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China Clouds Near-Term Prospects for Steel Producers' Stocks

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The Zacks Steel Producers industry consists of producers of a wide range of steel products for a number of end-use industries including for automotive, construction, appliance, container, industrial machinery, transportation and oil and gas. These products include hot-rolled and cold-rolled coils and sheets, hot-dipped and galvanized coils and sheets, reinforcing bars, billets, wire rods, strip mill plates, standard and line pipe and mechanical tubing products.

Here are the three major themes in the industry:

  • The steel producers industry faces risks stemming from U.S.-China trade tensions and economic cooling in China, the world’s top consumer of steel. The trade war has taken a heavy toll on the Chinese economy as reflected by China’s recent tepid economic indicators. A slowdown in steel demand in China amid a sluggish economy spells problem for the steel producers industry. Signs of weakness across the country’s major steel end-use markets — construction and automotive — as reflected by a slowdown in real-estate investment growth and declining car sales have clouded steel demand outlook.
     
  • The industry continues to reel under the effects of sustained oversupply of steel in the market, exacerbated by a surge in production in China to record highs in recent months. Notwithstanding the lingering trade tensions, China’s steel mills have been beefing up output to take advantage of strong profit margins. A glut of cheap Chinese steel driven by the ramp up in output amid weak domestic demand has put downward pressure on global steel prices of late.
     
  • The 25% tariff on steel imports, which the Trump administration levied in March 2018, has injected a new lease of life into U.S. steel producers, who long struggled to cope with a tide of subsidized foreign imports. The tariffs are boosting production capacity of U.S. steel producers amid declining imports. The tariffs have also provided a thrust to U.S. steel prices this year, giving American steel makers more pricing power. This has also provided margin benefits to U.S. steel producers. While there are still uncertainties surrounding tariffs including exemptions of countries, they should provide further cushion to U.S. steel producers in the near term.


Zacks Industry Rank Indicates Bleak Prospects

The Zacks Steel Producers industry is part of the broader Zacks Basic Materials Sector. It carries a Zacks Industry Rank #197, which places it at the bottom 23% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates gloomy near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s position in the bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually losing confidence in this group’s earnings growth potential. Since Jul 31, 2018, the industry’s earnings estimate for the current year has gone down 23.4%.

Before we present a few steel producers stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock market performance and current valuation.

Industry Lags Sector and S&P 500

The Zacks Steel Producers industry has lagged both the Zacks S&P 500 composite and the broader Zacks Basic Materials Sector over the past year.

The industry has declined 20.3% over this period compared with the S&P 500’s fall of 1.2% and the broader sector’s decline of 15.2%.

One-Year Price Performance

Industry’s Current Valuation

On the basis of the trailing 12-month enterprise value-to EBITDA (EV/EBITDA) ratio, which is a commonly used multiple for valuing steel stocks, the industry is currently trading at 8.24X, below the S&P 500’s 10.21X. However, it is ahead of the sector’s trailing-12-month EV/EBITDA of 7.25X.

Over the past five years, the industry has traded as high as 14.26X, as low as 5.38X and at the median of 8.11X, as the chart below shows.

Enterprise Value/EBITDA (EV/EBITDA) Ratio

Enterprise Value/EBITDA (EV/EBITDA) Ratio
 

Bottom Line

The steel producers industry remains hamstrung by sustained overcapacity, driven by a surge in Chinese production. Trade tensions between the United States and China also pose as headwinds to the industry. A weakening Chinese economy amid trade war has triggered a slowdown in China’s steel demand.
 
Nevertheless, trade tariffs have provided a reprieve to U.S. steel producers. The punitive tariffs are bearing fruit as reflected by a decline in U.S. steel imports. The tariffs should provide more protection to these producers moving forward.

Here, we present one stock with a Zacks Rank #2 (Buy) that is well positioned to gain amid the prevailing challenges. There are also three stocks with a Zacks Rank #3 (Hold) that investors may currently hold on to. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

POSCO (PKX - Free Report) : The consensus EPS estimate for this South Korea-based company has moved 7.3% higher for the current year, over the last 90 days. The stock, carrying a Zacks Rank #2, has an expected earnings growth of 20.7% for the current year. It also has an estimated long-term earnings growth rate of 5%.

Price and Consensus: PKX
 

United States Steel Corporation (X - Free Report) : The Pennsylvania-based company currently carries a Zacks Rank #3. It has an expected earnings growth of 182.5% for the current year. The company delivered an average positive earnings surprise of 12.3% in the trailing four quarters. It has an estimated long-term earnings growth rate of 8%.

Price and Consensus: X


 

Nucor Corporation (NUE - Free Report) : The North Carolina-based company has a Zacks Rank #3. The Zacks Consensus Estimate for earnings for 2018 indicates year-over-year growth of 115.7%. The Zacks Consensus Estimate for the current-year EPS has been revised 0.3% upward over the last 90 days. The company also has an estimated long-term earnings growth rate of 12%.

Price and Consensus: NUE



Steel Dynamics, Inc. (STLD - Free Report) : The Indiana-based company currently carries a Zacks Rank #3. It has an expected earnings growth of 110.6% for the current year. The company delivered an average positive earnings surprise of 5.2% in the trailing four quarters. It also has an estimated long-term earnings growth rate of 12%.

Price and Consensus: STLD


 

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