, the Netherlands, Turkey and the U.K. These actions are anticipated to assist American steel makers defend their turf against illegally dumped steel products and improve the margins of steel companies.

How to Play the Industry

As you can see, there are many reasons to be optimistic about the steel industry over the long haul. We particularly recommend stocks such as AK Steel which sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here. AK Steel delivered an average positive earnings surprise of 170.80% over the last 4 quarters. Stocks such as United States Steel and Ryerson Holding Corporation RYI are also good bets with a Zacks Rank #2 (Buy). United States Steel and Ryerson Holding also delivered an average positive earnings surprise of 140% and 47.57% respectively over the past 4 quarters.

However, the glut in cheap imports and slowdown in China will continue to weigh on the industry. In this scenario, staying away from stocks with an unfavorable Zacks Rank should be the right strategy. We strongly suggest steering clear from or getting rid of stocks with a Zacks Rank #5 (Strong Sell) which includes Haynes International, Inc. HAYN and ThyssenKrupp AG TYEKF.

Check out our latest Steel Industry Outlook for more on the current state of affairs in this market from an earnings perspective, and how the trend is shaping up for the future.

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