Against The Grain: Perfect Time To Buy Steel
Edgar is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Two years ago ArcelorMittal (NYSE: MT) gave a lasting legacy to the London Olympics when it constructed the Orbit in the east borough of Stratford. This 114 meter tubular steel structure shown below, which is 22 meters taller than the Statue of Liberty, is located near the Olympic Stadium, offering a panoramic view of London and surrounding areas.
"It is a fantastic way to give a lasting gift to London and to play a part in the regeneration of a specific area of London and to signal our support for an iconic global sporting event," said Mr. Mittal in an interview.
ArcelorMittal paid 19 million pounds and London Development Agency paid the other 4 million to complete the project. 2,000 tons of recycled steel was used during the construction, which is much less than the 83,000 ton of steel that was used for the Golden Gate Bridge.
However, if the Golden Gate Bridge was built today, then only 41,500 tons of steel would be needed. If the London Orbit was built 50 years ago, 4,000 tons of steel would be needed. That is because the innovative steel today is lighter in weight, but higher in strength.
And who can forget this next iconic beauty, Bird's Nest in 2008 Beijing Olympic Games. This stadium is enclosed with huge curved steel net that covers 91,000 people. The design and installation was very challenging for Jiangsu Yulong Steel Pipe Co. with 42,000 tons of steel and 4,000 tons of rectangle steel pipes used in this immense project.
Why am I telling you all this? Well, there are several reasons...
First and foremost, 2014 World Cup is coming up in Rio de Janeiro and the Brazilian government has already witnessed higher demand in steel for the construction sector. In 2013, steel demand in Brazil is expected to grow by 8% versus the 5.5% in 2012. Demand for carbon steel used in cars has grown 4% and is expected to be more robust next year with a growing Brazilian middle class. Here are some stocks that should benefit.
Although not favored by most, consider owning some Gerdau (NYSE: GGB), a $14.9 billion Brazilian based steel manufacturing company that produces long steel and flat steel items through a process of fabrication in electrical furnaces from scrap metal and purchased pig iron.
The largest recycler of Latin Americas saw its margins dwindle since last September, but revenue and profit margins are starting to come back with higher demand expectations from Brazil for upcoming quarters. I would wait until earnings release on November 1 before pulling the trigger, and wouldn't allocate more than 20% of my Brazil exposure to this stock.
If you want a healthier balance sheet and a yield of 6.28%, a better bet on Brazilian steel is Vale (NYSE: VALE), $58 billion producer of steel, iron ore, coal, nickel, fertilizers and manganese. They have a larger market cap and are more globally diversified than Gerdau. Observe their declining EPS for the last seven quarters with the price chart overlay. They went from earning $1.29 per share in Q1 2011, to $0.32 in Q3 of 2012, an incremental decline, but expectations for next quarter are $0.20 higher per share.
The worry has dissipated and I believe the time for a turnaround is here. Although the company suffered a major loss of revenue due to lower global sales as well as a higher cap ex, it is now focusing more on cutting costs and "doing more with less". We all know what that means, maintaining its strong balance sheet and preserving its good credit rating is of utmost importance to Vale until pricing power returns. Its P/E ratio is among the lowest of any stock in the metal and mining industry. With demand pushing higher in 2013, the stock is a strong buy at $18.32 in my opinion.
Domestically, steel demand has been a little soft lately, but super storm Sandy might provide fresh buying optimism. Not to mention, more and more utility companies are replacing their aging wood electric utility distribution poles with poles made out of steel. Steel poles are favored by utility companies since they're easily installed, are more durable, have uniform dimensions, impervious to insects and rot, and have lower life cycle costs.
According to American Iron and Steel Institute, in the week ending October 20, 2012 steel production was 1,722,000 net tons with a utilization rate of 69.7%, versus production of 1,781,000 tons same time last year with a utilization rate of 71.9%. Consequentially, most steel stocks have suffered a price decline in the last month except my favorite two: Nucor (NYSE: NUE) and Steel Dynamics (NASDAQ: STLD).
Nucor has returned 5% to shareholders in the last month despite its lower revenues of 8.6%. This shows resilience. Normally, it had a very good track record with consecutive bullish surprises, but in the last two quarters it has been plagued with weakness just like all its peers, bringing in only $0.35 a share. Its best quality price of heavy melt steel has fallen 17% to $365 per ton. While this is a definite cause to worry for the upcoming quarter, I still find Nucor as best of breed steel company that trades at a fair price and will benefit from a global demand rise.
I favor Steel Dynamics mainly due to their ability to weather the slowdown in lower cost structure and product diversity. The company has a high exposure to the cyclical auto and non-residential construction markets and suffers from a high ratio of liabilities to its assets relative to some of its peers. It saw a revenue rise of 27% last year and was able to offset some of its low steel and scrap prices by higher volume of sales. I'm a bit more bullish than the consensus of analysts for non-residential construction spending in 2013 and believe Steel Dynamics forward P/E of 9.65 is slightly undervalued against its next year EPS estimates of $1.44.
edgarambart30 has no positions in the stocks mentioned above. The Motley Fool owns shares of ArcelorMittal. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.