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Steel Stocks to Gain From Kobe Steel Data Fabrication Issue

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Japan’s third largest steel producer — Kobe Steel Limited — is currently grappling with data fabrication issues, shocking the country’s steel industry. The scandal, still unfolding, has strongly dented its customers’ confidence, who are now taking appropriate measures to check whether product specifications agreed on were met or not.

Since the news hit the market on Oct 8, Kobe Steel’s American Depository Receipt (ADR) price plunged 40% to $3.55 at the end of trading session on Oct 13.

Implications of Kobe Steel’s Data Fabrication

Per the latest data released by Kobe Steel, the falsified data regarding the product strength and other specifications, is likely to impact as many as 500 of its customers. This figure is more than double the number initially estimated by the company.

Products that have come under scanner include steel wires and other steel products, copper products, aluminium, and aluminium forging and casting products. Steel wires are increasingly used in car engines and tyres while the aluminium products are used in bullet trains. In addition to the automotive and train manufacturers, the issue has led the company’s aircraft manufacturer customers to assess the possible impact on their business.

Though made public in October, the irregularities came into Kobe Steel’s notice in August. The issue is still being investigated, but probability is high that its origin might be a decade old. The company is promising to assist the affected customers financially. Notably, no order cancellations have been communicated so far.

Boon for Other Steel Stocks?

Steel is crucial to economic well-being as it is used in construction, military application, infrastructure, machinery, appliances, transportation, agriculture, energy generation and many other end markets. The World Steel Association projects global steel consumption to grow 1.3% in 2017 and 0.9% in 2018.

Particularly in Japan, demand for steel is anticipated to rise 1.2% in 2017 and 0.6% in 2018. In the United States, we believe the Trump government’s proposed infrastructure investment of $1 trillion, if implemented, will spur demand for steel while other tailwinds are the strengthening housing, automotive and commercial construction markets. Additionally, growth in China’s Gross Domestic Product and improving construction sector will drive demand for steel.

On the supply side, China was the largest producer of steel in 2016, with Japan securing the second position. We believe that supply disruption caused by any major player in the steel industry will increase growth opportunities for other steel producers. With questions rising over the quality of steel produced by Kobe Steel, business scope for steel makers in the United States, Brazil and other nations have grown. Adding to the prospects is the falling steel export from China — a decline of 42% over the year-ago period was recorded in September.

Below we briefly discuss three steel makers that might gain from the Kobe Steel issue.

AK Steel Holding Corporation (AKS - Free Report) : The U.S.-based steel maker is a leading producer of flat-rolled carbon, stainless, electrical steel and tubular products. A large percentage of the company’s sales come from the automotive sector. It currently has $1.8 billion market capitalization.

The company’s stock price has grown roughly 2.3% in the last week. It currently carries a Zacks Rank #3 (Hold). In the event of Kobe’s fabrication issue, we believe this company might be a potential winner going forward.

Steel Dynamics, Inc. (STLD - Free Report) : The U.S.-based company, with $8.9 billion market capitalization, engages in the production and sale of hot-rolled and cold-rolled steel coils. It currently carries a Zacks Rank #3. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Its share price has improved 2.8% in the last week.

Gerdau S.A. (GGB - Free Report) : This Brazilian steel maker is the second-largest long steel producer in the world and the largest in the Americas. It engages in the production and distribution of crude steel (slabs, blooms and billets) and flat steel. It is also expanding its iron ore activities.

Its ADR price has increased 2.6% in the last week. The stock currently carries a Zacks Rank #2 (Buy).

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