China Steel Output Rises Despite Oversupply Amid Coronavirus

China’s steel production continues to expand notwithstanding disruptions from the coronavirus pandemic. Latest data revealed that steel mills in China — the world's biggest steel producer — ramped up production in the first two months of 2020 even though the country struggled to contain the outbreak of the deadly virus.

China, which accounts for more than half of the global steel output, churned out 154.7 million tons of crude steel in the first two months of the year, up 3.1% from the same period last year, per China's National Bureau of Statistics (NBS).

Too Much China Steel Spells Problem

While production continued to rise during the first two months of 2020, disruptions in transportation and logistics due to coronavirus led to surging finished steel inventories in China amid weak domestic demand. Steel demand weakened in China as major end-user industries were put in partial shutdown due to the outbreak. On the other hand, steel production increased as blast furnaces across the country continued to run notwithstanding coronavirus-induced disruptions.

The closure of a large number of factories across China to put a check on the spread of the virus disrupted the supply chain. The city of Wuhan in Hubei province, the epicenter of the coronavirus pandemic that has already infected more than 218,000 people and killed more than 8,800 globally, is one of China's biggest manufacturing centers and the country’s transportation and logistics hub. Coronavirus crippled the transport links across the country.

Per the China Iron and Steel Association, inventories of finished steel products were up 45% year over year in late February in China. Soaring steel inventories also put downward pressure on China’s domestic steel prices.

Continued build-up of inventories of steel products including hot-rolled coil and rebar due to rising production coupled with weaker domestic steel demand would further hurt prices in China and globally. Rising steel stockpiles has also ignited industry-wide concerns that it will lead China again flooding global markets with cheap steel exports.

The steel industry continues to reel under the effects of sustained oversupply of steel in the market, exacerbated by continued growth in production in China. Despite U.S.-China trade tensions, China’s steel mills beefed up output last year to take advantage of fat profit margins. Healthy domestic steel demand was another driving factor.

According to the World Steel Association ("WSA") — the international trade body for the iron and steel industry — China’s production jumped 8.3% year over year to 996.3 million tons in 2019. The country’s share of the world crude steel production rose to 53.3% in 2019 from 50.9% in 2018.

Notably, production from China shot up 7.2% year over year to 84.3 million tons in January 2020, per the WSA. Production surged despite the Lunar New Year holidays and the government's stringent measures including lockdowns and quarantines to contain the coronavirus.

Steel Sector Stung by Coronavirus

A slowdown in steel demand in China, the world’s top consumer, amid a slowing domestic economy spells problem for the steel industry. The lethal virus has taken a heavy toll on commodities including steel due to worries over demand weakness in China (Read: 5 Basic Materials Stocks to Buy Despite the Coronavirus Rout).

Notably, the outbreak has triggered a broad-based selloff in U.S. steel stocks. Shares of major U.S. steel makers such as United States Steel Corp. (NYSE:X) , Nucor Corporation (NYSE:NUE) , Steel Dynamics, Inc. (NASDAQ:STLD) have cratered roughly 57%, 48% and 55%, respectively, year to date.

U.S. steel prices also came under pressure over the past couple of months amid the virus plight. Some of the U.S. steel makers have recently announced fresh rounds of price hikes. However, the current weak economic and demand situations in China do not look supportive for higher steel prices over the near term.

The pandemic has wreaked havoc on China’s economy as reflected by recent tepid economic indicators. The country’s factory activity slumped to a record low in February, thanks to the outbreak. China’s services sector also spiraled down to all-time low last month.

Manufacturing activities in the country have been disrupted due to the shutdowns imposed by the Chinese authorities. While factories have started to gradually reopen, they are struggling to get back on their feet as raw materials are in short supply due to intense transport controls and many workers still remain quarantined. Activities are expected to pick up in April.

Meanwhile, the demand environment for steel in China is also expected to remain sluggish over the short haul as economic activities in the country are expected remain subdued amid the coronavirus crisis. The pandemic has slowed down activities in the construction space (a major steel end-use market) in China. The automotive industry, which consumes a big chunk of steel, is also among the industries that has been hit the hardest.

ArcelorMittal (NYSE:MT) , the world’s biggest steelmaker, envisions coronavirus to have a short-term negative impact on demand in China. The steel giant expects overall demand in the country to be flat to 1% higher in 2020.

The WSA also envisions a slowdown in demand in China this year amid a faltering domestic economy. Demand growth in China is projected to slow to 1% this year from an estimated 7.8% growth in 2019, per the trade body. A weak manufacturing sector is expected to be a deterrent.

The Zacks Steel Producers industry currently carries a Zacks Industry Rank #200, which places it at the bottom 21% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The Zacks Steel Producers industry has also underperformed the broader market year to date. The industry has tumbled 47.3% so far this year compared with the S&P 500’s decline of 21.5%.

Steel Stocks to Watch for

A couple of stocks worth considering in the steel space are EVRAZ plc EVRZF and Gerdau S.A. (NYSE:GGB) , both carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

EVRAZ has an expected earnings growth rate of 34% for 2020. The Zacks Consensus Estimate for its current-year earnings has moved up 1.5% in the last 60 days.

Gerdau has an expected earnings growth rate of 85% for 2020. Over the last 60 days, the Zacks Consensus Estimate for its current-year earnings has advanced 2.8%.

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