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Steel Industry Stock Outlook - May 2018

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The steel industry enjoyed a good run in 2017, barring a few lingering challenges. The industry will benefit from strong economic momentum being exhibited by advanced and developing economies, and sustained healthy demand in the automobile and construction sectors.

Further, President Trump’s plans for massive infrastructure spending — one of his key campaign promises — will be a catalyst for American steel makers given the expected increase in steel consumption. Notably, Trump’s aggressive trade policies are anticipated to provide more protection to the U.S. steel industry.

Steel Imports “Threat to National Security,” Trump Slaps Tariff

In March, President Trump implemented a tariff of 25% on steel imports and 10% on aluminum imports from all countries except Canada and Mexico, to counter an "assault on the country" by foreign competitors. This is an attempt to reinforce the American steel and aluminum industries, which have long been reeling under the onslaught of cheap imports and suffered significant reduction in production as well as employment.

This was the aftermath of the U.S. Department of Commerce’s investigations under Section 232 of the Trade Expansion Act of 1962 at the behest of the Trump administration. In fact, in January 2018, the investigating authority submitted reports to the President stating that the quantities of steel and aluminum imports “threaten to impair the national security.” Notably, U.S. steel imports were nearly four times the country’s exports. Six basic oxygen furnaces and four electric furnaces have been closed since 2000 and employment has slumped 35% since 1998.

Tariffs a Relief for Steel Industry

The imposition of tariff on imports would improve domestic steel production from its present capacity of 73% to approximately an operating rate of 80% — the minimum rate required for the long-term viability of the industry. It will also lead to lower imports into the United States, which would in turn, will boost demand for American steel. This will provide the domestic players with more pricing power and help to level the playing field.

According to the latest report from the American Iron and Steel Institute (“AISI”), an association of North American steel makers, total and finished steel imports have dipped 3.0% and 1.7%, respectively, year over year in the first quarter of 2018. For 2018, annualized total and finished steel imports is projected to decline 8.8% and 7.6% year over year, respectively.

This is a major improvement from the 15% rise noted in total steel imports in 2017. Despite the U.S. Department of Commerce’s imposition of several duties on additional steel products, imports refused to abate last year due to foreign producers’ overcapacity. Moreover, a delay in Section 232 investigation on steel imports by the U.S. Department of Commerce also triggered a spike in steel imports in 2017.

Steel Production Expands at Solid Pace

Following an increase of 5.3% in world crude steel output in 2017, the momentum continues in 2018. Per the World Steel Association, (“WSA”) global steel production improved 4.1% to 426.6 metric tons (Mt) on a year-over-year basis in the first quarter of 2018 propelled by higher output across all regions.

Steel production in Asia was pegged at 294 Mt in the quarter, an increase of 4.6% year over year. North America’s crude steel production registered a 1.9% rise to 29.5 Mt in the quarter while the EU produced 43.1 Mt of crude steel, rising 0.9% year over year. China, the world’s largest steel maker which accounts for around half of the global production, delivered a 4.5% rise in steel production to 74 Mt during the quarter.

Industry Positioning: Favorable

The Zacks Industry Rank relies on the same estimate revisions methodology that drives the Zacks Rank for stocks. The way to look at the complete list of industries is that, we put our X industries (all 265 of them) into two groups: the top half (i.e., industries with the best average Zacks Rank) and the bottom half (the industries with the worst average Zacks Rank).

In the last 10 years, using a one week rebalance, the top half beat the bottom half by a factor of more than 2 to 1. Click here to know more: About Zacks Industry Rank

Within the Zacks Industry classification, the Steel specialty, Steel producers, Steel-pipe and tube and industries are grouped under the Basic Materials sector (one of 16 Zacks sectors). The Steel specialty, Steel producers, Steel-pipe and tube, with a Zacks Industry Rank of #14, #23 and #102, respectively, remain in the top half.

Sector Level Earnings Trend: Positive

Per the Zacks Industry classification, the steel industries are grouped under the broader Basic Materials sector. Per our projections, earnings for the Basic Materials sector are anticipated to surge 38.6% in the first quarter of 2018. For full year 2018, the sector is anticipated to log an impressive earnings growth of 35%. In 2019, earnings growth will be 8.3%.

Ahead of S&P 500

The Steel Specialty, Steel Producers and Steel-pipe industries’ respective rise of 31.9%, 25.6% and 13.5% in the past year has outperformed the S&P 500’s growth of 11.8%.

Where’s the Industry Headed?

The WSA forecasts global steel demand to expand 1.8% in 2018 to 1,616.1 Mt as favorable global economic scenario, commodity prices and perked up investment will drive steel demand in both developed and developing economies. However, deceleration in China and weakened investment momentum due to higher interest rates has led to a weakened projection of 0.7% for 2019. As the China government continues to focus on shifting the growth driver toward consumption, investment is likely to further decelerate.

The outlook for steel demand in the United States is supported by strong demand and investment triggered by rising income and low interest rates. In the Eurozone, broadening recovery across countries, robust domestic demand, resumption in investment as well as pickup in non-residential construction and strong manufacturing activities will lead to growth.

Recovery in oil and commodity prices has improved the outlook for the Middle East. Provided geopolitical stability can be achieved, steel demand outlook for the region could further improve driven by reconstruction demand. The mild recovery in Russia and Brazil is anticipated to continue and in other Latin American countries, recovery is underway and growth will likely pick if reforms are implemented.

India is anticipated to act as the next growth engine, given its progressing construction and manufacturing sectors along with rapid urbanization and structural reforms. The Indian economy is stabilizing from the impact of currency reform and GST implementation and steel demand is expected to accelerate gradually, mainly driven by public investment.

However, rising trade tensions, inflationary pressure and tightening of the United States and EU monetary policies may cause market volatilities and trouble highly indebted emerging economies. These factors are likely to dampen the steel industry’s momentum. Meanwhile, the automotive and construction industries will continue to be the mainstays of the steel industry.

Some Stocks in Focus

Overall a favorable ranking, earnings growth expectation instils optimism for the industry. Investors can consider the following steel stocks that are backed by a solid Zacks Rank and healthy growth projections.

Steel Dynamics, Inc. (STLD - Free Report) can be a solid addition to one’s portfolio. The stock currently has a Zacks Rank #1 (Strong Buy) and a long-term estimated earnings growth rate of 32%. Over the past 90 days, its estimates for 2018 and for 2019 have gone up 21% and 12%, respectively. The company has an average positive earnings surprise history of 3.15% over the trailing four quarters. You can see the complete list of today’s Zacks #1 Rank stocks here.

Ternium S.A. (TX - Free Report) has an expected long-term earnings growth rate of 39%. It carries Zacks Rank of #1. Over the past 90 days, its estimates for 2018 and 2019 have gone up 33% and 17%, respectively. The company has an average positive earnings surprise history of 50.23% over the past four quarters.

Nucor Corp. (NUE - Free Report) , which carries a Zacks Ranked #2 (Buy), has an estimated long-term earnings growth rate of 20%. Its estimates for fiscal 2018 and fiscal 2019 have moved up 20% and 8%, respectively, over the past 90 days. The company has an average positive earnings surprise history of 3.78% over the trailing four quarters.

However, we suggest staying away from or getting rid of Zacks Rank #5 (Strong Sell) stocks such as Aperam S.A. (APEMY - Free Report) and Shiloh Industries, Inc. (SHLO - Free Report) which carries a Zacks Rank #4 (Sell). Both the stocks have been witnessing downward estimate revisions lately.

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