Steel shares have been lagging in 2013. The
Market Vectors Steel ETF
) is down over 15% year to date compared to the
SPDR 500 ETF
) which is up over 19% year to date. The underperformance
of the steel sector puts it in the spotlight for a turnaround and
may be a contrarian's delight. The graphic displays the
relative performance of the steel ETF.
Global growth shows signs of improvement:
There are signs the global economy's growth rate may be
reviving, and this could brighten the outlook for the steel
industry. The July U.S. manufacturing PMI jumped 4.5 to
55.4 posting its strongest result since June 2011, while the July
Eurozone manufacturing PMI hit a two year high at 50.3.
Both indices look to be in an upswing and suggest the economic
cycle is turning higher. The global economy is not firing
on all cylinders as the emerging markets are still lagging, but
strength in the U.S. and Europe could help bolster EM export
China is cutting steel capacity:
Beyond signs of improved economic growth, there are signs that
China is working to cut capacity in its steel industry. The
National Business Daily indicated that China could reduce
capacity in the sector by 400 million metric tons. The
reduction is expected to amount to about 40% of China's steel
capacity. A reduction in capacity could help pricing
power among global steel producers.
Valuation is attractive on a price to sales
Steel companies have a history of reporting losses and
volatile earnings depending on the economic cycle. As
a result, price to earnings ratios can become negative or not
meaningful. Sales are usually positive and make the price
to sales ratio easier to use for valuation in a historical
context. The table below displays the price to sales
ratio for a select group of steel stocks.
The price to sales ratios for the stocks in the table are all
well below their 10 year average and toward the lower end of the
range. This hints the sector has an inexpensive valuation
and is cheap.
) are trading at the smallest discounts and appear most expensive
relative to their historical valuation.
) are trading farthest from average and appear most
inexpensive. However, relatively to the peer group, AKS and
X have the lowest price to sales ratios.
Valuation looks less attractive based on next year's
The following table highlights the price to earnings ratio
based on the outlook for the next fiscal year's earnings (think
2014). In this case, most of the companies are trading at a
premium to their average. The sector looks on the expensive
side. NUE and
) have the narrowest premiums to average. STLD and
AKS also have the lowest ratios relative to the group.
Earnings estimates have generally come down:
The next table highlights the Zacks Rank and earnings
estimates revisions over the last 30 days. The Zacks Rank
is founded on analyst earnings revisions. Simply speaking,
companies with the greatest upward revision to earnings estimates
are ranked as a #1 (Strong Buy), while companies with the largest
downward revision to earnings estimates are ranked with a Rank #5
(Strong Sell). Notice that steel companies range in the
Rank #3 to Rank #4 categories. Slow global growth and the
weak tone of economic activity in the emerging world have hurt
the earnings outlook.
Notice that NUE has seen the greatest ratio of downward to
upward revisions, but STLD has seen a more two way
flow. Analysts appear most cool toward NUE, but there
appears to be a debate brewing over the direction of earnings at
Dividends are not supportive to the group:
The table also highlights dividend yields.
Dividend yields are limited for NUE and
), while AKS does not pay a dividend. MT, STLD, and CMC seem to
provide the strongest dividend opportunities.
MT's dividend yield stands out as way to get paid, while
waiting for price appreciation and a sector turnaround.
However, free cash flow after dividend payment was negative in
2011 and barely positive in 2012. Free cash flow after
dividend payment has been trending weak compared to longer term
history. The high dividend yield may reflect uncertainty over
STLD, with a 2.8% dividend yield, has shown more stability in
its free cash flow after dividend payment and may provide a more
conservative way to wait for price appreciation. CMC had
negative free cash flow after dividend payment in fiscal 2010 and
2011, but positive free cash flow after dividend in fiscal
Short interest has been building. Could a squeeze
be around the corner?
Generally, short interest has been rising in the steel sector.
It reflects caution in the sector. According to the
NASDAQ website, short interest has built in most of the
stocks. The table displays the high and low in the short
interest ratio since last August. There is potential for a
re-positioning in the sector - buying or short covering. The one
exception seems to be ZEUS, which has seen its short interest
ratio plunge in recent months. AKS and CMC seem to have the most
elevated short interest, but MT and NUE are not too far
Sentiment toward steel pricing seems cautious.
Automotive seems like a bright spot, but general commentary on
the industry has been unexciting. The recent lift in the
European and U.S. manufacturing PMIs coupled with ideas of China
cutting capacity could improve psychology and interest in the
The steel has been out of favor. However, signs of
accelerating economic growth may revive investor interest in the
sector. Earnings estimate revisions reflect apathy to
cautious toward the sector with EPS estimates falling more than
rising. The value play is not clear as price to sales and
price to forward earnings ratios provide a mixed outlook. A
basket approach, buying the ETF SLX may be the easiest way to
play for recovery and bet against the crowd.
Technically, one could make the case that the SLX is near
testing the breakout of a three year downtrend and has rotated
back above the 2011 and 2012 lows. This may suggest the
downtrend is running out of gas.
Those looking for value and repositioning in individual names
may think about NUE and AKS. Both companies carry high
short interest ratios compared to the last year. NUE looks
relatively inexpensive based on its two year forward earnings per
share estimate, while AKS has a low price to sales ratio both
outright and compared to its peers. Both are Zacks
Rank #3 (Hold). See if you can steal some profits from the market
in the steel sector.
COMMERCIAL METL (CMC): Free Stock Analysis
NUCOR CORP (NUE): Free Stock Analysis Report
MKT VEC-STEEL (SLX): ETF Research Reports
SPDR-SP 500 TR (SPY): ETF Research Reports
STEEL DYNAMICS (STLD): Free Stock Analysis
UTD STATES STL (X): Free Stock Analysis
OLYMPIC STEEL (ZEUS): Free Stock Analysis
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