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Industry Outlook

Although the automobile and construction sectors persistently support demand, the steel industry is reeling from the economic slowdown in China, and the continued weakness in the manufacturing sector and the glut of foreign steel imports into the U.S.

In the seven months of 2016, per the World Steel Association, global steel production decreased 1.2% to 929.6 metric tons (Mt) as production shrank across all regions. China, the world’s largest steel maker, again disappointed with a 0.5% decline.

Economic slowdown in China has dealt a massive blow to the global steel industry. Overcapacity and lower steel prices are hurting margins of Chinese steel producers. To mitigate these factors, efforts have been undertaken to reduce overcapacity and upgrade production in China's steel industry.

China’s economy grew at an annual rate of 6.7% in the second quarter of 2016, unchanged from the first quarter. For the fourth quarter, the growth rate is expected at 6.5%. Having stubbornly remained below 50 for the past two years, the Purchasing Managers’ Index (PMI) for the Chinese steel industry has remained above 50 in July and August. A reading above 50 marks growth, while that below 50 indicates contraction. However, it is still too early to predict a recovery for certain.

Meanwhile, according to the World Steel Association’s short range outlook published in April, steel usage in China is estimated to fall 4% in 2016. The severe depression in construction activities is leading to a slowdown in the manufacturing sectorsas well as to slower growth in the automotive sector, especially metal products. A recovery in the Chinese construction sector does not seem likely in the near future either.

In addition, the steel industry is challenged by waning investments, turbulence in the financial market and geopolitical conflicts in many developing regions. Lower oil prices have pulled down prices of steel as well, given the industry’s 10% exposure to the energy sector.

Steel demand from energy companies continues to be weak due to declining capital expenditure budgets. United States Steel Corp. (X - Free Report) , which is the biggest supplier to energy companies in North America, along with AK Steel Holding Corp. (AKS - Free Report) and ArcelorMittal (MT - Free Report) , remains affected by the slowdown.

U.S. steel mills remain impacted by depressed capacity utilization and a torrent of unfairly traded imports. The domestic market continues to be inundated with cheap imports from overseas producers, especially from China. American steel makers including Nucor Corp. (NUE - Free Report) , United States AK Steel, Steel Dynamics Inc. (STLD - Free Report) and ArcelorMittal USA, a part of ArcelorMittal, have borne the brunt of high levels of cheap imports. This has resulted in declining orders, idling of mills and layoffs across the board.

U.S. steel makers thus continue to actively press the U.S. regulators to stop unfair trade practices and enforce new trade laws to rescue the crisis-hit American steel industry. Consequently, steel market conditions have been recovering lately, driven by favorable developments on steel trade cases in the recent past. This has resulted in a year over year fall in steel imports in the first seven months of 2016. Steel prices also have rebounded partially of late, helped by punitive trade actions that led to levy of tariffs on imports.

Sector Level Earnings Trend

Within the Zacks Industry classification, the steel industry falls under the broader Basic Materials sector (one of the 16 Zacks sectors). The sector put up a disappointing 11.6% year-over-year decrease in earnings on the scoreboard for the second quarter.

Though sector growth will remain in the negative territory in the third quarter, a dip of 2.3% projected for the quarter which is not that steep compared to the previous drop. However, a dramatic recovery is projected during the fourth quarter with an 18.8% growth. The sector will log growth of 14.7% and 8.4% in the first and second quarters of 2017 respectively. (For a detailed look at the earnings outlook for this sector and others, please read our Earnings Trends report.)

Industry Ranking

Within the Zacks Industry classification, the “steel producers,” “steel-pipe and tube” and “steel specialty” industries are grouped under the Basic Materials sector (one of 16 Zacks sectors). We rank all of the 255 industries in 16 Zacks sectors based on the earnings outlook for the constituent companies in each industry. This ranking is available on the Zacks Industry Rank page.

The way to align the ranking and outlook from the complete list of Zacks Industry Rank for the 255+ companies is that the outlook for the top one-third of the list (Zacks Industry Rank of #85 and lower) is positive, the middle one-third (Zacks Industry Rank between #86 and #170) is neutral, while the outlook for the bottom one-third (Zacks Industry Rank #171 and higher) is negative.

The “steel-pipe and tube” and “steel specialty” industries are currently in the middle tier both with Zacks Rank of #104, which translates into a neutral outlook. The “steel producers” industries, on the other hand, are relegated to the bottom tier with a Zacks Rank #189, exhibiting a negative outlook.

What Lies Ahead?

The World Steel Association expects global apparent steel use to dip 0.8% in 2016 to 1,488 Mt, after the 3% decline in 2015. The U.S. steel industry continues to face the threat of cheaper imports in the wake of a stronger dollar and lower oil prices. Steel market conditions in the U.S. have improved of late, driven by favorable developments on steel trade cases in the recent past.

Steel prices recovered during the second quarter of 2016, helped by punitive trade actions that led to a levy of tariffs on imports. U.S. steel producers continue to actively press the U.S. regulators to stop unfair trade practices and ensure a fairer and more competitive market for American steel makers and workers.

China will remain a deterrent factor as uncertainty persists related to the impact of government measures aimed at stabilizing the decelerating economy. The International Monetary Fund projects China’s growth to slow down further to 6.2% in 2016.

Meanwhile, India is anticipated to act as the next growth engine, given its progressing construction and manufacturing sectors, rapid urbanization and structural reforms. The European economy, on the other hand, is on a slow road to recovery. Steel demand in the EU is expected to inch up 1.4% in 2016. This is a positive for companies like ArcelorMittal, which generates almost half of its revenues from this region. United States Steel also has a significant presence in Europe.

Although the steel industry will remain under pressure for some time, it is certainly expected to grow thereafter on the back of the automotive and construction industries. At this juncture, we recommend stocks such as ArcelorMittal (MT - Free Report) which sports a Zacks Rank #1 (Strong Buy) and Ternium S.A. (TX - Free Report) which carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

However, we suggest staying away from or getting rid of Zacks Rank #5 (Strong Sell) stocks such as LB Foster Co. (FSTR - Free Report) and Universal Stainless & Alloy Products Inc. (USAP - Free Report) .

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