Global Slowdown Hits the Steel Trade

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China-based Baoshan Iron & Steel Co, the world’s fourth largest steelmaker, has closed the Shanghai plant that it purchased for $2.2 billion just four years ago. With the falling levels of demand, the plant has been piling up losses. It was primarily used to manufacture steel slabs for the ship-making industry. Baosteel hasn’t disclosed when the plant will be reopened.

The Chinese government approved a $160 billion stimulus package, but the steel industry is doubtful about it being enough to boost demand to spur growth. Baosteel’s rival and China’s biggest overall steel producer, Hebei Iron And Steel Co, has also cut its production and expects overall demand to fall. Iron ore prices have fallen by 25% this year, touching a three year low while more than 35% of iron-ore mines have stopped production in the country.  Zhang Dianbo, assistant President of Baosteel, has urged the government to give relief to steelmakers by cutting taxes. Amid slowing economic growth, it is unlikely that demand for ships and construction would pick up. This month, China’s daily crude steel production had fallen by 2% to 1.86MT. 

Iron ore prices, despite the recent spike from early September, have declined more than 30% in the past 52-weeks.

Vale SA (NYSE: VALE), however, is expecting global steel demand to rise by 2.5% and China’s steel output to increase by 3%-5% by 2013. The company is therefore continuing with its expansion strategy. Although Vale has identified that the prices are likely to stay between $100 and $120 per ton in the near future, the China Iron and Steel Association estimated average costs will be~$80 per ton and that high taxation is hurting the industry’s competitiveness.

China has become one of the biggest steel importersin the world, rising in 2011 to the 7th largest per capita steel consumer at 459.8 kg. While most U.S. listed steel-makers have paid regular dividends this year, Moody’s warned on Sept. 27that business conditions for the steel industry will be worse in the coming 12 to 18 months despite the $780 billion stimulus package, 15% of which was reserved for infrastructure projects. That's why the ratings agency downgraded the U.S. steel industry’s outlook from stable to negative.

This is a direct impact of a weak American economy, the European debt crisis, and low GDP growth in China. Interestingly, steel imports in the U.S. increased by 18% year over year in August, which Moody’s suggests has created further imbalances in the market. The current capacity utilization levels are at 70%, while the purchasing management index (PMI) hovers around 49%. If the U.S. can improve capacity utilization to at least 75% and the PMI increases to and remains at 50% for two consecutive months, then the U.S. steel outlook would turn stable. In the current economic environment, it is not entirely impossible for the U.S. steel industry to climb back to stable in the coming quarters.

ArcelorMittal (NYSE: MT), the world’s biggest steel manufacturer (responsible for 6% of the total global steel output), has seen its shares fall by 10% since January, while U.S. Steel Corp (NYSE: X) and its bigger rivaland Steel Dynamics (NASDAQ: STLD) are down 13.7% and 4%, respectively. 

US Steel’s ROE has been negative for the 12 months ending June 30, while all of its rivals have managed positive returns. It also has a high fixed cost structure; therefore it is relatively a riskier investment, evident in its beta. ArcelorMittal offers the highest yield but has a very high P/E, which makes it an expensive buy, while Steel Dynamics' yield is within the industry range.

<table> <tbody> <tr> <td> </td> <td> <p><strong>MT</strong></p> </td> <td> <p><strong>X</strong></p> </td> <td> </td> <td> <p><strong>STLD</strong></p> </td> </tr> <tr> <td> <p><strong>ROA</strong></p> </td> <td> <p>2.37%</p> </td> <td> <p>1.64%</p> </td> <td> <p> </p> </td> <td> <p>4.37%</p> </td> </tr> <tr> <td> <p><strong>ROE</strong></p> </td> <td> <p>0.92%</p> </td> <td> <p>-7.92%</p> </td> <td> <p> </p> </td> <td> <p>6.19%</p> </td> </tr> <tr> <td> <p><strong>Beta</strong></p> </td> <td> <p>2.61</p> </td> <td> <p>2.40</p> </td> <td> <p> </p> </td> <td> <p>1.94</p> </td> </tr> <tr> <td> <p><strong>P/E</strong></p> </td> <td> <p>136.81</p> </td> <td> <p>N/A</p> </td> <td> <p> </p> </td> <td> <p>17.22</p> </td> </tr> <tr> <td> <p><strong>Yield</strong></p> </td> <td> <p>4.30%</p> </td> <td> <p>1.00%</p> </td> <td> <p> </p> </td> <td> <p>3.20%</p> </td> </tr> </tbody> </table>

Overall, the steel industry is presenting some opportunities for the long term investors, but general volatility and an expected fall in steel demand for the next year and a half means that investors should remain cautious in this market. Even in the face of Chinese plant closures and lower overall competition, the performance of the U.S. steel companies means that they aren't worth investing in. I see no compelling reason to believe a long-term shift in the fundamentals of the American steel industry will take place amid this situation. Labor and regulatory costs in the U.S. are too high to compete with emerging manufacturing powerhouses like Vietnam and India, regardless of their current financial difficulties.


PeterPham8 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.

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