Two Strong Steel Sector Plays


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Moving The Market

The driving factors behind the 33% increase in spot steel prices over the past two months are the surging cost of coking coal and iron ore due to weather-related issues in Australia and a global increase in the demand for steel. According to industry analysts and research provided by the steel industry, this rising price trend is expected to continue through the rest of 2011, affecting pricing for both industrial and consumer goods that rely on steel as a key material. Most notably, this continuing trend is expected to significantly affect the auto powertrain and chassis, infrastructure component and wind turbine manufacturing sectors.

Revere Outlook

To examine the performance of the companies most affected by the change in the availability of these raw materials and their pricing, Revere analyzed the supply and customer chains of two dominant types of steel manufacturers - integrated steel mills and mini mills. Unlike integrated steel mills that rely on coking coal to smelt iron ore in blast furnaces, mini mills are less dependent on these raw materials, and instead use electric furnaces to produce steel from scrap steel recycled from metal products. Companies such as Nucor Corporation ( NUE ) and Steel Dynamics ( STLD ) that utilize the mini mill approach exclusively are in a better position than the integrated manufacturers.

Of the 18 publicly-traded steel mills in Revere's database, 14 are mini mills that account for approximately 60% of domestic steel production and the 4 remaining publicly-traded integrated producers account for the remaining 40%. Year-to-Date and 3-month returns of mini mills have outperformed the integrated steel manufacturers by 4.9% and 8.9% respectively. both have outperformed the S&P 500 over the past 3-month period, and the Revere Mini mills Index has outperformed the overall market so far in 2011.

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Steel Customers

In examining the customers of steel manufacturers, Revere uncovered three sectors that rely extensively on steel as a key component to their products and may lack the ability to pass along their increased costs to their customers. They are:

  • The Revere Powertrain & Chassis sector consists of companies that manufacture automotive powertrain, chassis and body parts.
  • The Revere Infrastructure Components sector consists of companies that manufacture products for building roads, highways, bridges and industrial plants. Examples of these products include large steel superstructures for building bridges or metal pipes for petroleum production and transportation.
  • The Revere Wind Turbine manufacturing sector consists of companies that build turbines for harnessing wind energy. According to a recent study for the U.S. Department of Energy, over 80% of a typical wind turbine consists of steel.

The year-to-date performance of these three sectors trail the S&P 500 with the Revere Wind Turbine Manufacturing sector underperforming at one point by as much as 18.5%. The Revere Powertrain & Chassis sector has underperformed the S&P 500 by more than 5% YTD, proving the impact of these recent steep increases in the price of steel despite the strong demand globally for new cars and trucks.

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Alternatives to Steel

While products such as aircraft and railroads require steel and have no alternatives, manufacturers of other consumer and industrial products are increasingly turning to alternative materials to maintain their margins in an effort to control costs. Based on a review of Revere's database of all publicly traded companies and their 10K filings, close to 20% of steel products is sold to the container and construction sectors. This has presented opportunities for some steel users to turn to alternatives, such as converted wood, plastic, and glass. In fact, these sectors have already shown early signs of significant stock appreciation, with the Revere Converted Wood & Paper sector , the Revere Plastic Products sector and the Revere Glass Products sector all outperforming the S&P 500 year-to-date by 10.9%, 3.1% and 2.2% respectively.

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  • The rising cost of raw materials such as coal and iron will continue to weigh on the performance of steel manufacturers, particularly the integrated steel mills.
  • The stock performance of major steel customers has already been hit, due in part of the steep increase in spot steel prices over the past two months. Many of these companies may not be in a position to readily pass along their increased costs to their customers, including Wind Turbine and Infrastructure Component manufacturers as well as Powertrain & Chassis suppliers.
  • Companies that offer alternatives to steel in the Converted Wood, Plastic, and Glass sectors may also benefit if steel prices continue to climb higher or stay at current record high levels, with has been widely forecast.

Companies to Consider

Myers Industries ( MYE ) - a low cost plastic container and pallet manufacturing company whose products serve a variety of industrial, agricultural, and consumer sectors. Myers is trading at a P/E ratio of less than 14, below peers and the overall market. It also provides investors with a 2.8% dividend yield. In addition, the company is followed by just two analysts, so its performance is not as widely known as some of its competitors.

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Steel Dynamics ( STLD ) - a mini mill steel company serving primarily the industrial and transportation sectors. Its operating and net profit margins that are more than twice the industry average. While sales took a big hit during the recession of 2009, they have rebounded by 59% in 2010 and are expected to grown another 30% in 2011. This expectation is based on the fact that many of its customers, such as Catapillar ( CAT ) and CSX ( CSX ), are also expected to experience continued growth.

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Revere Data analysts Aakarsh Ramchandani, Jeremy Zhou and Li-Hann Chiu contributed research analysis and graphs for this piece.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

See also Computer Sciences: Cash Cow With Potential for Rapid Dividend Growth on

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Commodities
More Headlines for: CAT , CSX , MYE , NUE , STLD

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