About the Industry
The steel industry can well be termed the backbone of modern
society, considering steel's varied uses -- be it in construction,
transport, electrical appliances, food packaging, etc. In terms of
its composition, steel is an alloy of iron and carbon containing
less than 2% carbon and 1% manganese and small amounts of silicon,
phosphorus, sulfur and oxygen.
Steel products are classified into four broad categories: flat
steel products, long steel products, and scrap and semi-finished
products. Flat products include plates, hot-rolled strip and
sheets, and cold-rolled strip and sheets. The long steel product
category includes wire rods, beams, reinforced bars and merchant
bars. The products under both these categories are rolled from
steel slabs, which are considered as unfinished or semi-finished
products that are generally not sold.
The world steel industry is a large one. According to the World
Steel Association, world crude steel production was a record 1,527
million tons (Mt) in 2011. However, despite its size, the steel
industry remains relatively fragmented. The industry is highly
cyclical and intensely competitive.
A Look into Major Consumer Markets
Historically, the automotive and construction markets have remained
the largest consumers of steel, absorbing more than half of the
total steel produced. The industry caters to large automakers such
General Motors Company
Ford Motor Co.
Toyota Motor Corporation
Honda Motor Co. Ltd.
Houses, buildings, skyscrapers and bridges rely on steel for their
strength. Other steel consuming industries include appliances,
agricultural implements, converters, containers, energy, electrical
equipment and industrial machinery.
Over the last few years, China has emerged as the major consumer of
steel. Ranked on the basis of consumption, the U.S. follows next
with Japan, India and South Korea in tow.
Global Production Numbers
As mentioned above, world crude steel production was a record 1,527
Mt in 2011, outperforming the 2010 record of 1,414 Mt, a 6.8% jump.
In the first quarter of the current fiscal year, world crude steel
production was 377.3 Mt, which improved to 388.6 Mt in the second
China retained its status as the largest steel producing
country, yielding almost half of the global output at 47%, growing
1.7% year over year in the second quarter. Japan, the second
largest producer, posted a 4.3% increase. The United States held
the third position, producing 23 Mt of crude steel in the quarter,
7.5% higher than second quarter of 2011 and comprising 6% of the
total global output. Asia improved 2.3% to 251.9 Mt, while Europe
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Performance: Before & After
After enjoying sturdy growth for most of the past decade, the steel
industry suffered a setback in 2008 due to the recession, as
consumers utilized existing inventories rather than buying new
stock. However, the industry turned around in late 2009 and
continued to grow in 2010 and 2011, in tandem with the global
The growth witnessed in 2011 was noteworthy considering the
widespread headwinds facing the industry: the ongoing Eurozone
sovereign debt crisis, earthquakes in Japan, the political unrest
in the Middle East resulting in a surge in oil prices, and the
tightening of government monetary measures in many emerging
Demand for steel has benefited from growth witnessed in the
developing economies that helped counter the sluggishness in
developed economies. Asia, particularly China, continued to be the
principal driver of growth. Demand for steel products nonetheless
remains below pre-recession levels. Questions about China's growth
going forward also add an element of uncertainly to the outlook.
The automotive and construction markets have historically been the
largest consumers of steel. The automotive sector is showing
significant promise. In February 2012, total motor vehicle sales
reached their highest level in the past 4 years at 15.1 million
SAAR (Seasonally Adjusted Annual Rate). In May, many auto
manufacturers made their best Memorial Day sales in over five
In June, total motor vehicle sales were at 14.1 million, improving
from 13.8 million in May. Domestic sales rose from 10.6 million
SAAR in May to 11.1 million SAAR in June, almost close to the
highest level of 11.4 million attained in February.
The outperformance was somewhat helped by lower gasoline prices,
which made domestic trucks more attractive and increased from 5.92
million SAAR in May to 6.14 million SAAR in June, the highest
number of domestic trucks sold since March 2008. For the first half
of 2012, sales averaged 14.3 million SAAR. We believe these upbeat
numbers bode well for the steel industry.
On the contrary, the construction sector has been a drag on the
steel companies' earnings. According to the American Institute of
Architects, the architecture billings index, an economic indicator
that provides an approximately nine-to-twelve-month glimpse into
the future of non-residential construction spending activity, was
48.4 in April 2012, dipping further to 45.8 in May and 45.9 in
As a reminder, the March reading of 50.4 was significant, as any
score above 50 indicates an increase in billings. After hovering
above 50 for five consecutive months, the index dipped to negative
territory from April. This points to a potential weakness in
non-residential construction, with little hope of a near-term
As per the U.S. Department of Commerce, housing starts increased
6.9% to a seasonally adjusted annual rate of 760,000 in June 2012
from the revised rate of 711,000 in May 2012 and 23.6% above June
2011. Though the June results have been the strongest since October
2008, it is approximately half the 1.5 million annual pace that
economists consider normal.
Building permits in June were at a seasonally adjusted annual rate
of 755,000, though 3.7% lower than the May figure of 784,000, 19.3%
above the June 2011 number. In fact, building permits issued in May
jumped to the highest level in the past four years.
To surmise, record-low mortgage rates, rising rents and reduced
prices of properties are luring buyers. These figures provide a
glimmer of hope that U.S. residential construction is finally on
the road to recovery. But it will likely be a long time before the
industry's conditions can be called 'normal' again.
How Well Did Steel Stocks Fare?
Reflecting on the first quarter results of the steel companies in
our coverage -
United States Steel Corp.
AK Steel Holding Corporation
) - we see revenues benefitting from higher average steel prices.
On the volume front it was a mixed bag as ArcelorMittal and U.S.
Steel witnessed a rise, while Nucor and AK Steel suffered declines.
Revenues increased at all the companies except AK Steel. However,
we note margin compression across the board.
As we look into second-quarter results, Nucor's volumes saw a lift
but a fall in average prices constrained its revenues. Profit was
affected considerably by an oversupply in the industry and a gloomy
European market. The rest of the companies have yet to release
their second quarter numbers.
Let's have a preview of what the companies are expecting in the
second quarter. Arcelor Mittal expects steel shipments in the
second quarter of 2012 to be at similar levels with the first
quarter. The Mining segment is expected to benefit from seasonally
higher iron ore shipments. The company forecasts that all of its
segments will demonstrate improved underlying profitability in the
second quarter. It expects that EBITDA for the first half of 2012
will be higher than the first half of 2011. ArcelorMittal
anticipates its own iron ore and coal production to increase by
approximately 10% in 2012.
U.S. Steel expects all three of its segments to report positive
results in the second quarter with total segment results in line
with the first quarter. Improvement in average realized prices is
expected to show in the next quarter with its European segment
expected to report positive income.
AK Steel has provided a muted guidance for the quarter in a range
of 4-6 cents per share, well below last year's earnings of 32 cents
in the wake of macroeconomic weakness and falling spot prices. The
company expects shipments to be slightly higher than the first
quarter of 2012 while average prices are expected to remain flat
with the first quarter.
Now, what will be the exact picture in the upcoming results? The
U.S. steel market is plagued by oversupply and increased imports.
Although Chinese steel production, which was responsible for
causing the glut to some extent, has somewhat slowed down, supply
in the steel market still overshadows demand, primarily driven by
weakness in the construction industry.
Increasing domestic imports along with oversupply in the industry
due to a ramp-up of operations by other steelmakers, is putting
pressure on prices. A recent fall in scrap prices has further put
pressure on steel pricing. We expect weak pricing to weigh on
second quarter results. Furthermore, the European debt crisis and
its potential global impact remain an overhang on the steel
Given the scenario in Europe, ArcelorMittal, the world's largest
steelmaker by volume and Europe's largest steelmaker, decided to
idle five of its 25 blast furnaces in Europe and announced the
extended idling of a number of facilities. The company will
continue to align its steel growth projects to match demand
In addition, the company's focus on its mining business given its
more attractive returns has resulted in some planned steel
investments being deferred. To reduce its exposure to Europe, the
company has also sold its 24% share in European energy company
Industry Capacity & Demand/Consumption
World crude steel capacity utilization ratio inched up to 80.4% in
June 2012 from 79.7% in May, but dipped 2.5 percentage points from
As per the data released by the U.S Department of Commerce, U.S.
capacity utilization ratio in April 2012 was at 80.9%, 9% above the
April 2011 level and the highest rate since September 2008. Though
the capacity utilization rate has increased significantly by 98%
from the lows seen in April 2009, it still remains below historical
In the U.S., apparent consumption, which is used to measure
domestic demand for steel, stood at 8.7 Mt in April 2012, up 0.4%
from the sequentially preceding month. When we compare it with the
trough experienced in April 2009, demand was up a considerable
Price Trends Seen So Far
Steel prices are generally volatile, in line with the highly
cyclical nature of the global steel industry. Following an extended
period of rising prices, steel prices plunged during the financial
and economic crisis of 2008 due to the sudden drop in demand. This
was further intensified by massive industry destocking as customers
cleared their steel inventories.
Steel producers, in turn, suffered the worst casualties, recording
lower revenues and margins, and even had to write down finished
steel and raw material inventories. Steel prices saw a recovery in
late 2009 that followed into 2010 but remained below the
pre-financial crisis level.
In 2011, steel prices remained volatile, increasing in the first
half on the back of strong demand, higher raw material costs,
improved activity in the automotive, appliance and other industrial
segments while construction still remained relatively weak in many
regions. Prices fell in the second half as demand decreased due to
uncertainty surrounding the Euro-zone sovereign debt crisis. The
fourth quarter particularly exhibited weakness due to a sharp drop
in iron ore prices in October and as customers renewed destocking
considering the uncertain economic environment.
Despite the price improvement in first-quarter 2012, there has been
a slump in pricing in the second quarter due to a glut in imports,
oversupply in the market from zealous steelmakers, weak demand in
Europe and tempering growth in Asia. A resumed downturn in steel
prices would materially and adversely affect the margins for the
second quarter. We feel that the recovery in pricing momentum will
be driven by a reviving economy, no further crisis in the Euro-zone
and a rebound in construction activity in the developing countries,
in particular China, India and South Korea.
A Closer Look at the Factors Affecting Steel
Rising raw material prices:
The steel industry consumes substantial amounts of raw materials
including iron ore, coking coal and coke besides requiring a lot of
energy. Increases in raw material prices necessitate a
corresponding increase in steel selling prices.
However, the situation gets tricky in the wake of lower demand,
when it becomes increasingly challenging to pass on raw material
price hikes to consumers. Historically, energy prices have varied
significantly. This trend is expected to continue due to market
conditions and other factors beyond the control of steel companies.
Overcapacity and fluctuation in steel imports-exports:
The steel industry has always suffered from overcapacity. Steel
consumption in China and other developing economies has increased
at a rapid pace. In response, steel companies have ramped up their
steel production capability with scope for increasing further
Steel production capability, particularly in China, appears to be
in excess of China's domestic market demand. Considering that China
is the largest steel producer, the export of the surplus steel at
subsidized prices to other markets casts a major impact on world
steel trade and prices.
Consumers in the U.S. are importing cheaper steel from China,
forcing domestic steel producers to sell at lower prices, and
sometimes even at a loss. The U.S. government has thus been
imposing anti-dumping duties on Chinese steel imports.
Steel prices are generally sensitive to changes in global and local
demand, which are in turn governed by worldwide and
country-specific economic conditions and available production
capacity. Although the steel industry has been recovering since the
2008 recession, the recent Euro-zone sovereign debt crisis added to
the still-tentative recovery in the developed world has again
created a lot of uncertainty in the market. This has resulted in
many countries suspending investment in infrastructure and other
industries, impacting steel prices.
Threat from substitutes:
Steel has many substitutes like aluminum, cement, composites,
glass, plastic and wood. A shift toward other substitutes, whether
due to lower costs or government mandates on the basis of
environmental or other reasons, would significantly impact prices
and demand for steel products.
Raw Material Trends
The primary inputs for the steel industry are iron ore and coking
coal, along with coke, scrap, alloys and base metal. The industry
also uses large volumes of natural gas, electricity and oxygen in
its steel manufacturing operations.
Iron ore prices have remained relatively high in 2009, which
continued in the first half of 2010. However, prices fell in the
second half of 2010. In 2011, iron prices were up most of the year
before prices fell in October.
The iron ore industry is highly concentrated with only three major
Rio Tinto Plc
BHP Billiton Ltd.
), having significant pricing power. The risk lies in further
consolidation among raw material suppliers.
In March, Vale, Rio Tinto and BHP Billiton signed agreements to
sell iron ore through China's new spot trading platform. The
platform has been set to strengthen pricing power and improve
transparency. China is the largest iron ore importer and also has
the world's largest spot iron ore market. With the involvement of
major foreign miners, the trading platform's position can have more
influence over the price of the raw material.
Mergers and acquisitions (M&A) have remained an important
growth strategy in the steel industry. M&A activities prevent
additional steel capacity, providing production efficiency and
economies of scale. The biggest example is Mittal Steel's
acquisition of Arcelor in 2006. The Tata Steel and Corus merger in
2008 is another instance of industry consolidation.
After a lull during the global economic downturn of 2008-2009,
M&A activity of various steel and mining players, including
Chinese and Indian companies, has quickly picked up.
Consolidation has been primarily driven by the urge to increase
global scale and operations, and access new markets. The industry
is likely to see more M&A activity in the coming years as the
industry players prepare themselves for a recovery in the long run.
Further, steel makers are now focused on acquiring or are
considering acquiring mines or stakes in mines to secure raw
materials at more competitive prices.
Recently, Nucor completed the acquisition of Skyline Steel, a
steel-foundation manufacturing and distribution subsidiary of
ArcelorMittal, for approximately $605 million.
Skyline Steel has been distributing Nucor's piling products for
over 20 years and has been a key customer of H-piling and hot
rolled sheet piling from Nucor-Yamato Steel. Through the
acquisition, Nucor aims to integrate Skyline into its system and
make it a more valuable downstream customer of coiled plate and
sheet products. In addition, the company expects the technological
know-how of both the companies to help them with innovative
solutions for the construction industry.
Skyline has an impressive distribution network serving the U.S.,
Canada, Mexico and the Caribbean markets, providing solutions for
application in heavy civil construction, marine construction,
underground commercial parking, storm protection, bridge and
highway construction and environment containment projects in the
infrastructure and construction industries. This is a smart move
for Nucor towards inorganic growth since Skyline's excellent
network will enable it to expand in North America.
Going forward, the abatement of the Eurozone crisis, recovery in
the U.S. economy and developments in the Chinese real estate and
construction sector will determine the fate of such deals. However,
given the prevailing uncertainty, we expect moderate growth in
Steel Usage Forecasts
The World Steel Association projects global steel usage to rise
3.6% in 2012, a sharp deceleration from 2011's 5.6% growth. This
reflects continuing slowdown of Chinese steel demand and Eurozone
debt crisis uncertainties. Questions about the U.S. growth outlook
also loom on the horizon.
China's steel use in 2012 is estimated to grow 4% to 648.8 Mt,
following 6.2% growth in 2011. The slackening is due to the economy
entering a less steel-intensive growth phase as a result of the
government's efforts to rebalance the economy and restrain the real
estate bubble. After a weak performance in 2011, India is expected
to grow by 6.9% to reach 72.5 Mt.
Apparent steel use in the U.S. is forecast to grow 5.7% in 2012. In
Central and South America, apparent steel use will attain a
historical high of 49.1 Mt, up 6.8% in 2012. Brazil is expected to
return to positive growth. Japan's steel use is expected to drop
0.6% to 63.7 Mt in 2012 due to the impact of exchange rate
appreciation in spite of the reconstruction efforts following the
March 2011 earthquake. Steel usage in the European Union is
expected to decline by 1.2% to 150.9 Mt in 2012 as sovereign debt
In 2013, world steel demand is expected to increase 4.5% to
approximately 1,486 Mt. China's steel usage is expected to grow at
4% to 674.8 Mt from 2012 projections. India is expected to pick up
pace and grow 9.4%, triggered by urbanization and surging
infrastructure investment. In 2013, the steel use in the U.S. is
envisioned at 99.5 Mt, recording 5.6% growth. Brazil is expected to
grow 6.7% to reach 52.5 Mt in 2013. Japan is expected to decline
further by 2.2% to 62.3 Mt, comprising 77% of the 2007 level.
Europe is however expected to record a modest recovery of 3.3% to
155.8 Mt in 2013.
Even though demand has increased overall in the past two years,
growth in steelmaking capacity is still ahead of demand and remains
a significant challenge for the industry. This has been further
exacerbated by the European sovereign debt crisis which has put a
bar on investments in large scale projects in Europe and reduced
capital for growth.
The uncertain global economy:
The steel industry was significantly affected by the global
economic crisis in 2008. Even though it is recovering, demand has
still not reached pre-recession levels. The debt crisis in Europe
remains a concern and the U.S. has had to resort to quantitative
easing to thwart sluggish demand.
The saving grace is the spurt of growth witnessed in the developing
economies that helped counter the sluggishness in the developed
economies. Asia and particularly China continued to make up for the
stalemate in Europe and North America.
However, there are signs of moderation in China's real estate
sector, which accounts for almost half of the total steel demand in
the country. China has cut its 2012 growth target to an eight-year
low of 7.5%. A slowing Chinese economy will have a negative impact
on infrastructure and construction spending and on the steel
industry as well. However, we believe the steel industry's
long-term story in the country remains intact, underpinned by
China's urbanization and industrialization programs.
Dependence of margins on raw material prices:
The steel companies' margins are dependent on the extent to which
changes in raw material prices are passed through to steel selling
prices. The time lag between the raw material price change and the
steel selling price change, and the date of the raw material
purchase and the actual sale of the steel product in which the raw
material was used, are also important factors affecting margins.
To Sum Up
All said, we believe growth in the industry will be tempered by
concerns regarding the continued financial uncertainty and
volatility and the quintessential issue of overcapacity. Global
steel demand will improve gradually in line with the recovery in
the user industries, automotive and residential construction. While
the automotive sector holds promise, we have yet to see a sustained
recovery in the construction sector, to enforce a more positive
Emerging and developing economies will continue to drive growth
while recovery of steel demand in the developed world will be slow.
Despite concerns regarding a slowing economy, demand in China will
grow in the long term given the vast capital outlay on
infrastructural development. In this game, its neighbor India is
not behind and will likely be a major consumer driving the steel
However, second quarter results will face headwinds in the form of
low prices due to overcapacity and surge of imports. Slowing growth
in China, the largest steel producer, and the sticky situation in
Europe will add to near-term headwinds.