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Steel Industry Back in Favor: Time to Buy?

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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. have thrust steel company stocks to new highs, particularly following the November election.

There are plenty of reasons to be optimistic about the broader steel industry, both in the short term 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 Remains a Pillar of Strength

The homebuilding market remains strong for the economy as well as 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 and sustainable growth in architectural activity. The American Institute of Architects (AIA) anticipates spending in the non-residential building sector to advance around 6% in 2017. Nucor Corporation (NUE - Free Report) and Commercial Metals Company (CMC - Free Report) are the leading steel suppliers to the non-residential construction sector.

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 catalysts 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 - Free Report) , ArcelorMittal (MT - Free Report) , Nucor Corporation and Steel Dynamics Inc. (STLD - Free Report) would benefit from the momentum in construction.

Automotive Will Provide Thrust

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. Moreover, the trend will be backed by 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 Corp. (AKS - Free Report) 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 anticipated to record exponential growth in the future. This will be fuelled 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. Steel demand in the sub-continent is projected to grow backed by reforms to boost consumption and infrastructure investment.

Steady Growth in Developed Economies

Developed economies are expected to witness a stable recovery momentum. Steel demand in these regions will grow 0.7% in 2017 and 1.2% in 2018. In the EU, steel demand recovery remains on track, backed by resilient consumption and a mild recovery in construction. Eurozone monetary policy will remain on its current path. If political stability can be maintained, investment is anticipated to pick up and provide a further boost to the recovery.  In the U.S., an improving job market and a strong housing sector and Trump’s infrastructure push will support growth in steel demand.

Imposing Anti-Dumping Duties

U.S. steel companies have been battered 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 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.

One of the major factors that have stimulated a recovery in the steel sector is favorable developments on a number of trade cases that led to a decline in steel imports. Affirmative rulings in these cases have been a positive catalyst for the U.S. steel industry. Steel imports fell around 15% year over year in 2016 on the back of punitive trade actions that led to levy of tariffs on imports.

U.S. regulators, in mid-2016, imposed a whopping final anti-dumping duty rate of 209.97% on imports of corrosion-resistant steel from China and also slapped a hefty final anti-dumping duty rate of 265.79% on Chinese cold-rolled steel. The DOC, in Sep 2016, also levied anti-dumping duties on imports of certain hot-rolled steel flat products by seven countries.

Moreover, the DOC, last month, issued positive final rulings in anti-dumping duty investigations on imports of carbon and alloy steel plates from eight countries. The commerce department found that these exporters are selling these products in the U.S. at unfairly low prices and, therefore, are subject to anti-dumping duties. The U.S. International Trade Commission (“ITC”) is scheduled to make final ruling on this case in May.

Also President Trump’s announcement of an investigation into whether cheap steel imports from China and other nations are hurting national security has instilled optimism. Trump also said that “steel is critical to both our economy and our military” and it is a “historic day for American steel.”

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 ArcelorMittaland Nucor Corporation, both flaunting a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

ArcelorMittal has an expected long-term EPS growth rate of roughly 11.51%. It has delivered an average positive earnings surprise of 143.80% in the trailing four quarters. ArcelorMittal’s share price has gained 45.8% in the last year, outperforming the Steel-Producers industry’s gain of 28%.

Nucor delivered an average positive earnings surprise of 11.63% in the past four quarters. The stock has an expected long-term estimated growth rate of 12%. Nucor has delivered a return of 30.1% over the past year, ahead of the Steel-Producers industry’s gain of 28%.

Valmont Industries, Inc. (VMI - Free Report) is also a good pick. Armed with a Zacks Rank #2 (Buy), the stock has an estimated long-term earnings growth of 10%. It has delivered an average positive earnings surprise of 4.37% in the last four quarters.

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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