Should Steel Stocks Be A Part Of Your Portfolio?

In the past few years demand for steel has been on the rise, owing to the rapid growth witnessed in developing economies that helped to counter the slowdown in developed nations. Asia, particularly China, remained the principal growth driver.

However, the current scenario is slightly alarming with the conventional growth engine, China, adding an element of uncertainty to the outlook. Nevertheless, there are plenty of reasons to be optimistic about the broader steel industry, both in the short and the long term. Below, we discuss some of the key reasons and what investors in the steel sector can look forward to in the coming months and years:

Rebound in Construction

The housing and construction sector is the largest consumer of steel today, accounting for almost half of the steel consumption. The home construction market recovered at a steady pace in 2014, largely on the back of overall economic growth, improving job numbers, growing consumer confidence, moderating home prices, stabilizing mortgage rates and a low level of housing inventory. This momentum is likely to continue in 2015.

The US Architecture Billings Index (ABI), an economic indicator that provides an approximately nine-to-twelve-month glimpse into the future of non-residential construction spending activity, remained over 50 for most of the recent months. Any score above 50 indicates an increase in billings.

Renewal of long-stalled construction projects and much awaited access to credit from lending institutions along with an improving overall economy have helped revitalize the commercial real estate sector in recent months. Moreover, requirement for emerging projects, such as education facilities and government buildings, is creating demand in the sector. The American Institute of Architects’ (AIA) is projecting that spending in the non residential building sector will rise 7.7% and commercial/industrial will rise 11.8% in 2015.

In the long term, as urban population increases worldwide, so will the need for steel to build skyscrapers and public-transport infrastructure. Emerging economies will continue to be major demand drivers due to the huge amount of steel required for urbanization and industrialization. Hence, the demand for steel is expected to remain strong in the years to come.

Companies like United States Steel Corporation (NYSE:X), Arcelormittal (NYSE:MT), Nucor Corporation (NYSE:NUE) and Steel Dynamics Inc (NASDAQ:STLD) will benefit from the momentum in construction.

Automotive Sector at Full Throttle

The automotive sector, which is the second-largest steel consumer, is showing significant promise despite threats from other materials. The recent slump in global oil and gas prices has been a blessing for automakers.

U.S. light-vehicle sales increased for the fifth consecutive year in 2014, improving on the 6-year high achieved in 2013. In fact, for the first time since the recession in 2008, U.S. auto sales surpassed 16 million units in 2014. The rising trend in sales is expected to continue in 2015, driven by falling fuel prices, low interest rates, enhanced job security, rising wages and household wealth, improving consumer confidence, residual pent-up demand, attractive deals and vehicle launches. Moreover, the high average age of light vehicles on U.S. roads is resulting in high replacement demand for cars as well as car parts.

Auto industry in the Asian countries, particularly China and India, are also expected to flourish over the next five to seven years. China is the biggest and fastest growing auto market in the world in terms of number of vehicles sold. With the automakers riding the wave of strong demand, steel is expected to benefit from the same in the years to come. ArcelorMittal and AK Steel Holding Corporation (NYSE:AKS) generate a large portion of their revenues from auto companies.

Investment in Oil and Gas

In spite of the current drop in oil prices, there will be significant capital investment in the oil and gas sector over the next few years. This should support demand for premium oil country tubular goods (OCTGs). Moreover, substantial investment is also expected in other parts of the oil and gas value chain, viz. distribution pipelines and refineries.

Growth in the Indian Steel Sector

India is currently the fourth largest producer of steel in the world. The Indian steel industry is expected to register exponential growth in the future, riding on increasing urbanization, and projected growth of infrastructure, automobile and real estate sectors. India's outlook has improved following the election of the new government which is promising pro-business reforms. The government of India has set a target to triple Indian steel production to 300 million tons by 2025.

Imposing Anti-Dumping Duty

To capitalize on the growing U.S. energy infrastructure demand, foreign manufacturers had flooded the U.S market with cheap imports. Trade cases were filed by the U.S. companies, that were affected by surge in imports, against their foreign counterparts.

The U.S. International Trade Commission (USITC) ruled that OCTG (oil country tubular good) imports from South Korea, India, Taiwan, Turkey, Ukraine and Vietnam will be subject to duties. South Korea was a major player considering that OCTG exports to the United States from the country were worth $818 million in 2013, more than the combined imports from the other countries.

The imposition of duty was welcome news for the steel players. This will boost the margins of steel companies which were forced to cut down production and idle plants, threatened by cheap steel imports.

Consolidation

Mergers and acquisitions (M&A) have always been an important growth strategy for the steel industry, leading to additional steel capacity, production efficiency and economies of scale. However, consolidation was minimal during the 2012—2013 period, given economic uncertainties as the companies were primarily focused on conserving cash, shedding unproductive operations, cutting costs and restructuring.

In 2014, some renewed activity in the space infused optimism. In Sep 2014, AK Steel acquired Dearborn, MI-based Severstal North America's integrated steelmaking assets for $700 million in cash. The facilities complement AK Steel's existing carbon steel operations, while giving it access to highly modernized and upgraded steelmaking equipment and facilities. The acquisition will also enable AK Steel to increase its profitability and operational efficiency, while allowing it to attain cost synergies by saving purchase, transportation and overhead costs.

Steel Dynamics Inc (NASDAQ:STLD) completed the acquisition of Severstal Columbus, LLC for $1.625 billion in cash, also in the month of September last year. This acquisition will expand the company’s annual steel shipping capacity to 11 million tons, representing a roughly 40% rise. Steel Dynamics will get an exposure to the high-growth oil country tubular goods and automotive markets with the addition of Columbus. Further, Columbus brings forth geographic diversification and growth opportunities for Steel Dynamics.

Also, in Sep 2014, Nucor agreed to buy Gallatin Steel Company from global steel giant ArcelorMittal and Brazilian steel maker Gerdau SA (NYSE:GGB) for roughly $770 million in cash. The acquisition of Gallatin Steel is in sync with Nucor's strategy of profitable growth. The buyout is expected to reinforce the company’s foothold in the key Midwest region and allow it to better serve its flat-rolled customers in the growing pipe and tube segment. The addition of Gallatin Steel is expected to enhance Nucor's total flat-rolled product annual capacity by 16% to around 13 million tons.

Bottom Line

As you can see, there are plenty of reasons to be optimistic about the steel industry for the long haul. But what about investing in the space right now?

Check out our latest Steel Industry Outlook here for more on the current state of affairs in this market from an earnings perspective, and how the trend is looking for this sector from now onwards.

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