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Steel Producers Industry Outlook: China Dampens Prospects

Anindya Barman

The Zacks Steel Producers industry consists of producers of a wide range of steel products for a number of end-use industries including automotive, construction, appliance, container, industrial machinery, transportation, and oil and gas. These products include hot-rolled and cold-rolled coils and sheets, hot-dipped and galvanized coils and sheets, reinforcing bars, billets, wire rods, strip mill plates, standard and line pipe, and mechanical tubing products.

Here are the industry’s three major themes:

  • The industry continues to reel under the effects of sustained oversupply of steel in the market, exacerbated by a surge in production in China. Notwithstanding the U.S.-China trade tensions, China’s steel mills have been beefing up output to take advantage of healthy profit margins. A glut of cheap Chinese steel driven by the ramp up in output amid weak domestic demand has put downward pressure on both Chinese and global steel prices. China’s output is expected to go up in the coming months as Beijing has lifted production restriction (aimed at curbing pollution during the winter months) across most cities. This may put further pressure on steel prices.
     
  • The industry faces risks emanating from trade tensions and economic cooling in China, the world’s top consumer of steel. The trade war has taken a huge toll on China as reflected by its tepid economic indicators. A slowdown in steel demand in that country amid sluggish economic conditions pose problems for steel producers. 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.
     
  • The 25% tariff on steel imports, which the Trump administration levied last year, has provided a reprieve to U.S. steel producers, which long struggled to cope with a tide of subsidized foreign imports. The tariffs are driving production capacity of U.S. steel producers amid declining imports. Leveraging strong cash flows, a number of U.S. steel producers are investing heavily to beef up production capabilities and upgrade facilities. The tariffs have also provided a boost to U.S. steel prices, giving American steel makers more pricing power. This has also provided margin benefits to U.S. steel producers. Although U.S. steel prices tracked downward in the back half of 2018 on concerns over a slowdown in steel demand in China, prices rebounded in February 2019 and have remained stable since then. While there are still uncertainties surrounding the tariffs including exemptions of countries, they should provide further boost to U.S. steel producers over the near term.


Zacks Industry Rank Indicates Bleak Prospects

The Zacks Steel Producers industry is part of the broader Zacks Basic Materials Sector. It carries a Zacks Industry Rank #199, which places it at the bottom 22% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates gloomy near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s position in the bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are pessimistic about this group’s earnings growth potential. Over the past year, the industry’s earnings estimate for the current year has gone down 39.1%.

Before we present a few steel producers stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock market performance and current valuation.

Industry Lags Sector and S&P 500

The Zacks Steel Producers industry has lagged both the Zacks S&P 500 composite and the broader Zacks Basic Materials Sector over the past year.

The industry has declined 29.1% over this period compared with the S&P 500’s rise of 10.8% and broader sector’s decline of 10.1%.

One-Year Price Performance

 

Industry’s Current Valuation

On the basis of trailing 12-month enterprise value-to EBITDA (EV/EBITDA) ratio, which is a commonly used multiple for valuing steel stocks, the industry is currently trading at 5.91X, below the S&P 500’s 11.13X and the sector’s 7.65X.

Over the past five years, the industry has traded as high as 10.02X, as low as 5.38X and at the median of 7.90X, as the chart below shows.

Enterprise Value/EBITDA (EV/EBITDA) Ratio



 

Enterprise Value/EBITDA (EV/EBITDA) Ratio


 

Bottom Line

The steel producers industry remains hamstrung by sustained overcapacity, driven by a surge in Chinese production. Trade tensions between the United States and China also pose as headwinds to the industry. A weakening Chinese economy amid trade war has triggered a slowdown in steel demand in China.

Nevertheless, trade tariffs have injected a new lease of life into U.S. steel producers. The punitive tariffs are bearing fruit as reflected by a decline in U.S. steel imports. The tariffs should provide more protection to these producers going forward.

Here, we present two stocks carrying a Zacks Rank #2 (Buy) that are well positioned to gain amid the prevailing challenges. There are also a couple of stocks with a Zacks Rank #3 (Hold) that investors may currently hold on to. You can see the complete list of today’s Zacks #1 Rank stocks here.

Schnitzer Steel Industries, Inc. (SCHN): The consensus EPS estimate for this Oregon-based company has moved 10.2% higher for the current year, over the last 30 days. The stock, carrying a Zacks Rank #2, has also delivered an average positive earnings surprise of 29.9% in the trailing four quarters.

Price and Consensus: SCHN


 

TimkenSteel Corporation (TMST): The Ohio-based company, carrying a Zacks Rank #2, has an expected earnings growth of 527.3% for the current year. The consensus EPS estimate has moved 3% higher for the current year, over the last 30 days.

Price and Consensus: TMST



 

Nucor Corporation (NUE): The North Carolina-based company, carrying a Zacks Rank #3, delivered an average positive earnings surprise of 2.1% in the trailing four quarters. The company also has an estimated long-term earnings growth rate of 12%, higher than the industry average of 7.3%.

Price and Consensus: NUE



 

Commercial Metals Company (CMC): The Texas-based company currently carries a Zacks Rank #3. It has an expected earnings growth of 27.5% for the current year. The company delivered an average positive earnings surprise of 6.7% in the trailing four quarters. It also has an estimated long-term earnings growth rate of 9.3%.

Price and Consensus: CMC



 

 

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Timken Steel Corporation (TMST) : Free Stock Analysis Report
 
Schnitzer Steel Industries, Inc. (SCHN) : Free Stock Analysis Report
 
Nucor Corporation (NUE) : Free Stock Analysis Report
 
Commercial Metals Company (CMC) : Free Stock Analysis Report
 
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