Steel Industry Stock Outlook - Sept. 2015

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The steel industry has long been considered the "backbone" of the economy. While the strong automobile and improving construction sectors continue to support demand, the steel industry is currently facing three major headwinds: falling prices, economic slowdown in China and foreign steel import into the U.S.

Per the World Steel Association, global steel production decreased 2.2% to 948 metric tons (Mt) within the January-July period as production shrank across all the regions, barring Europe and the Middle East. China, the world's largest steel maker, continued to disappoint with a 1.8% decline, whereas India fared better, registering a 4.3% increase in production.

Economic slowdown in China has dealt a massive blow to the global steel industry. China's steel industry is still reeling under overcapacity with barely any signs of recovery. The Purchasing Managers Index (PMI) for the Chinese steel industry has stayed below the mark of 50 for 17 straight months, signaling a persistent conflict between supply and demand. Steel usage is expected to dip 0.5% in 2015 and 2016 as per the World Steel Association's short range outlook published in April this year.

U.S. steel mills remain hobbled by depressed capacity utilization and a torrent of unfairly-traded imports. The domestic market continues to be inundated with cheap imports from overseas producers, especially from China. American steel makers including Nucor Corporation ( NUE ), United States Steel Corp. ( X ), AK Steel Holding Corporation ( AKS ), Steel Dynamics Inc. ( STLD ) and ArcelorMittal USA, a part of ArcelorMittal ( MT ), have suffered heavily due to high levels of imports, reflected by decline in orders, idling of mills and layoffs across the nation.

And to top it all, the slump in oil prices had a significant negative impact on steel prices given the industry's 10% exposure to the energy sector. Steel demand from energy companies is expected to go down when exploration companies reduce their capital expenditure budgets. U.S Steel, which is the biggest supplier to energy companies in North America (along with AK Steel and ArcelorMittal) continues to be impacted by the slowdown.

Furthermore, iron ore prices dropped to their lowest levels as surging low-cost supplies from Australia and Brazil led to a glut on the global market while demand slowed in China, the top consumer. Notwithstanding the low prices, Vale S.A. ( VALE ) reported record second-quarter iron ore production and aspires to produce even more down the line. BHP Billiton Limited ( BHP ) beat its own production guidance for iron ore in fiscal 2015 and stated that it was on track for additional growth in the current year, following major expansion work.

Since steel companies enter into long-term supply agreements with their suppliers, they have not been able to take full advantage of lower iron ore prices. When these supply agreements are renegotiated this year, they are likely to be executed at lower prices and hence, help in reducing unit production costs of the steel players.

While companies like ArcelorMittal and U.S. Steel that produce most of their iron ore requirements through captive mines are unlikely to benefit from this, companies like AK Steel will have a competitive edge as they are less vertically integrated.

Sector Level Earnings Trend

Within the Zacks Industry classification, the steel industry falls under the broader Basic Materials sector (one of the 16 Zacks sectors). The sector put up a 3.7% year-over-year increase in earnings on the scoreboard for the second quarter.

Going forward, the sector's earnings graph is expected to take a nosedive with 13.6% decline in the third quarter, but pick up with a 10.6% increase in the fourth quarter. (For a detailed look at the earnings outlook for this sector and others, please read our Earnings Trends report.)

Industry Ranking - Negative

Within the Zacks Industry classification, the "steel producers", "steel-pipe and tube" and "steel specialty" industries are grouped under the Basic Materials sector (one of 16 Zacks sectors). We rank all of the 257 industries in the 16 Zacks sectors based on the earnings outlook for the constituent companies in each industry. This ranking is available on the Zacks Industry Rank page.

The way to align the ranking and outlook from the complete list of Zacks Industry Rank for the 257+ companies is that the outlook for the top one-third of the list (Zacks Industry Rank of #86 and lower) is positive, the middle one-third (Zacks Industry Rank between #87 and #173) is neutral, while the outlook for the bottom one-third (Zacks Industry Rank #174 and higher) is negative.

The "steel producers," "steel-pipe and tube" and "steel specialty" industries are ensconced in the bottom tier with respective Zacks Rank of #199, #246 and #257, depicting a negative outlook.

What's in Store for the Industry?

The World Steel Association expects global apparent steel use to increase by 0.5% to 1,544 Mt in 2015 and grow 1.4% in 2016 to reach 1,565 Mt. The U.S. steel industry continues to be under the threat of cheaper imports in the wake of a stronger dollar and lower oil prices. However, U.S. steel makers carry on their ongoing battle against unfairly traded, cheap imports that continue to flood the domestic market.

The American steel industry has also commended President Obama for signing two major trade bills -- Trade Promotion Authority ("TPA") and Trade Adjustment Assistance ("TAA") -- that should help domestic producers protect their turf against illegally dumped cheap steel products. U.S. steel makers are still actively pressing Congress to stop unfair trade practices and enforce new trade laws to rescue the ailing American steel industry.

China will continue to be a deterrent factor as uncertainty persists regarding the impact of government measures aimed at stabilizing the decelerating economy. Much hope is pinned on India, which is expected to act as the next growth driver given its progressing construction and manufacturing sectors, rapid urbanization and structural reforms from the new government.

The European economy is on the slow road to recovery. Steel demand in the EU is expected to go up 2.1% this year and 2.8% in 2016. This is a positive for companies like ArcelorMittal, which generates almost half of its revenues from the region, and United States Steel that has significant operations in Europe.

Although the steel industry will remain under pressure in 2015, it is certainly expected to grow thereafter, riding on the back of automotive and construction industries.

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UTD STATES STL (X): Free Stock Analysis Report

VALE SA (VALE): Free Stock Analysis Report

STEEL DYNAMICS (STLD): Free Stock Analysis Report

NUCOR CORP (NUE): Free Stock Analysis Report

ARCELOR MITTAL (MT): Free Stock Analysis Report

BHP BILLITN LTD (BHP): Free Stock Analysis Report

AK STEEL HLDG (AKS): Free Stock Analysis Report

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

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

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