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Steel: Off the Scrap Heap

By Leo Larkin After a weak performance in the last two years, the steel industry appears to be recovering in 2002. Steel supplies are tight relative to demand, aided by a stronger economy, a lower amount of steel in the marketplace because of a production decline of 11.5% in 2001, and reduced inventory liquidation by steel distributors. Accordingly, prices had firmed considerably through mid-May, 2002.

For the balance of 2002, S&P sees continued gains in shipments and higher revenue per ton for producers, both sequentially and year-over-year. However, the industry as a whole will probably barely return to profitability in 2002 as legacy costs -- such as retiree pension and medical benefits -- and higher energy prices partially negate the benefits of higher volume and increased prices.

CAPACITY AND IMPORTS. S&P's expectation for a recovery is based mostly on developments that reduce the amount of steel in the marketplace, which would raise prices. The principal positive factor for the industry in 2002 is less supply, the result of two trends:

First, after declining by 11.5% in 2001, domestic steel output in 2002 shouldn't increase much due to large capacity reductions. As reported by American Metal Market, as of late May, 2002, cessation of operations by bankrupt steelmakers, combined with idling of capacity by solvent companies, had cut domestic steel capacity by some 25 million tons.

Second, lower imports. Foreign steel shipments to the U.S. fell 20.8% in 2001. S&P thinks a decline of lesser but still sizable magnitude will occur in 2002 as result of the Bush Administration's March, 2002, decision to impose tariffs on selected steel imports, under section 201 of the 1974 Trade Act.

TIGHT SUPPLIES. Another factor that should aid the industry in 2002 is that distributors will likely stop liquidating inventory. Supply and demand now appear to be more nearly in balance, so further liquidation will likely be minimal. S&P believes that the inventory sell-off will come to a halt by mid-2002.

The process may even reverse as tight supplies push prices higher. This will prompt distributors to rebuild inventories partly as a hedge against rising prices in the future.

S&P's current favorites in the steel group include minimill Nucor (NUE) and steel recycler Commercial Metals (CMC), both ranked 4 STARS (accumulate). Analyst Larkin covers steel stocks for Standard & Poor's

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