Steel Stocks Should 'Steel' be Avoided
Tony is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The economic slowdown in China has reverberations that are felt in many industries all around the globe, some more so than others. Perhaps no item is more closely identified with Chinese economic growth than steel. So it is no surprise that weakness in China has hit companies in the steel industry very hard, even here in the U.S.
Just look at the poor performance of the high beta names in the steel sector such as United States Steel (NYSE: X) and AK Steel Holding (NYSE: AKS), which are down more than 60 percent and 50 percent respectively over the past 52 weeks. U.S. Steel and AK Steel suffer more than other global steel companies because of their relatively high fixed costs. By the way, U.S. Steel releases it next earnings report on July 31 and AK Steel releases its next report on July 24. Both companies are expected to report that the drop in steel prices have squeezed their margins even further.
Even global steelmaker ArcelorMitall ADR (NYSE: MT) has fallen roughly 50 percent in the last year. This company has a lot of steelmaking capacity in recessionary Europe which is not good news either in the long term. The head of the European steel body EUROFER said recently Europe's steel industry is in terminal decline and that three-quarters of its capacity may be shut over the next two decades. ArcelorMittal itself is said to be considering shutting some European capacity soon.
While weak global macro economic conditions are a contributing factor to the steelmakers' woes, China is the main culprit here. China's steelmakers, like its leading steelmaker Baosteel, have been cutting prices while maintaining high production levels (roughly 2 million tons a day) in an effort to protect their market share.
Unfortunately for the steel companies, conditions continue to deteriorate for the steel industry in China itself. Chinese steel prices are sinking, which cannot be good news. The world's most heavily traded steel futures contract, the Shanghai rebar future, hit a 2012 low this week at 3,848 renminbi ($603) per ton, the lowest price since the rebar future was launched in early 2009. Prices have dropped because demand for steel in China has slowed sharply in 2012 to just a 4-5 percent forecast growth. A far cry from the last decade when demand for steel in the country rose five-fold.
The poor conditions for the steel industry globally has even led to talk about 'peak steel.' That is, both steel demand and output reaching a plateau at about the 1.5-1.6 billion ton range. If the people backing that concept are correct, then steel companies are going to have to completely rethink their business plans and how they run their companies.
Even if China launches a major economic stimulus plan ala 2008, with an emphasis on steel-heavy infrastructure, it is likely to give only a temporary reprieve to Chinese and global steelmakers. Even China can only build so many skyscrapers and bridges.
The outlook for the industry, at least for the next several years, is decidedly bleak and steel stocks have reacted accordingly. Peter Marcus, managing partner of U.S.-based consultancy World Steel Dynamics, summed up the outlook for the Financial Times nicely, “For the next five years, the steel industry faces a rutted road strewn with potholes. A lot of companies are going to find it hard to make money.” And so will investors in the sector who should look for continued weakness from the steel stocks.
For investors interested in playing the global steel sector long or short, perhaps the easiest way to do so is through an exchange traded fund. There are currently two ETFs with a focus on steel: the Market Vectors Steel ETF (NYSEMKT: SLX) and the PowerShares Global Steel Portfolio.
SLX has mining companies Vale and Rio Tinto among its major positions, but the rest of the portfolio is focused on steel stocks with nearly half of the portfolio in U.S. companies and another 10 percent in European stocks. PSTL also has some mining stocks like Vale among its top holdings and has about 20 percent each devoted to European and U.S. steel stocks.
tdalmoe 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.