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Soft Demand, China Mar Outlook of Steel Producers Industry

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The Zacks Steel Producers industry serves a wide range of end-use industries such as automotive, construction, appliance, container, industrial machinery, transportation, and oil and gas with various steel products. These 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 industry’s three major themes:

  • Sluggish steel demand poses problems for the steel producers industry. The trade war-induced slowdown in China’s economy has triggered a contraction in steel demand in China, the world’s top consumer. Signs of weakness across the country’s major steel end-use markets — construction and automotive — as reflected by sluggish real-estate investment growth and falling car sales have clouded the steel demand outlook. The world’s largest automobile market contracted for the second straight year in 2019 amid a slowing domestic economy and tariff war with the United States. A weakening manufacturing sector is also expected to limit steel demand growth in the United States. While the de-escalation in trade tensions due to the recent announcement of the preliminary trade deal offers a glimmer of hope, a material improvement in the demand environment for steel is not expected anytime soon given the global economic slowdown.
     
  • The industry continues to reel under the effects of sustained oversupply of steel in the market, made worse by continued growth in Chinese production. China, which accounts for roughly half of the global steel output, is a significant contributor to global steel excess capacity. Notwithstanding a slowdown in the Chinese economy and Beijing’s efforts to cut steel capacity, its steel mills continue to crank up output to take advantage of healthy profit margins. Chinese production increased at a fast pace during 2019. A glut of cheap Chinese steel has put downward pressure on both its own and global steel prices. China’s steel overcapacity remains an overhang for the industry over the near term.
     
  • The 25% tariff on steel imports, which the Trump administration levied last year, drove up production capacity of U.S. steel producers. Improved capacity also provided a boost to domestic steel production. However, higher production, partly driven by restarted mills, contributed to the sharp decline in U.S. steel prices last year. In fact, after rallying to multi-year highs in 2018 on the back of Trump-imposed tariffs, U.S. steel prices fell back to the pre-tariff levels in 2019. Sliding steel prices, softening demand across major domestic end-markets and trade tensions weighed on U.S. steel producers last year. Driven by consecutive price hike actions by major U.S. steel mills and supply-side actions, U.S. steel prices have lately gained some traction. However, a significant recovery in prices is not expected over the near term given the oversupply in the market and weak domestic steel demand.

 
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 #156, which places it at the bottom 39% 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 a dull near term. 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 pessimistic about this group’s earnings growth potential. Over the past year, the industry’s earnings estimate for the current year has declined 58.4%.

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 10.2% over this period compared with the S&P 500’s rise of 25.6% and the broader sector’s growth of 1%.


One-Year Price Performance

 



 

Industry’s Current Valuation

On the basis of 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 7.13X, below the S&P 500’s 11.99X and the sector’s 9.58X.

Over the past five years, the industry has traded as high as 9.56X, as low as 4.93X and at the median of 7.42X, 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 continued growth in Chinese production. A weakening Chinese economy amid trade war has also triggered a slowdown in steel demand in China. Lower U.S. steel prices are also hurting American steel producers.

Here, we present three stocks sporting a Zacks Rank #1 (Strong Buy) and one carrying a Zacks Rank #2 (Buy) that are well positioned to gain amid the prevailing challenges. You can see the complete list of today’s Zacks #1 Rank stocks here.

Commercial Metals Company (CMC - Free Report) : The Texas-based company currently carries a Zacks Rank #1. It has an expected earnings growth of 17.3% for fiscal 2020. The company delivered an average positive earnings surprise of 15.3% in the trailing four quarters. The consensus EPS estimate for current fiscal earnings was revised 17.9% upward over the last 60 days.

Price and Consensus: CMC

 



 

Steel Dynamics, Inc. (STLD - Free Report) : The Indiana-based company currently carries a Zacks Rank #1. Consensus earnings estimate for the current year was revised 4.2% upward over the last 60 days. The stock also has an expected long-term earnings per share growth rate of 12%.

Price and Consensus: STLD

 



 

Ternium S.A. (TX - Free Report) : Luxembourg-based Ternium has a Zacks Rank #1. The company beat the Zacks Consensus Estimate in three of the trailing four quarters, delivering a positive average earnings surprise of 11.2%. The consensus EPS estimate for 2020 earnings also increased 2.8% over the last 60 days.

Price and Consensus: TX

 



 

 

Nucor Corporation (NUE - Free Report) : The North Carolina-based company has a Zacks Rank #2. The consensus EPS estimate for 2020 was revised 2% upward over the last 60 days. The company also delivered a positive earnings surprise in each of the trailing four quarters, with an average beat of 6%.

Price and Consensus: NUE

 


 

 

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