Increasing modernization in the 21st century has doubled global steel production from 851 Mt (million tons) at the turn of the century to 1,606 Mt in 2013. The size notwithstanding, the industry remains relatively fragmented. It is also highly cyclical and intensely competitive.
In the past two years, the continuing Euro-zone difficulties, slow growth in developed economies and a cooling of emerging economies took a toll on the industry. Growth in the Chinese economy, which in recent years has been one of the main demand drivers for steel, slowed down. Overcapacity has also been a perennial problem. Stiff competition in the United States from domestic producers having newer or expanded facilities, as well as the threat of cheaper imports, continues to result in significant oversupply compared to demand.
2014 is expected to be a “transition year” for the steel industry with all major steel-consuming countries expected to log positive growth. This will also be the first time since 2006 when the growth rate in China will be outpaced by growth elsewhere. As China transitions to a services and consumer-driven economic growth mode, national mandates to rationalize capacity will affect supply. Meanwhile, global steel supply and demand will grow in tandem with economic recovery around the world.
In the long term, as urban population increases worldwide, so will the need for steel to build skyscrapers and public-transport infrastructure. Emerging economies will also continue to be a major driver of demand due to the huge amount of steel required for urbanization and industrialization. The demand for steel is thus expected to remain strong in the years to come.
Let’s have a look at how things are shaping up at this moment.
Global Production: Growth Picking Up despite a Weak Start to 2014
As mentioned above, world crude steel production was 1,607 Mt in 2013, reflecting a 3.5% annual climb, led by increases in Asia and the Middle East that helped counter the declines elsewhere. China was once again the leading producer of steel, contributing a record 48.6% of the global output, followed by Japan, United States and India. Fourth-quarter production in Europe rebounded with the first positive year-over-year movement since the fourth quarter of 2011. This was in contrast to the decline in production seen all through the year.
The steel industry started 2014 on a weak footing with a 0.4% decline in production in January, dragged down by China due to soft industrial activities during the Chinese Lunar New Year holidays. The industry soon regained its ground, as production picked up in China and India. Gains in the European Union, thanks to a recovery in steel demand in the region, coupled with a strong rise in the Middle East also contributed to the uptrend.
Per the latest data available from the World Steel Association, global steel production has increased 2.2% to 668 Mt in the first 5 months of 2014. China has churned out 50% of the total, growing 2.7% over the same time frame. Production in the European Union rose 4.6% to 70 Mt. United States held the third spot with production climbing 1.5% to 49 Mt. Japan nudged up 1.5% to 45 Mt, slipping from its second position as a recent increase in sales tax by the government hurt demand in the country. India moved up 1.9% to reach 34 Mt.
Improving Capacity Utilization
The average capacity utilization ratio in 2013 was 78% compared with 76% in 2012. The crude steel capacity utilization ratio in January 2014 was 74.4%, climbing to 77.6% in February and 79% in March, while slipping nominally to 78.7% in April. Capacity utilization ratio in May 2014 was 78.5%, down 0.7 percentage points year over year and 0.2 percentage points sequentially.
Steel Prices: Drivers & Trends
Steel prices are generally volatile owing to the highly cyclical nature of the global steel industry. Rising raw material prices have a direct impact on steel prices. Furthermore, overcapacity, a glut in cheaper Chinese steel imports, unfavorable economic conditions and shifts toward other substitutes significantly impact steel prices. The unstable situation in Europe and tempering growth in Asia kept prices in check in 2013. The lower steel prices continue to affect margins of major steelmakers including ArcelorMittal (MT - Analyst Report) , United States Steel Corp. (X - Analyst Report) , Nucor Corp. (NUE - Analyst Report) and AK Steel Holding Corp. (AKS - Analyst Report) .
A sustained downside in steel prices will materially affect the margins of steel companies. We believe that the recovery in pricing momentum will only be driven by a reviving economy, stabilization in the Euro-zone, and a rebound in construction activity in the U.S. and developing countries, in particular China and India.
Raw Material Trends: Fall in Iron Prices
The primary raw materials for the steel industry are iron ore, coking coal, coke, scrap, alloys and base metal. The industry also uses large volumes of natural gas, electricity and oxygen to manufacture steel.
The cost of iron ore is crucial as it directly affects the price of steel. Iron ore prices had an overall good run in 2013, thanks to Chinese demand. China is currently the largest producer of steel and consequently the largest consumer of iron ore, accounting for around 60% of the global seaborne market. However, in 2014, iron ore prices have fallen over 30% to date due to continued slowdown in the world's second largest economy, combined with a surge in supply. In fact, steel hit a low of $89 per ton, falling below the $90 mark for the first time since 2012.
In the next few years, a wave of new supply of iron ore is slated to hit the market as the Big 4 iron ore producers ? Vale S.A. (VALE - Analyst Report) , BHP Billiton Limited (BHP - Analyst Report) Rio Tinto plc (RIO - Analyst Report) and Fortescue Metals Group Limited (FMG.AX) ? are going gung ho with their expansion plans to augment production capacity. Brazil and India will also step up their exports. In case this excess supply is not matched by adequate demand, it will expose the market to falling prices. On top of this, any weakness in the Chinese economy will put iron ore prices under threat.
Consolidation & Divestitures
Mergers and acquisitions (M&A) have remained an important growth strategy in the steel industry, leading to additional steel capacity, production efficiency and economies of scale. However, consolidation was minimal in the past two years, given the economic uncertainties as companies primarily focused on conserving cash, shedding unproductive operations, cutting costs and restructuring.
ArcelorMittal, the world's largest steelmaker by volume, sold its 15% stake in iron ore mines in Canada for $1.1 billion to a consortium that included South Korean steelmaker POSCO (PKX - Analyst Report) and Taiwan-listed steelmaker China Steel. The divestiture was in line with the company's plans to get rid of production overcapacity in Europe as well as reduce its debt.
Despite its acquisition-led growth, ArcelorMittal had suspended M&A activity in 2008 and 2009. After the notable acquisition of Baffinland Iron Mines in 2011, ArcelorMittal resumed acquisitions in Nov 2013. It announced the acquisition of ThyssenKrupp Steel USA from ThyssenKrupp AG (TYEKF - Snapshot Report) through a joint venture partnership with Nippon Steel & Sumitomo Metal Corporation. The acquisition will complement ArcelorMittal’s existing operations in the United States and strengthen its product offering. The company does not plan to ramp up capital expenditure or hike dividends until market conditions improve.
We expect M&A activity to remain muted in 2014 until prices stabilize and the industry strikes a balance between supply and demand. Going forward, the stabilization in the Euro-zone, recovery in the U.S. and Chinese economy will determine the fate of M&A deals. M&A activity is expected to go up in the Indian steel industry. The country has become the world’s third largest steel consumer and has the potential to take the second spot.
A Disappointing Q1
The curtains have fallen on the first-quarter earnings season. Within the Zacks Industry classification, the steel industry falls under the broader Basic Materials sector (one of the 16 Zacks sectors). Overall, for the sector, earnings decreased 2.7% in the quarter while revenues nudged up 0.9%. This is a marked deceleration from the fourth quarter of 2013 wherein sector earnings had risen 16% while revenues had moved up 2.9%. Nevertheless, the Basic Material sector had a beat ratio (percentage of companies coming out with positive surprises) of 50% in Q1.
The earnings dip should not unduly worry investors as the sluggishness was broad based and not concentrated in any particular sector. Lousy weather took most of the blame for the Q1 debacle. For further details about earnings for this sector and others, please read our 'Earnings Trends' report.
Q2 & Beyond – Holds Promise
Earnings in the sector are expected to decline 4.5% in the second quarter of 2014. However, the picture will improve dramatically in the second half of 2014 with 21.6% growth expected for both the third and fourth quarters. Overall in 2014, the sector’s projected earnings growth rate is 9.7%, which is expected to almost double to 18.8% in 2015.
Industry Ranking: Overall Neutral
We rank all of the 260 industries in the 16 Zacks sectors based on the earnings outlook for the constituent companies in each industry. This ranking is available in the Zacks Industry Rank page.
The way to align the ranking and outlook from the complete list of Zacks Industry Rank for the 260+ companies is that the outlook for the top one-third of the list (Zacks Industry Rank of #87 and lower) is positive, the middle one-third (Zacks Industry Rank between #89 and #176) is 'Neutral' while the outlook for the bottom one-third (Zacks Industry Rank #174 and higher) is negative.
The steel-pipe and tubes producers feature in the top tier with a Zacks Industry Rank #53, indicating a positive outlook. The steel specialty industry and steel producers are currently in the mid tier with a respective Zacks Industry Rank #104 and #168, indicating a neutral outlook. Overall, the outlook for the industry is weighted more toward neutral.
Please note that the Zacks Rank for stocks, which are at the core of our Industry Outlook, has an impressive track record, verified by outside auditors, to foretell stock prices, particularly over the short term (1 to 3 months). The rank, along with the Expected Surprise Prediction (ESP) (Read: Zacks Earnings ESP: A Better Way to Find Earnings Surprises) helps in predicting the probability of earnings surprises.
What’s in Store for the Industry?
The overall scenario is expected to improve in 2014. Steel demand will grow in the U.S. on the back of an improving global economy and the strong momentum in the automotive markets. The turnaround in the construction sector will definitely provide a much-needed boost to the steel industry.
After years of strong demand, China's steel usage is expected to lose steam due to the government's ongoing attempt to restructure the economy, focusing on domestic consumption instead of exports. A slowdown in the real estate market and weaker infrastructure investment growth are likely to weaken Chinese steel demand this year.
India, on the other hand, will pick up pace driven by its construction and manufacturing sectors, and structural reforms from the new government. Much hope is pinned on India to drive the next growth engine, given its high population and rapid urbanization. Demand in Japan will be subdued in 2014 due to the consumption tax hike affecting the construction and automotive sectors negatively but will again rise in 2015. After two years of contraction, steel demand in Europe is likely to improve on the back of a flourishing automobile sector and a recovering construction sector.
With the global economy gradually on the mend, the World Steel Association expects continued recovery in steel demand in 2014 and projects global steel usage to increase 3.1% in 2014. For 2015, world steel demand is projected to grow further by 3.3% and reach 1,576 Mt. Improving demand is also expected to boost steel prices.
The steel industry offers a worthy investment opportunity for 2014, as optimism returns, the automobile industry looks good and so does the construction sector in most developing economies. Add to this a neutral Zacks Rank and solid earnings growth projection making for a good case for steel.