Yahoo Finance Are Steel Stocks a Good Buy in 2016?
The steel industry has been on a ride worthy of the roller coasters made with its product.
Year to date, the Dow Jones U.S. Iron & Steel index is up 26.5 percent, but over the past year, the index is down 5.8 percent, with a big dip in the middle. Share prices for steelmakers have been whipsawed since 2014 amid the vagaries of China's steel appetite, demand from the domestic automotive, construction and energy sectors and a trade battle over low-priced imports.
Experts differ as to whether now is a buying opportunity and even whether steel stocks are worthy long-term investments or shorter term trades.
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Here's a look at the pros and cons of putting money into the steel sector.
Pros. Steel stocks' bounce recently is a move off extremely low levels, and now could be a good time for longer term investors to get in, as there is more potential for demand to rise than to fall, says Macquarie Securities analyst Aldo Mazzaferro.
Between now and the third quarter, he sees American steel stocks surprising Wall Street with better-than-expected earnings.
The nature of the industry could be in favor of investors, says BB&T Capital Markets analyst Garrett Nelson. It looks like earnings will improve this year and next, he says.
An advantage to investing right now is demand will start to improve at some point, even as supply is already keeping steel prices elevated and helping company earnings, says Credit Agricole Securities analyst David Lipschitz.
Although demand remains soft, U.S. companies have been helped by tariffs imposed on some foreign steel producers and could see a 15 percent increase in shipping volume, Mazzaferro says.
"Very rarely do you get a double-digit move," he says.
Cons. The biggest concern for investing in steel companies right now is that their stock has had its move higher, Mazzaferro says.
A lot of expected gains have already been priced into the stocks, Nelson says.
Other risks include weaker economic data from China and changes in steel prices, says Lipschitz, who is bearish on the sector. For example, there could be an influx of steel from swing importers like Japan, Turkey and Spain if steel prices continue to rise, Mazzaferro says.
When to invest? Charles Bradford, president of New York-based metals and mining research firm Bradford Research, says the industry will increasingly face headwinds as the Federal Reserve raises interest rates. High rates will likely strengthen the dollar, which would make steel exports more expensive and imports more attractive.
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Bradford recommends buying when price-earnings multiples are high because that's when the earnings portion is at its lowest and the stock prices are probably at their bottom. "The time to buy these stocks is when they really look bad," he says. "If the Fed raises interest rates and dollar goes up that will give you another chance."
Bradford, who owns shares in AK Steel Holding Corp. (AKS) and ArcelorMittal (MT), sees steel companies as short-term trades against the dollar. "They are not long-term investments," he says.
Those who do want to hold onto steel stocks have to consider capital structures and the economic cycle, says KeyBanc Capital Markets analyst Phil Gibbs. Steel stocks tend to do well at the beginning and end of U.S. economic cycles, he says.
American steel stocks to consider. Steel Dynamics (STLD) and Nucor Corp. (NUE): Gibbs thinks these companies, which make steel from recycled scrap, could increase market share by producing the metal more cheaply than higher cost producers who have been forced to take manufacturing capacity offline.
Steel Dynamics also has a good mix of value-added steel products and a variable cost structure, he says. Nelson says the company has generated a lot of cash flow over the past months and its balance sheet will continue to improve.
The company is Nelson's top pick because it is operating with an industry leading capacity utilization and, along with Nucor, would be able to make accretive acquisitions when other companies may be struggling, Nelson says.
Like Steel Dynamics, Gibbs sees Nucor as able to grow its market share and dividends. He also likes its cash position for either reducing debt or making acquisitions.
Mazzaferro sees Nucor, as well as Steel Dynamics, as all-weather stocks.
Nucor and Steel Dynamics are safer bets because their main input material is scrap steel, giving them more variable costs and allowing them to keep margin even if steel prices fall because scrap prices will fall as well, Nelson says.
AK Steel and United States Steel Corp. (X): Gibbs considers these companies to be riskier bets, but they could offer more upside if oil heads to $60 a barrel, the dollar weakens 10 percent and China decides to curtail production. Of the two, he likes AK Steel better because of its free cash flow generation.
Mazzaferro has AK Steel at an outperform rating, but says it is more risky because of its debt load, and it needs a stronger market for long-term profitability.
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Lipschitz says if the price of steel falls, companies that make steel using their own iron ore as a key ingredient, such as U.S. Steel, don't fare as well as the recyclers, who will pay less for scrap steel.
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