By Sam Stovall
Tariff protection. Shrinking supply. Economic recovery. This combination of factors has sparked investor interest in steel stocks -- those that have managed to survive the sector's wrenching downturn -- propelling the still-fragile industry onto the list of those with top Standard & Poor's .
Year-to-date through Apr. 12, 2002, the S&P Steel Index rose 18.1%, vs. the S&P Super 1500's 2.1% decline. The former climbed 11.1% in 2001, compared with the latter's 11.8% retreat. And S&P analyst Leo Larkin expects the group to outperform the 1500 again in 2002.
Why? Larkin has several reasons. First, several bankrupt companies have stopped operating as a result of the industry's severely depressed conditions in the last few years. LTV Corp., the nation's fourth-largest producer, closed shop in December, 2001. Earlier, Trico Steel, Northwestern Steel & Wire, and Gulf States Steel shut down. More companies may follow in 2002, says Larkin. The net effect of all these closures: A reduced supply of steel on the market and a removal of excess production capacity from the industry.
The 12% production decline in 2001 will cause a tightening of supply in 2002 -- at the same time that demand picks up, fueled by the nascent U.S. economic recovery. Furthermore, Larkin says steel distributors and end users will rebuild inventories in 2002 after depleting their stocks in 2001, thereby helping to lift prices and profits for producers.
Developments on the political front will also be helpful. The Bush Administration's March, 2002, decision to impose tariffs on selected steel imports, under section 201 of the 1974 Trade Act, will limit supply and boost prices, according to Larkin.
Looking back, he notes that the industry's strength began to wane considerably in the second half of 2000, as a result of a very weak fourth quarter. Losses continued to pile up in 2001. The nation's eight-largest steel companies reported results that were awash in red ink in 2001, reflecting weak demand from durable-goods producers, along with distributors' decision to work off existing inventories rather than spend heavily on new stock. Bethlehem Steel, the nation's third-largest producer, filed for bankruptcy in October, 2001.
Although orders and prices began to pick up in late December, 2001, Larkin notes that the industry's finances remain fragile. On Mar. 7, 2002, the day after the Administration announced the tariff imposition, National Steel, the nation's sixth-largest producer, filed for bankruptcy.
Based on S&P's expectation of a stronger U.S. economy in 2002, Larkin sees steel demand rising slightly from 2001's depressed levels. He lists some longer-term positives for the industry: More production curtailments as additional steel companies cease operations, further consolidation of the domestic industry, and a possible international agreement among various nations and steel producers to cut global output.
Larkin's top pick in the steel group right now is minimill Nucor (NUE ), which carries Standard & Poor's highest investment ranking, 5 STARS, or buy (see BW Online, 2/25/02, "Nucor: This Minimill Could Be a Giant").
S&P Relative Strength Rankings
These industries carry six-month relative strength rankings of "5" as of Apr. 12, 2002 -- meaning that they're in the top 10% of the 115 industries in the S&P Super 1500 (the combined S&P 500, S&P MidCap 400, and S&P SmallCap 600) based on prior six-month price performance.
*S&P's ranking system for the appreciation potential of stocks over a 6- to 12-month period: 5 STARS (buy), 4 STARS (accumulate), 3 STARS (hold), 2 STARS (avoid), 1 STAR (sell).
Stovall is chief sector strategist for Standard & Poor's