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Stock Strategist Industry Reports

A Bumpy Ride Ahead for Steelmakers?

The industry is in recovery, but the climb will not be smooth.

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The last two years have been difficult for steel producers, and a brighter picture is still off in the distance. Although we believe that consumption has bottomed and is rebounding, the journey to recovery is going to be slow. However, this doesn't mean decent profits are a pipe dream. Thanks in large part to China, industry fundamentals are slowly improving, but it is often a game of two steps forward and one step back, especially when you look at how steel prices and raw material costs have behaved this year. No matter which way demand and prices are headed, the best any steel company can do in this environment is prepare for volatility.

Prices Are Not the Indicator They Once Were
It used to be that higher steel prices came from stronger demand, as supply was relatively fixed in the short term. This is no longer so. First, in recent years, steelmakers have increased their ability and willingness to adjust production to meet demand, so supply has played a greater role in determining prices than it has in the past. Second, steel buyers and distributors have improved their working capital management, and are able to operate with much smaller inventories than in the past. Therefore, short-term supply changes can have a much greater impact on steel prices by creating the impression of a shortage when the supply chain is lean. Given the degree to which higher-cost inventories weighed on the earnings of steel mills and steel buyers when prices tanked in late 2008 and early 2009, lean inventories have become de rigeur.

Bridget Freas does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.