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Should You Buy Steel Stocks Now?

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Since the beginning of the year, the steel industry has done remarkably well, making it one of the hottest segments of the materials sector. But as we enter the second half of the year, one question worth asking is whether this strength is likely to continue.

And to answer this question, it makes sense to go into the reasons behind the recent strength. As in the case of all commodities, strength or weakness basically comes from two things: volume and price. And during the last few months, we’ve seen some import restrictions, production constraints and supply chain issues that have combined to raise prices.

Steel volumes generally depend on the level of its consumption in the top consuming sectors. And these would be construction, automotive and machinery. So let’s take them one at a time.

Construction primarily constitutes residential, commercial, government/infrastructure and institutional. The residential segment is going full steam with huge demand from positive demographics and pandemic-related considerations. And the strength should continue through the end of the year (and beyond).

Commercial construction remains slow, but should only pick up from here as a certain level of normalcy returns. Big users of steel such as the energy sector remain slow, but should also pick up going forward.

On the government/infrastructure side, the 5-year $973-billion bipartisan agreement to overhaul the country’s infrastructure covers transportation, roads, bridges, passenger and freight rail, public transit, EVs, the electricity grid, broadband, clean water and other infrastructure. So this should be a big boost to steel consumption.

Most governments across the world are using infrastructure buildup as a tool to get back to growth following the pandemic. This is a positive for global steel consumption and pricing.

In the automotive market, we’re seeing supply chain issues. Auto demand strengthened relatively quickly last year, as people focused on their own transport. Used cars were the top priority, but the rental car market that supplies this segment had already depleted their stock without adding sufficient new cars to their fleets.

So now, demand for new cars have sky-rocketed, with both individuals and fleet owners creating the demand. Additionally, chips diverted to other sectors last year led to component shortages that are continuing this year.

New chip capacity is being added rapidly, but impacted auto manufacturers are using workarounds to deal with the situation in the short term. In short, this is another red-hot market that is contributing to the strength in steel demand.

On the machinery side, there are several changes unfolding. There was a big cutback in production last year that is coming back this year. There’s also an added impetus here from increased demand for automation and robotics for safety and increased efficiency (this is a long-term driver). This market is also contributing to the current strength in steel demand, although it makes up a smaller piece than the others.

Thus we see that the demand outlook for steel is robust. So as factories step up utilization (which was 82.7% in the week ending Jun 26 compared to 56.8% in the same week last year) and given that there’s no capacity shortage according to IHS Markit, sales should also remain very strong.

As far as pricing is concerned, increased production and a pickup in imports are expected to lead to moderation through the rest of the year. However, it will all depend on the level of demand that hits this year instead of the following year/s.

This is a very strong situation to be in and is reflected in the Zacks rank of the Steel - Producers industry of 9 (out of 250+ Zacks-classified industries), placing it at the top 4%. The Steel – Specialty industry is at number 37 (top 15%).

Given the strong prospects, there are umpteen number of stocks to choose from. So here are a few that are expected to grow earnings more than 100% this year but are also valued cheaply on the basis of their forward 12 months’ earnings and with respect to the S&P 500-

Aperam (APEMY - Free Report) , ArcelorMittal (MT - Free Report) , Nucor Corporation (NUE - Free Report) , Schnitzer Steel Industries, Inc. (SCHN - Free Report) , Olympic Steel, Inc. (ZEUS - Free Report) , Ryerson Holding Corporation (RYI - Free Report) and Voestalpine AG (VLPNY - Free Report) .

Final Words

Being a chief component of many other industries, the steel industry is typically good to invest in early on in the cycle, i.e., when a market is recovering or when it is growing. So capacity expansions and infrastructure builds are obvious positives.

In the case of steel in particular, China plays a big role since it contributes about 57% of the global steel production and consumes an almost equal share. China recovered quickly from the pandemic last year and the government is leveraging infrastructure to fuel growth.

At the same time, its COVID relief packages won’t repeat this year, growth in the residential construction market is being contained and restrictions on production may be put in place this year on environmental considerations. If China changes its position on any of these things, it could have a notable impact on volumes and therefore, pricing.  

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