While the strong automobile and improving construction sectors continue to support steel demand, a slowdown in China, surging steel imports in the U.S. and falling oil prices have emerged as the major problems for the industry. Moreover, the steel industry’s perennial concern -- overcapacity -- remains.
Per the World Steel Association, global steel production decreased 1.7% to 536 metric tons (Mt) within the January—April period as production shrank across all regions. China, the world’s largest steel maker, continued to disappoint with a 1.3% decline, while its neighbor India fared better, registering a 6.7% 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 few signs of recovery. Steel industry PMI in May dipped 5.8 points to 42.4, a 16-month low. The PMI reading translates into China's steel industry having been in recession for 14 months. 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.
Steel imports surged to alarmingly high levels in the back half of last year, which continued in the first quarter of 2015 as well. This is a negative for steel players like Steel Dynamics Inc. (NASDAQ:STLD - Snapshot Report), Arcelormittal (NYSE:MT), AK Steel Holding Corporation (NYSE:AKS) (Analyst Report) and United States Steel Corporation (NYSE:X) (Analyst Report).
And to top it all, the slump in oil prices had a 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 as exploration companies reduce their capital expenditure budgets. U.S Steel, one of the biggest suppliers to energy companies in North America along with AK Steel and ArcelorMittal, continues to be impacted by the slowdown.
In the first quarter of 2015, iron ore, one of the primary raw materials for steelmakers, suffered its largest quarterly loss since 2009 as surging low-cost supplies from Australia and Brazil led to a glut on the global market as demand slowed in China, the top consumer. Three big iron ore miners -- VALE SA (NYSE:VALE), Rio Tinto (NYSE:RIO) and Bhp Billiton (NYSE:BBL) -- reported record production, while global steel production declined 1.8% in the quarter.
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). Currently, 42.9% of the stocks in the sector have reported fourth-quarter results. The sector did not fare well in the first quarter, putting up a 1.8% year-over-year decline in earnings on the scoreboard.
Going forward, the sector’s earnings graph is expected to take a nosedive with 2.6% decline in the second quarter and 5.8% drop in the third quarter. However, for the fourth quarter, a 0.1% drop in earnings is anticipated, not as drastic as the previous quarters.
Overall, in 2015, the sector will log earnings growth of 1.9% and accelerate to growth of 18.4% in 2016.
Industry Ranking
We rank all of the 260 industries in the 16 Zacks sectors based on the earnings outlook for the constituent companies in each industry. This ranking is available in the Zacks Industry Rank page.
The way to align the ranking and outlook from the complete list of Zacks Industry Rank for the 258+ 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 #172) is neutral, while the outlook for the bottom one-third (Zacks Industry Rank #173 and higher) is negative.
The “steel specialty” features in the top tier enjoying a Zacks Industry Rank #20, with a positive outlook. The “steel producers” industry is in the middle tier with a Zacks Industry Rank #149, indicating a neutral outlook while the “steel-pipe and tube” industry lies in the bottom tier with a Zacks Rank #225, reflecting a negative outlook. Looking at the exact location of these industries, it is difficult to conclude about the general outlook for the steel industry as a whole.
Please note that the Zacks Rank for stocks, which are at the core of our Industry Outlook, has an impressive track record, verified by outside auditors, to foretell stock prices, particularly over the short term (1 to 3 months). The rank, along with the Expected Surprise Prediction (ESP) (Read: Zacks Earnings ESP: A Better Way to Find Earnings Surprises) helps in predicting the probability of earnings surprises.
What’s in Store for the Industry?
The World Steel Association forecasts 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, a gradually healing economy, strength in the automotive market and rebounding construction activity will support demand. Looking at the steel companies in our coverage, Nucor Corporation (NYSE:NUE), which is a key supplier for real estate companies, as well as ArcelorMittal and AK Steel, generate a large portion of their revenues from auto companies. However, the energy sector’s steel demand could be subdued in 2015 given the trending low oil prices.
China will continue to be a deterrent factor as uncertainty remains 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 mend as evident from 0.4% growth in the eurozone GDP in first-quarter 2015, helped by a weak euro, lower crude oil prices and the central bank’s support. 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 U.S. Steel that has significant operations in Europe.
Although the steel industry will remain under pressure in 2015, it is certainly expected to grow thereafter. Expectations of positive earnings growth, which though muted in 2015 is set to accelerate in 2016, instills optimism in the sector.