Self-Defeating

Why U.S. Steel Stocks Aren't Loving Tariffs

If America's metals industry doesn't catch the wave of innovation, it risks getting dumped.
Photographer: jfelton/Getty Images
AK STEEL HOLDING CORP
-0.09
At Closing, June 19th
4.63 USD

If import tariffs are meant to improve prospects for the U.S. steel industry, why aren't local investors celebrating?

Shares in Nucor Corp. fell 2.7 percent as President Donald Trump signed his tariff order Thursday, while U.S. Steel Corp. dropped 2.9 percent. Steel Dynamics Inc. was down 2.8 percent, and AK Steel Holding Corp. lost 4.1 percent.

Relative to their first shock of excitement Feb. 16 when Commerce Secretary Wilbur Ross tabled his levy proposals, the four major U.S. producers are all trading lower.

Part of the answer is that the proclamation, due to take effect this month, excludes the main sources of U.S. steel imports -- Canada and Mexico -- and leaves the door open for other allies to get a pass too. Another part is probably because shareholders have been buying the rumor and selling the fact.

There's more to it than that, though. The best answer is likely that steel isn't a simple commodity that rises and falls in response to input data like a line on a chart. Instead, it's a basket of specialty products that each have their own unique characteristics.

Take AK Steel, the fourth-largest producer. So far, it's been the major loser from Trump's steel policies, with the stock declining 30 percent over the past year. That drop sharply outpaces the 8.6 percent fall in an index of steelmakers on Tokyo's Topix, which by rights should be the bigger losers from protectionism in Washington.

American Exceptionalism

Most of the past year's improvement in U.S. steelmaker shares has been in line with the global industry. AK Steel has underperformed even that

Source: Bloomberg

Note: Rebased. March 8, 2017=100.

AK's weakness is telling because it's the U.S. steelmaker that's been trying hardest to innovate and go up the value chain in recent years. Thanks to a focus on specialty products for the automotive and electrical power industries, its average selling price is about a third higher than those claimed by its bigger rivals, which largely sell commodity metal that's cheaper than most imported product.

The problem is that AK's specialist focus means its cost base is higher, too, at about 91 percent of net sales. Any increase in domestic output as a result of the tariffs will put upward pressure on scrap prices, the biggest expense for most U.S. steelmakers. That will particularly squeeze producers like AK that are less able to capitalize on replacement demand as imports suffer.

Cheap at the Price

AK Steel, which gets the best selling prices for its product, hasn't gained from the prospect of tariffs

Source: Company reports, U.S. Census Bureau, Gadfly calculations

Note: All figures are for 2017 calendar year flat products. U.S. Steel's European operations have been excluded. Imports to the U.S. calculated as import value of flat products divided by tonnage.

It's a similar situation in aluminum. At the time of their split on the eve of the 2016 election, the old Alcoa Corp.'s specialized-products business, Arconic Inc., was the one most favored by investors. Unlike Alcoa's lumbering, costly fleet of aging smelters, Arconic's high-tech products for carmakers and aerospace companies were seen as the future.

So much for that. While Arconic still trades on a higher (if narrowing) price-earnings multiple, its shares have gained only 31 percent since the break, versus a 106 percent jump at Alcoa.

Brains Ain't Everything

Price-earnings valuations suggest investors think Arconic is the better bet than Alcoa. Share price movements since their split suggest the opposite

Source: Bloomberg

Note: Rebased. Nov. 1 2016=100.

The underlying problem in all this is that the protectionist strategy being pushed by the White House has a use-by date.

The happy fate of developed countries should be to give up manufacturing low-margin, commodity products and move toward more profitable niches. That's what Japanese steelmakers JFE Holdings Inc. and Nippon Steel & Sumitomo Metal Corp. are doing, planning to spend more than $20 billion over the next three years to increase production of specialty metals.

The strategy being pursued by some of the large North American steelmakers has been to play politics as an alternative to innovation. To the extent they now have their tariffs, that's paid off -- but the tepid response of their share prices indicates that investors don't expect the current situation to last.

Governments come and go, and even the Trump administration's stance on this policy has seesawed multiple times in recent months. The future, however, keeps on advancing -- and if America's metals industry doesn't try to catch the wave of innovation, it risks getting dumped by it.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    David Fickling in Sydney at dfickling@bloomberg.net

    To contact the editor responsible for this story:
    Katrina Nicholas at knicholas2@bloomberg.net

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