Following the late-2008 recession, many companies in the steel industry saw their profits tumble, as global economic weakness curtailed infrastructure and capital investment spending, putting pressure on steel demand and, consequently, prices. Long-considered an indicator of economic growth and progress due to its critical role in industrial development as well as automobile production, the steel industry is highly cyclical and prone to multi-year downturns reflecting the health of the global economy. Most recently, high domestic unemployment, uncertainty surrounding the European debt crisis, and fears of an impending economic recession have taken a toll on steelmakers, many of whose shares have only partially taken part in the broader stock-market recovery witnessed since early 2009.
That being said, recent share-price weakness has left many of these companies trading at attractive valuations. Moreover, given solid underlying fundamentals, recent signs of spreading economic improvement, and favorable intra-industry trends, we think that several companies in the steel industry are well-positioned to benefit from a cyclical recovery over the next few years, barring an unforeseen exogenous demand shock.
Indeed, with auto sales improving markedly as of late, and signs of positive momentum in the labor market, the economy (and with it, the steel industry) could well pick up steam, especially if ongoing housing market and European debt crisis woes begin to abate. Furthermore, moving forward, demand for steel is likely to be driven to a considerable extent by emerging market economies such as those of China and India, where rapid economic progress and a rising middle class have led to significant capital investment.
In fact, over the past decade, China has emerged as a major player in the steel market, currently accounting for around half of global production, mostly through large, state-owned companies. Given the already highly-competitive nature of the industry, combined with China’s artificially undervalued currency, these companies have increased global competitive pricing pressures, as cheaper Chinese imports have forced domestic producers to lower prices. Although this remains a concern over the intermediate term, we believe that ongoing anti-dumping measures, a gradual appreciation of its currency, and political pressures to accelerate said appreciation, will offset pricing pressures over the longer term. That said, one of the strongest steel-price drivers would certainly be a sustained economic recovery.
Any discussion of the steel industry is incomplete without mention of ArcelorMittal (MT), the world’s largest steel producer. In line with a greater steel industry trend towards consolidation, the company was formed through the 2006 merger of Mittal Steel and Arcelor. Following a demand pickup early in 2011, the company posted weaker second-half results on the back of European debt-crisis concerns. Like many others in the industry, ArcelorMittal has yet to fully recover from the most recent recession, having posted top- and bottom-line results in 2011 that were well below their 2007-2008 levels. That said, several metrics appear to be improving: average selling prices seem to have stabilized and are even increasing steadily; capacity utilization is increasing; and the company has experienced some top-line momentum since 2009. Furthermore, ArcelorMittal has a good deal of cash on hand, with which it will likely pursue further capacity expansion and, importantly, vertical integration. Indeed, large steel companies have increasingly sought to mitigate the effects of commodity-price volatility through the purchase and operation of mining entities, from which they obtain iron ore, a major input for integrated steel production. All told, as the economy gradually improves, ArcelorMittal should be able to utilize its dominant position to gain further market share and economies of scale, which could well become reflected in higher profits and considerable share-price recovery.
Another company worth examining is Korea-based POSCO (PKX). Despite an ongoing recovery of both the top and bottom lines, the company’s shares are trading at a discount to their historical price-to-earnings multiple, and well below their 2007 highs. Moreover, given recent improvement in the shipbuilding, home appliance, and automobile sectors, reflective of healthy Korean economic growth, the company should post record top- and bottom-line results this year. Further, POSCO’s expansion into emerging markets such as Indonesia, Thailand, and India, as well as its focus on vertical integration, augurs well for longer-term prospects.
Finally, we take a look at U.S. Steel Corporation (X), a somewhat smaller player in the industry, which holds perhaps the most risk, but also the most potential reward, among the names discussed so far. Despite having recovered somewhat from their 2009 levels, the top and bottom lines have remained under pressure due to lower demand and depressed steel prices. Indeed, the company posted a 2011 loss, albeit by a much narrower ore than in the previous year. That said, the company’s recent woes may present an attractive investment opportunity for more adventuresome investors. Although the company uses a good deal of leverage (long-term debt represents around 50% of total capital), it should have sufficient cash flow to cover its expenses, especially if market conditions improve. Indeed, U.S. Steel stands to benefit greatly should steel prices and the general economy continue to recover over the coming years.
At the time of this article’s writing, the author had a position in ArcelorMittal.