Investors’ concerns about the steel sector have deepened following Arcelor Mittal’s (NYSE:MT) announcement that it plans to mothball one of its German plants in response to weakening demand. Together with the broader concerns about the world economy, this news helped drive Mittal’s shares down over 7% in Tuesday’s trading. The stock isn’t alone, however — the entire sector has seen its share prices evaporate amid the latest phase of the global growth scare. Below is a table showing the recent performance of some key players in the industry:
At this point, the sector is so beaten up that most steel stocks appear attractive on a valuation basis. Keeping in mind that forward P/Es are very iffy for any cyclical right now, and also that P/Es in general aren’t always the best guide for steel companies, the table below nonetheless presents a compelling picture:
From steel companies’ recent performance results, it would appear that the fundamental picture has completely fallen apart. However, even though Mittal and other steel names have cited a modest slowdown in demand following an extended period of restocking, recent data shows the demand picture — at least in the United States — has been relatively stable:
This chart is consistent with a recent Standard & Poor’s report that predicted a 7% increase in consumption in 2012. Additionally, the charts below — sourced from the World Steel Association website — show that production and capacity utilization, in contrast to the sector’s stock market performance, have in fact remained fairly mostly steady in recent months:
It’s also notable that steel and scrap prices have held up relatively well even as steel stocks have plummeted. Taken together, these factors indicate that while the downturn has some basis in reality — as evidenced by Mittal’s decision to close its furnace in Germany — a great deal of the sector’s underperformance is based on fear. If the much-anticipated recession fails to come to fruition, steel names could offer quite a bit of upside from these levels.
The caveat, of course, is that cyclicals in general, and steel stocks in particular, are likely to remain under pressure as long as the markets remain focused on the prospect of slowing economic growth. And the downside can be significant — in 2007-08, worries about growth caused the bottom to fall out of steel stocks. For example, U.S. Steel (NYSE:X) fell from $191.96 on June 28, 2008, to $20.97 on Nov. 20 — an 89% collapse that dwarfs the stock’s 42% decline in the past two-plus months.
Still, at a time in which the potential bad news already has been discounted to the tune of 20% to 50% declines in the major steel stocks, there appears to be an asymmetric opportunity in the group. At this point, any whiff of good news — especially a sign that the global economic outlook is less dire than the markets are currently anticipating — will move these stocks to the top of the performance charts in very short order.
The bottom line: It’s still too dangerous to take an aggressive long position in steel, but this sector will be an excellent source of beta if the market can regain its footing in the fourth quarter. Be ready to jump on this opportunity once sentiment finally improves.
