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Is a Tough Q2 Earnings Season in Store for U.S. Steel Stocks?

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U.S. steel companies reaped the benefits of higher domestic steel prices in 2018 that largely helped them to rack up solid earnings last year. However, a sharp decline in steel prices this year spells trouble for American steel makers. Moreover, recent profit warnings from some key players amid falling steel prices and demand have raised concerns about a possible weak second quarter for the U.S. steel industry.

Are U.S. steel producers bracing for a disappointing second quarter? Let’s have a look.

Downbeat Guidance From Major Players

Some of the major U.S. steel makers came up with lower-than-expected earnings guidance for the June quarter this week. U.S. steel giant Nucor Corporation (NUE - Free Report) , on Monday, issued underwhelming guidance for the second quarter. It sees earnings per share in the band of $1.20-$1.25 for the quarter, reflecting a decline from $1.63 in the first quarter and $2.13 in the year-ago quarter.   

Nucor expects performance in the steel mills unit to decline sequentially in the second quarter. The company noted that service center destocking is affecting order rates. Lower scrap prices and higher supply in the domestic market have led to aggressive inventory management by the company’s customers.

Steel Dynamics, Inc. (STLD - Free Report) also provided downbeat guidance for the second quarter as it expects lower earnings in its steel operations in the quarter. The steel producer expects earnings for the quarter in the band of 86-90 cents per share. That is a decrease from 91 cents per share recorded in the previous quarter and $1.53 per share it earned a year ago.

Steel Dynamics expects earnings from its steel operations to be lower sequentially in the second quarter mainly due to reduced profitability from the long product steel operations as shipments and metal spread fell in the quarter. Average product prices declined across the steel platform in the second quarter, the company noted. Steel Dynamics also said that inventory destocking and hesitancy in steel buying have resulted from a softening scrap pricing environment.  

Moreover, United States Steel Corp. (X - Free Report) on Tuesday provided disappointing second-quarter profit guidance and said that it will idle three blast furnaces in response to the weakening market conditions. The company expects adjusted earnings per share to be roughly 40 cents for the quarter. The projected earnings reflect a decrease from 47 cents per share recorded in the previous quarter and $1.46 per share the company earned a year ago.

The company said that its Flat-Rolled segment is being hurt by lower steel prices and weakening end market demand. Flooding in the southern United States also led to lower-than-expected shipments in the second quarter.

Moreover, the company sees sequentially lower adjusted EBITDA for both its U.S. Steel Europe (USSE) and Tubular segments in the second quarter. Lower selling prices are putting pressure on Tubular margins while higher imports and headwinds related to raw material costs and demand continue to hurt the USSE unit.

Nucor currently has a Zacks Rank #3 (Hold), while both Steel Dynamics and U.S. Steel carry a Zacks Rank #5 (Strong Sell).

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Falling Steel Prices, Weaker Demand Are Worries

The 25% tariff on steel imports, which the Trump administration imposed in March 2018, provided a thrust to U.S. steel prices last year, driving profits and cash flows of American steel makers including Nucor, U.S. Steel, Steel Dynamics and AK Steel Holding Corp. (AKS - Free Report) .

The trade actions also boosted production capacity of American steel producers amid lower imports. They have helped U.S. steel industry capacity break above the important 80% level – the minimum rate required for sustained profitability of the industry. Improved capacity has led to increased U.S. steel production. A number of U.S. steel producers are investing heavily to beef up production capabilities and upgrade facilities.

The tariffs led to a spike in U.S. steel prices during the first half of 2018. However, the momentum was short-lived as U.S. steel prices tracked downward in the back half of the year and dropped sharply during the fourth quarter. Prices continue to retreat so far this year.

A concoction of factors is to blame for the downward drift in U.S. steel prices. Higher U.S. steel production, partly driven by restarted mills, has contributed to the drop in domestic steel prices.

According to American Iron and Steel Institute (“AISI”), an association of North American steel makers, U.S. raw steel production through mid-June 2019 was 44,997,000 net tons at a capability utilization rate of 81.5%, up 5.9% from 42,472,000 net tons a year ago at a capability utilization rate of 76.7%. Rising domestic supply is hurting U.S. steel prices.

Uncertainties surrounding global economic growth and concerns over a slowdown in steel demand in China (the world’s top consumer) amid a cooling Chinese economy are other factors for the decline in steel prices.

In fact, after rallying to multi-year highs on the back of Trump administration’s imposition of tariffs on imported steel, U.S. steel prices have now fallen back to the levels seen prior to the tariff announcement. The benchmark hot-rolled coil steel prices are now well below their peak level of roughly $920 per short ton (st) reached in July 2018. Prices are down more than 35% from the high levels reached last year.

Lower U.S. steel prices will likely put downward pressure on selling prices of American steel makers and crimp their margins in the second quarter.

Waning steel demand also poses problems for steel producers. Slowdown across major end-use markets such as automotive, construction and energy are hurting steel demand. Demand has softened across the United States and Europe.

Moreover, a slowing Chinese economy amid trade war has triggered a slowdown in steel demand in China. Signs of weakness across the country’s major steel end-use markets — construction and automotive — as reflected by a slowdown in real-estate investment growth and falling car sales have clouded steel demand outlook. As such, softening end-market demand may also hurt profitability of U.S. steel makers.  

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