About the Industry
The steel industry can well be termed the backbone of modern
society considering steel’s varied uses, be it in construction,
transport, electrical appliances, food packaging and the like. In
terms of its composition, steel is an alloy of iron and carbon
containing less than 2% carbon and 1% manganese and small amounts
of silicon, phosphorus, sulfur and oxygen.
Steel products are classified into four broad categories: flat
steel products, long steel products, scrap and semi-finished
products. Flat products include plates, hot-rolled strip and
sheets, and cold-rolled strip and sheets. The long steel product
category includes wire rods, beams, reinforced bars and merchant
bars. The products under both these categories are rolled from
steel slabs, which are considered as unfinished or semi-finished
products that are generally not sold.
The world steel industry is a large one. According to the World
Steel Association, world crude steel production was a record 1,527
million tons (Mt) in 2011. However, despite its size, the steel
industry remains relatively fragmented. The industry is highly
cyclical and intensely competitive.
A Look into Major Consumer Markets
Historically, the automotive and construction markets have remained
the largest consumers of steel, absorbing more than half of the
total steel produced. The industry caters to large automakers such
as General Motors Company (GM), Ford Motor
Company (F), Toyota Motor Corporation
(TM) and Honda Motor Company (HMC).
Houses, buildings, skyscrapers and bridges rely on steel for their
strength. Other steel consuming industries include appliances,
agricultural implements, converters, containers, energy, electrical
equipment and industrial machinery.
Over the last few years, China has emerged as the major consumer of
steel. Ranked on the basis of consumption, United States follows
next with Japan, India and South Korea in tow.
Global Production Numbers
As mentioned above, world crude steel production was a record 1,527
Mt in 2011, outperforming the 2010 record of 1,414 Mt, a 6.8% jump.
China continues to be the largest steel producing country,
generating almost half of the global output at 46%, and growing
8.9% year over year. Japan posted a 1.8% decline affected by last
year's earthquake. The United States enjoyed the third
position, producing 86.2 Mt of crude steel, 7.1% higher than 2010
and comprising 6% of the total global output.
North America’s crude steel production was 118.9 Mt, an increase of
6.8% on 2010. Asian production grew 7.9% to 988 Mt and Europe
rose 4.6% to 329 Mt. Among the top 10 steel producing countries, as
per the World Steel Association, Turkey outperformed the rest on
the basis of year-over-year growth with a 17% surge in production
to 34 Mt. South Korea followed with a 16% clip to 68.5 Mt.
January figures from the ongoing fiscal show a downtrend of 7.8%
year over year aggregating to steel production of 117 Mt but
consistent with December 2010 levels. Chinese production
dropped 13% to 52 Mt while Japan posted an 11% drop to 8.6 Mt. In
Asia, overall decline was noted at 11.4% to 73.8 Mt and Europe
dipped 2.7% to 17.3 Mt. The United States fared better with an
annual climb of 5.7% to 7.6 Mt.
Performance: Before & After
After enjoying a sturdy growth for most of the past decade, the
steel industry suffered a decline in 2008 due to the recession, as
consumers utilized existing inventories rather than buying new
stock. However, the industry turned around in late 2009 and
continued to grow in 2010 and 2011, in tandem with global economic
activity.
The growth witnessed in 2011 was noteworthy considering the
widespread headwinds facing the industry: the ongoing euro area
sovereign debt crisis, earthquakes in Japan, the political unrest
in the Middle East which resulted in a surge in oil prices, and the
tightening of government monetary measures in many emerging
nations.
Demand for steel has benefited from the spurt of growth witnessed
in the developing economies that helped counter the sluggishness in
developed economies. Asia, particularly China, continued to be the
principal driver of growth. Demand for steel products nonetheless
remains below pre-recession levels. Questions about China’s growth
going forward also add an element of uncertainly to the
outlook.
In 2010, the automotive industry began to recover from the effects
of the recession. The automotive sector is showing significant
promise. In February 2012, total motor vehicle sales reached the
highest level since February 2008, at 15.1 million SAAR (Seasonally
Adjusted Annual Rate). For the first two months of 2012, sales have
averaged 14.6 million SAAR, outperforming the Street expectations.
We believe these upbeat numbers bode well for the steel
industry.
The construction sector has been a drag on the steel companies’
earnings. Unlike the automotive sector, the housing industry
struggled in 2011 and continues to be severely impacted by the
after effects of the recession. Housing starts in the United States
in 2011 remained near historically low levels for the third
consecutive year compared to pre-recession activity.
According to the data released by the U.S. Department of Housing
and Urban Development, housing starts increased 34.7% to a
seasonally adjusted annual rate of 698,000 in February 2012 from
February 2011. Building permits in February were at a seasonally
adjusted annual rate of 717,000, 34.3% above the February 2011
figure of 534,000.
These figures provide a glimmer of hope that U.S. residential
construction is finally on the road to recovery. But it will likely
be a long time before the industry’s conditions can be called
‘normal’ again.
We also see some early signs of recovery in non-residential
construction. According to the American Institute of Architects,
the architecture billings index, an economic indicator that
provides an approximately nine to twelve month glimpse into the
future of non-residential construction spending activity, was 51.0
in February 2012.
The index has remained over 50 for the fourth consecutive month, a
sure indicator of an overall rise in demand in the construction
industry. The optimism is seen across most regions of the country
and the major construction sectors.
However, given the uncertainty in the markets, we are still a
little skeptical about the sustainability of the momentum. We thus
expect soft-to-very-moderate near-term growth in demand in this
sector as clients exercise caution in pursuing new projects and
face difficulty in accessing financing for projects.
How Well Did the Steel Stocks in Our Coverage
Fare?
Reflecting on the 2011 results of the steel companies in our
coverage -- ArcelorMittal (MT), AK Steel
Holding Corporation (AKS) and Nucor
Corporation (NUE) -- we find revenues increasing across
the board due to higher average steel prices and increase in
shipments.
ArcelorMittal, the world’s largest steel producing company, belched
out 91.9 Mt in fiscal 2011, representing 6% of the world's steel
output. ArcelorMittal’s 2011 sales increased 10% to $94 billion
while AK Steel’s sales climbed 8% to $6.5 billion. Nucor recorded
sales increase of 21% to reach $20 billion.
In terms of profitability, Nucor stood tall with its fiscal 2011
EPS of $2.45, almost six fold the 42 cents earned in 2010.
ArcelorMittal’s EPS in fiscal 2011 plummeted 31% to $1.19. AK Steel
reversed its year-ago loss to earn 9 cents (excluding special
items) in 2011. United States Steel Corp (X),
though still in red, narrowed its fiscal 2011 loss per share to 47
cents from the year-ago loss of $3.36.
The steel companies expect volumes to improve in 2012 on recovering
demand from improving end-markets, backed by a recuperating global
economy. They expect operating results to significantly improve
from 2011 levels mainly driven by improved average realized prices
and higher shipments. Steel consumption is expected to grow in the
automotive, transportation, energy, industrial and the agricultural
sectors.
However, the European debt crisis and its potential global impact
remain an overhang on the steel industry. ArcelorMittal has idled 5
of its 25 blast furnaces in Europe. The company will continue to
align its steel growth projects to match demand situations.
Furthermore, the company’s focus on its mining business given its
more attractive returns has resulted in some planned steel
investments being deferred.
Currently, Nucor, United Steel and AK Steel retain a Zacks #3 Rank
(Hold) for the short term (1 to 3 months) that corresponds with our
Neutral recommendations in the long term. ArcelorMittal retains a
Zacks #4 Rank (Sell) and we have recently downgraded our long-term
recommendation from Neutral to Underperform.
Industry Capacity & Demand/Consumption
Dynamics
World crude steel capacity utilization ratio inched up 0.5
percentage point to 71.3% in January 2012 from December 2011 but
dipped 9.6 percentage points from January 2011. U.S. capacity
utilization ratio in January 2012 was a forty-month record high at
77.6%, an increase from the December 2011 utilization rate of
75.2%. Though the capacity utilization rate has increased
significantly from the April 2009 low level, it still remains below
the historical averages.
In the United States, apparent consumption, which is used to
measure domestic demand for steel, stood at 8.6 Mt in January 2012,
up 15.6% year over year and 11.6% from the sequentially preceding
month. When we compare it with the trough experienced in April
2009, demand was up a considerable 86.1%.
Price Trends Seen So Far
Steel prices are generally volatile, in line with the highly
cyclical nature of the global steel industry. Following an extended
period of rising prices, steel prices plunged during the financial
and economic crisis of 2008 due to the sudden drop in demand. This
was further intensified by massive industry destocking as customers
cleared their steel inventories. Steel producers in their turn
suffered the worst casualties, recording lower revenues and
margins, and even had to write down finished steel and raw material
inventories.
Steel prices saw a recovery in late 2009 that followed into 2010
but remained below the pre-financial crisis level. In 2011, steel
prices remained volatile, increasing in the first half on the back
of strong demand, higher raw material costs, improved activity for
the automotive, appliance and other industrial segments though
construction remained relatively weak in many regions.
Prices fell in the second half as demand decreased due to
uncertainty surrounding the Euro-zone sovereign debt crisis. The
fourth quarter particularly exhibited weakness due to a sharp drop
in iron ore prices in October and as customers renewed destocking
considering the uncertain economic environment.
So far in 2012, the steel industry is seeing some price hikes. We
feel that the recovery in pricing momentum will be driven by a
reviving economy, no further crisis in the Euro-zone and a rebound
in construction activity in the developing countries, in particular
China, India and South Korea.
A Closer Look at the Factors Affecting Steel
Prices
Rising raw material prices: The steel industry consumes
substantial amounts of raw materials including iron ore, coking
coal and coke besides requiring a lot of energy. Increases in raw
material prices necessitates a corresponding increase in steel
selling prices.
However, the situation gets tricky in the wake of lower demand,
when it becomes increasingly challenging to pass on raw material
price hikes to consumers. Historically, energy prices have varied
significantly. This trend is expected to continue due to market
conditions and other factors beyond the control of steel
companies.
Overcapacity and fluctuation in steel imports-exports: The
steel industry has always suffered from overcapacity. Steel
consumption in China and other developing economies has increased
at a rapid pace. In response, steel companies have ramped up their
steel production capability with scope for increasing further
capacity.
Steel production capability, particularly in China, appears to be
in excess of China’s domestic market demand. Considering China is
the largest steel producer, the export of the surplus steel at
subsidized prices to other markets casts a major impact on world
steel trade and prices. Consumers in the United States are
importing cheaper steel from China, forcing domestic steel
producers to sell at lower prices, and sometimes even at a loss.
The U.S. government has thus been imposing anti-dumping duties on
Chinese steel imports.
Economic recovery: Steel prices are generally sensitive to
changes in global and local demand, which are in turn governed by
worldwide and country-specific economic conditions and available
production capacity. Although the steel industry has been
recovering since the 2008 recession, the recent Euro-zone sovereign
debt crisis added to the still-tentative recovery in the developed
world has again created a lot of uncertainty in the market. This
has resulted in many countries suspending investment in
infrastructure and other industries, impacting steel prices.
Threat from substitutes: Steel has many substitutes like
aluminum, cement, composites, glass, plastic and wood. A shift
toward these or other substitutes, whether due to lower costs or
government mandates on the basis of environmental or other reasons,
would significantly impact prices and demand for steel
products.
Raw Material Trends
The primary inputs for the steel industry are iron ore and coking
coal, along with coke, scrap, alloys and base metal. The industry
also uses large volumes of natural gas, electricity and oxygen in
its steel manufacturing operations.
Iron ore prices have remained relatively high in 2009, which
continued in the first half of 2010. However, prices fell in the
second half of 2010. In 2011, iron prices were up most of the year
before prices fell in October.
The iron ore industry is highly concentrated with only three major
players: Vale (VALE), Rio Tinto
(RTP) and BHP Billiton (BHP) having significant
pricing power. The risk lies in further consolidation among raw
material suppliers.
In a recent development, VALE, Rio Tinto and BHP Billiton will soon
sign agreements to sell iron ore through China’s new spot trading
platform. The platform will officially start operating in the first
half of the year and has been set to strengthen pricing power and
improve transparency.
China is the largest iron ore importer, and also has the world’s
largest spot iron ore market. With the involvement of major foreign
miners, the trading platform’s position can have more influence
over the price of the raw material.
Consolidation
Mergers and acquisitions (M&A) have remained an important
growth strategy in the steel industry. M&A activities prevent
additional steel capacity, providing production efficiency and
economies of scale. The biggest example is Mittal Steel’s
acquisition of Arcelor in 2006. The Tata Steel and Corus merger in
2008 is another instance of industry consolidation.
After a lull during the global economic downturn of 2008-2009,
M&A activity of various steel and mining players, including
Chinese and Indian companies, has quickly picked up.
Consolidation has been primarily driven by the urge to increase
global scale and operations, and access new markets. The industry
is likely to see more M&A activity in the coming years as the
industry players prepare themselves for a recovery in the long run.
Further, steel makers are now focused on acquiring or are
considering acquiring mines or stakes in mines to secure raw
materials at more competitive prices.
Going forward, the abatement of the Euro-zone crisis, recovery in
the US economy and developments in the Chinese real estate and
construction sector will determine the fate of such deals.
However, given the prevailing uncertainty, we expect moderate
growth in M&As.
Challenges Ahead
Overcapacity: Even though demand has increased overall in
the past two years, growth in steelmaking capacity is still ahead
of demand and remains a significant challenge for the industry.
This has further worsened by the European sovereign debt crisis
which has put a bar on investments in large scale projects in
Europe and reduced capital for growth.
The uncertain global economy: The steel industry was
significantly affected by the global economic crisis in 2008. Even
though it is recovering, demand has still not reached pre-recession
levels. The debt crisis in Europe remains a concern and the United
States has had to resort to quantitative easing to thwart sluggish
demand.
The saving grace is the spurt of growth witnessed in the developing
economies that helped counter the sluggishness in the developed
economies. Asia and particularly China continued to make up for the
stalemate in Europe and North America.
Earlier this month, BHP Billiton, the world’s biggest miner, hinted
at flattening iron ore demand as well as steel growth in China
triggering concerns. However, the company believes the steel
industry’s long-term story in the country remains intact,
underpinned by China’s urbanization and industrialization programs.
The company forecasts that the country's annual steel output will
still rise by around 60% by 2025.
There are signs of cooling in China’s real estate sector, which
accounts for almost half of the total steel demand in China.
Earlier this month, China cut its 2012 growth target to an
eight-year low of 7.5%. A slowing Chinese economy will have a
negative impact on infrastructure and construction spending and on
the steel industry as well.
Dependence of Margins on Raw Material Prices: The steel
companies’ margins are dependent on the extent to which changes in
raw material prices are passed through to steel selling prices. The
time lag between the raw material price change and the steel
selling price change, and the date of the raw material purchase and
the actual sale of the steel product in which the raw material was
used are also important factors affecting margins.
To Sum Up
All said, we believe growth in the industry will be tempered by
concerns regarding the continued financial uncertainty and
volatility and the quintessential issue of overcapacity. Global
steel demand will improve gradually in line with the recovery in
the user industries, automotive and residential construction. While
the automotive sector holds promise, we have yet to see a sustained
recovery in the residential sector, to enforce a more positive
outlook.
Emerging and developing economies will continue to drive growth
while recovery of steel demand in the developed world will be slow.
Despite concerns regarding a slowing economy, demand in China will
grow in the long term given the vast capital outlay on
infrastructural development. In this game, its neighbor India is
not behind and will likely be a major consumer driving the steel
industry.
AK STEEL HLDG (AKS): Free Stock Analysis Report
BHP BILLITN LTD (BHP): Free Stock Analysis Report
FORD MOTOR CO (F): Free Stock Analysis Report
GENERAL MOTORS (GM): Free Stock Analysis Report
HONDA MOTOR (HMC): Free Stock Analysis Report
ARCELOR MITTAL (MT): Free Stock Analysis Report
NUCOR CORP (NUE): Free Stock Analysis Report
RIO TINTO-ADR (RIO): Free Stock Analysis Report
TOYOTA MOTOR CP (TM): Free Stock Analysis Report
VALE SA (VALE): Free Stock Analysis Report
UTD STATES STL (X): Free Stock Analysis Report
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