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Stock Strategist Industry Reports

Avoid the Steel Trap

Fundamentals indicate trouble ahead for U.S. steelmakers.

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U.S. steelmaker stocks have rallied sharply after a painful 2015 and are now pricing in much better times ahead. Given the impact of skyrocketing steel prices, the perception of improved supply discipline in China, and protectionist trade cases, the consensus narrative now argues that the worst is over. We strongly disagree and see more pain ahead for U.S. steelmakers. Barring a significant improvement in demand, we are hard-pressed to buy into the thesis that elevated steel prices are sustainable. We contend that the peak has already been realized and that prices will move materially lower by the end of 2016. Based on our outlook, every U.S. steelmaker we cover is trading above fair value. In particular, we urge investors to avoid highly leveraged blast furnace operators, as their future cash flows are most sensitive to falling steel prices. We see the most considerable downside for  AK Steel (AKS),  U.S. Steel (X), and  ArcelorMittal (MT).

The year-to-date rally in U.S. steel prices is a direct result of three key factors: Trade cases have reduced import volumes, Chinese stimulus drove a steel demand shock, and the Chinese central government has advertised increased supply discipline. U.S. trade cases have had a clear impact on steel trade flows. In China, however, we expect stimulus effects to prove fleeting and promises of supply discipline to go unfulfilled. Rather than signaling a recovery after prices plummeted 35% in 2015, we argue that sharply higher steel prices represent a brief upcycle amid a prevailing downdraft. Additionally, steel demand both globally and in the United States remains soft, and we see no signs of a sustainable improvement.

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