The Surprising Strength of Steel
By Leo Larkin
Standard & Poor's Equity Services is keeping its neutral outlook on the steel industry in the wake of the White House's Dec. 4 announcement that it would lift tariffs on imported steel originally imposed in March, 2002. The tariffs had sparked friction between the U.S. and key trading partners in Europe and Asia.
Steel stocks suffered declines following the announcement. However, they remain solidly in the plus column year-to-date, with the S&P Steel industry subindex rising 31.5% through Dec. 1, vs. a 21.7% gain for the S&P Super 1500. After trailing the Super 1500 through October, 2003, the group staged a strong rally. We think the recent strength may reflect a shift of funds to steel, which lagged behind the market for most of 2003, from other groups of metals stocks that have risen sharply.
We believe the removal of the tariffs will have little impact, given what appears to a cyclical decline in the U.S. dollar and strong steel demand overseas, particularly in China. To the extent that imports place downward pressure on prices, we believe that they'll hasten the shutdown of marginal U.S. steel outfits and speed consolidation of a domestic industry that we believe is rife with financially weak companies. However, longer term, we anticipate that a much more concentrated group of companies will likely emerge that should be able to compete more effectively in the global steel market.
We expect solid improvement in industry operating performance in 2004 and believe that stock prices will at least track the S&P 1500. Operating results for 2003's first three quarters deteriorated from the year-earlier level, as sharply higher raw-material costs outweighed increased sales and higher volume.
Another negative factor was a decline in North American auto production. While we see negative comparisons for all of 2003, vs. 2002, it appears that prices have stabilized and that 2003's second quarter may have marked a bottom. According to data compiled by the American Iron & Steel Institute, shipments through September rose 6.8% and imports fell 27%.
Assuming 4.6% real GDP growth in 2004, vs. 3% estimated for 2003, and moderate raw-material costs, we believe sales and operating results should improve. Other positive factors for the industry in 2004 will be a forecasted rise in North American auto production and expected continued weakening of the U.S. dollar relative to most currencies.
Longer term, we think the industry will benefit from greater pricing power as a result of recent consolidation, a lower cost structure, and a cyclical decline in the U.S. dollar.
Our top stock pick in the steel group is Nucor (NUE ; recent price, $51). With what we see as a solid balance sheet and strong cash-flow generation, we think Nucor is well positioned to gain market share as a result of the current consolidation of the domestic steel industry. We also like Steel Dynamics (STLD ; $21), ranked 4 STARS (accumulate), which we consider an attractive, cyclical growth company. As for other industry players, we maintain 3-STARS (hold) recommendations on U.S. Steel (X ; $26) and AK Steel (AKS ; $3).
Analyst Larkin follows metals and mining stocks for Standard & Poor's