The year 2014 has been turbulent for the steel industry. Even though demand in the U.S showed resilience, the slowdown in China, surging steel imports and falling oil prices played the major spoilsports. Overcapacity, which has been a perennial problem for the industry, has also significantly affected steel prices.
The economic slowdown in China, the largest steel consumer, accounting for almost half of global steel consumption, has dealt a massive blow to the global steel industry. Per the World Steel Association, in stark contrast to the high demand levels in China in the past years, steel usage is projected to grow a meager 0.8% in 2015.
Moreover, the European economy has not displayed adequate recovery, as is evident from the slight growth of 0.2% in Eurozone GDP in the third quarter of 2014. Germany and France, two of the Eurozone’s largest economies have avoided recession by a whisker. Also, the Eurozone’s current growth pace is only about half the potential growth rate and that the GDP is still more than 2% below its level at the start of 2008. These adverse economic factors will affect companies like ArcelorMittal (NYSE:MT)), which generates almost half of its revenues from the region and United States Steel Corp. (NYSE:X) with significant operations in Europe.
Given the weaker-than-expected performance in the emerging and developing economies in the first half of 2014, the World Steel Association had trimmed its short-range outlook for global steel usage (published in Jun 2014). It is projected to grow at a tepid pace of 2%.
Moreover, the U.S. steel industry continues to contend with surging steel imports. This, in addition to the oversupply in the industry, is pressuring prices and prospects of domestic steel producers.
Steel companies were also in for a “Crude” shock as the slump in oil prices had a negative impact on steel prices given its 10% exposure to the energy sector. Steel demand of energy companies is expected to go down as 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 Holding Corporation (NYSE:AKS) and ArcelorMittal would be impacted by the slowdown.
Iron ore and coal are the primary raw materials for steelmakers. Iron ore lost 50% of its value in 2014. Given that steel companies enter into long-term supply agreements with their suppliers, they could not take full advantage of lower iron ore prices in 2014. As these supply agreements are renegotiated this year, these agreements will likely be executed at lower prices and help in reducing unit production costs of the steel players. While companies like ArcelorMittal and U.S. Steel Corp. which produce most of their iron ore requirements through captive mines will not benefit much, companies like AK Steel will have a competitive edge as they are less vertically integrated.
Steel demand is expected to grow in the U.S., riding on the back of an improving global economy, strong momentum in the automotive markets and a turnaround in the construction sector. The housing market is expected to continue its good run in 2015 as the Fed will maintain its patient stance on interest rates. The automobile sector, which is the second largest steel consumer, will also benefit immensely from the lower gasoline prices and strong job market. India will also pick up pace driven by its construction and manufacturing sectors, and structural reforms from the new government.
The fourth-quarter earnings season has just taken off. Within the Zacks Industry classification, the steel industry falls under the broader Basic Materials sector (one of the 16 Zacks sectors). To date, 14.3% of the stocks in the sector have reported their numbers putting up a 44.9% year-over-year increase in earnings on the scoreboard. The sector has an impressive beat ratio (percentage of companies coming out with positive surprises) of 100% so far.
Taking into account the other companies that are yet to report their results, earnings of the Basic Material sector is expected to dip 4% for the fourth quarter. However, the sector will pick up steam in 2015 and witness a rise of 5.5% in the first quarter, 9.8% in the second, 0.6% in the third and 16.3% in the fourth quarter of 2015. Overall, in 2014, the sector will log earnings growth of 12.6% and accelerate to growth of 18.8% in 2015.
At the onset of the fourth-quarter earnings, it is wise to bet on the companies that have the potential to beat earnings in their upcoming releases. An earnings beat would reinstate investor confidence in the stocks, leading to immediate price appreciation.
How to Make a Choice?
With a number of industry players, zeroing in on the right stocks may appear to be a daunting task. This is where our proprietary methodology comes in handy. It’s fairly simple – stocks with the combination of a favorable Zacks Rank – Zacks Rank #1 (Strong Buy), #2 (Buy) or #3 (Hold) – and a positive Zacks Earnings ESP are the ones that are likely to beat earnings estimates this announcement.
Earnings ESP is our proprietary methodology for determining stocks that have high chances of delivering earnings surprises in their next earnings announcement. It shows the percentage difference between the Most Accurate Estimate and the Zacks Consensus Estimate. Our research shows that for stocks with this combination, the chance of a positive earnings surprise is as high as 70%.
Here are two steel stocks that are currently equipped with the right combination of elements to post an earnings beat.
Ryerson Holding Corporation
Delaware-based Ryerson Holdings (NYSE:RYI) is one of the largest processed and distributor of metals in North America. It also has operations in Canada, China and Brazil. The company processes and distributes a full line of over 75,000 products in stainless steel, aluminum, carbon steel and alloy steels and a limited line of nickel and red metals in various shapes and forms. The company serves several industries including oil and gas, industrial equipment, transportation equipment, heavy equipment and electrical machinery. Ryerson currently has a $239 million market capitalization and carries a Zacks Rank #3 (Hold).
The Zacks Consensus Estimate for the fourth quarter is at 24 cents and earnings for fiscal 2014, is projected at 61 cents. The Earnings ESP is at +4.17%.
Over the past few years, the company has undergone a transformation process that will help it to benefit from the anticipated recovery in the broader industrial market in the U.S. Ryerson’s broad geographic reach, extensive breadth of products and services and a lean operating structure will also prove advantageous. Further, the company has a broad and diverse customer base that provides a strong platform for growth in a recovering economy while protecting from regional and industry-specific downturns. Moreover, Ryerson's projection of strong free cash flow generation should help in reducing its debt level and also in pursuing organic as well as inorganic growth opportunities.
-Ryerson is expected to report its fourth-quarter results on February 2.
Ternium S.A.
Ternium (NYSE:TX) manufactures and processes a broad range of value-added steel products for the construction, automotive, home appliances, capital goods, container, food and energy industries. With production facilities located in Mexico, Argentina, Colombia, the southern United States and Guatemala, Ternium serves markets in the Americas through its integrated manufacturing system and extensive distribution network.
This leading Latin American steel producer has a market capitalization of $3 billion with an annual production capacity of approximately 10.9 million tons of finished steel products. Ternium currently has a Zacks Rank #3. The Zacks Consensus Estimate for fourth quarter is at 61 cents and for fiscal 2014, it stands at $2.47. The Earnings ESP is at +13.12%.
Shipments will be higher in the fourth quarter of 2014 mainly as a result of the ramp-up of Ternium’s new facilities in Mexico. Ternium expects relatively stable operating income in the fourth quarter of 2014, reflecting slightly lower steel prices and lower raw material and purchased slab prices.
Demand for steel products in the U.S. and Mexican markets remain strong driven by the continued expansion of manufacturing activity in both countries. In the Southern Region, Ternium expects the performance of the Argentine construction and industrial sectors to be stable relative to the average of the first nine months of 2014.
-Ternium is expected to report its fourth-quarter results in February 18.
Moving Forward
China will continue to be a deterrent factor while the slowdown in the European Union poses concern. Nevertheless, the steel industry will grow, but at a muted pace supported by the automobile and construction industries.
A sneak peek at the space for some possible winners backed by a solid Zacks Rank and a positive Zacks Earnings ESP could be a great idea for investors to gain from this earnings season. The stage is finally set for steel stocks to provide better returns to patient investors.