US steel sector: Impacted by changing dynamics?
Recently returned from the US, Michael Ward, Senior Research Analyst at Nikko AM, shares his thoughts on the US steel sector and the medium to long-term impact of its changing dynamics.
The steel sector is seen as one of the larger beneficiaries of a number of proposed initiatives from the Trump administration. Site visits and management presentations hosted by BlueScope Steel and Sims Metal, two leading Australian steel companies with operations in the US, have contributed to the observations below in addition to site visits across the US steel value chain from scrap collection to steel production and steel distribution.
US steel fundamentals
When looking at the US steel sector, the volume outlook appears to reflect a balance between auto demand and energy demand. Auto demand declined for the first five months of the year, being somewhat of a surprise in the face of cheap financing, low gas prices and relatively strong employment figures. With auto demand making up around 30% of the US steel market this could prove a demand headwind. The offset is a potentially better energy sector, which, being less than 10% of demand is minimal. Combined with continued construction sector growth (around 40% of demand), this should mitigate any auto weakness.
Pricing is coming under pressure on the back of the weaker volume outlook, and has moved back to below US$600/t for hot rolled coil. This is, in part, a function of expected seasonal weakness, moving into the Northern Hemisphere summer, but also a function of the underlying weaker market. There have been some announcements of sheet price increases in recent weeks, however feedback appears mixed. Feedback from the distributor channel suggests the likelihood of a price increase succeeding in the short term is unlikely.
A period of transition
One potential short-term positive for pricing is the Section 232 review of the Trade Expansion Act, recently conducted by the Secretary of Commerce around steel imports and their threat to national security.
If this review finds evidence of such a threat, the President has the power to unilaterally decide on how to reduce the threat from imports through bans, quotas or tariffs. The steel market appears to be waiting for an announcement from the Trump administration to take its next lead on pricing.
Beyond the short-term we see a number of longer-term issues for the steel industry. Firstly, the continued transition away from blast furnaces to more flexible electric arc furnaces (EAF) appears likely to continue, with the blast furnace producers ultimately most likely to be squeezed out.
Secondly, we believe the industry is fragmented and oversupplied, with little real pricing power. Thirdly, trade protection appears critical for the continued health of the sector. Without it, the industry’s profitability profile could be significantly altered. The dark side to higher prices is potentially higher imports of finished goods. In the end, it could be argued that the measures may cost more jobs across the US economy than they save in the steel sector.
What this means for investors
Focusing specifically on BlueScope Steel, we continue to feel comfortable with our assumptions that trade protection should increase the US pricing premium over Asian steel, and improve US steel manufacturer spreads over raw materials. It is worth noting that this is an assumption based on policy that can be reversed as quickly as it was implemented.
The consequences of such a move could be somewhat dire, given the longer-term challenges faced by the industry. The good news for BlueScope Steel is that such a move appears unlikely in the short to medium-term.
Important Information
This material is issued by Nikko AM Limited ABN 99 003 376 252, AFSL 237563 (Nikko AM Australia). The information contained in this material is of a general nature only and does not constitute personal advice, nor does it constitute an offer of any financial product. It is for the use of researchers, licensed financial advisers and their authorised representatives, and does not take into account the objectives, financial situation or needs of any individual. The information in this material has been prepared from what is considered to be reliable information, but the accuracy and integrity of the information is not guaranteed. Figures, charts, opinions and other data, including statistics, in this material are current as at the date of publication, unless stated otherwise. The graphs, figures, etc., contained in this material include either past or backdated data, and make no promise of future investment returns, etc. Past performance is not an indicator of future performance. Any economic or market forecasts are not guaranteed. Any references to particular securities or sectors are for illustrative purposes only and are as at the date of publication of this material. This is not a recommendation in relation to any named securities or sectors and no warranty or guarantee is provided.
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