Chicago, IL – January 26, 2016 – Today, Zacks Equity Research discusses the Steel (Part 3), including Steel Dynamics Inc. (STLD), United States Steel Corp. ( X), ArcelorMittal (MT), AK Steel Holding Corporation (AKS) and Nucor Corporation (NUE). Industry: Steel (Part 3) Link: https://www.zacks.com/commentary/69183/what39s-going-against-the-steel-industry The steel industry is poised to benefit from solid demand in the U.S and emerging markets like India. But steel stocks have to grapple with equity market volatility and a host of other broader factors. Below, we discuss some of the key reasons and what investors in the steel sector can look forward to in the coming months and years. Rise in Cheap Imports in the U.S.
China’s steel exports crossed the benchmark of 100 million tons for the first time last year in the wake of shrinking domestic demand amid a flagging economy. China is the world’s top steel producer, contributing around half of the global output.
China’s steel exports increased 20% year over year to 112.4 million tons in 2015, according to data released by the General Administration of Customs. China alone exported 10.66 million tons of steel in December, a roughly 11% jump from the previous month.
The country has built up massive excess capacity, posing a threat to the global steel industry. The worsening gap between supply and demand, with barely any sign of recovery, further darkens the picture. The Purchasing Managers’ Index (PMI) for the Chinese steel industry has stayed below the mark of 50 for 20 straight months, signaling a sharp disparity between supply and demand.
A slump in the domestic property market, which accounts for a significant part of China’s steel consumption, severe credit crunch and weak infrastructure investment continue to hurt steel demand in China. Moreover, China’s move to devaluate its currency has triggered accelerated steel exports from the country. A cheaper yuan has made Chinese exports less expensive in overseas markets.
These cheap imports hurt the margins of American steel players like Steel Dynamics Inc. (STLD), United States Steel Corp. ( X), ArcelorMittal (MT ), AK Steel Holding Corporation (AKS) and Nucor Corporation ( NUE).
Slowdown in China
As discussed above, demand in China has slowed down due to the country's tepid property market and weaker infrastructure investment. China’s GDP moderated to 6.8% for the fourth quarter, its lowest reading since the financial crisis. The country’s 6.9% growth for 2015 was a marked deceleration from the 7.3% gain last year, and its weakest in 25 years. A renewed plunge in China's stock markets and weak factory and service data stoked concerns among global investors about the health of the world's second-biggest economy.
China’s weaker-than-expected December manufacturing activity triggered a big sell-off in Chinese equity markets. This had repercussions on other asset classes including commodities and global equities. China’s steady devaluation of its currency has sent its equity markets as well as global stocks in a tizzy. Steel stocks have also fallen with the current wave of the metal meltdown. Geopolitical Tensions
The performance of some key emerging and developing economies has deteriorated due to internal structural issues, lower commodity prices associated with China’s economic slowdown, and escalating political instability. Russia and Brazil are experiencing severe contraction in steel demand. Geopolitical tensions and political instability in the Middle East, Africa and Ukraine continue to have a negative effect.
Excess Capacity, a Perennial Problem
The biggest obstacle to the path of persistent growth and profitability of the steel industry is excess capacity. The industry is under relentless pressure caused by years of excess steel-making capacity, further aggravated by weak demand and uneven economic growth. To solve this problem, steelmaking capacity needs to be reduced for the industry’s profit margin to reach a sustainable level, and to raise the capacity utilization rate from below 80% levels. The industry remains highly fragmented compared to other global businesses, and the restructuring and consolidation needed to eliminate overcapacity is progressing at a slow pace.
Falling U.S. Steel Prices
Falling steel prices have been a big challenge for U.S. steel companies. Major companies including AK Steel, U.S. Steel and Steel Dynamics have cut spot steel shipments as prices deteriorated sharply in the fourth quarter. As prices of raw materials including iron ore, coal and steel scrap are also falling, it would be difficult for U.S. steel mills to justify price hikes. Prices of other industrial metals, including aluminum and copper, are also on a downtrend. Lower spot steel prices are expected to affect steel companies this year.
Falling Oil Prices
The energy sector, which was once buoyant due to shale discoveries and rising production of crude oil, accounts for 10% of U.S. steel consumption. Steel is necessary to make rigs and transport oil. Steel demand from the energy sector is being affected as exploration companies have reduced their capital expenditure budgets in the wake of tumbling oil prices.
Steel products used by the energy industry are also known as oil country tubular goods (or OCTG). U.S. Steel, being the biggest supplier of these goods in North America, is bearing most of the brunt.
Low Crude Steel Capacity Utilization
The crude steel capacity utilization ratio remained stubbornly below 80% in 2014 and has stayed there in 2015. The average capacity utilization in 2015 through November was 70.5%, with the graph going downhill. Excess steel capacity has been a perennial problem for the steel industry and steel prices generally move in tandem with capacity utilization rates. To remain competitive, some major steel companies have idled their steel plants in a bid to rationalize operations.
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