It turns out tariffs weren’t the cure-all for the steel industry. In fact, the US steel industry outlook continues to depend on the end markets that it supplies. Those end markets, most of which are cyclical themselves, are subject to the same economic expansion and contraction constraints as the steel industry.
What Happened to the US Steel Industry?
The top four largest steel producers in the United States include Nucor (NUE), U.S. Steel (X), Steel Dynamics (STLD), and AK Steel (AKS). The chart below shows their stock price performance since the beginning of 2018.
In March 2018, Trump announced the 25 percent tariffs on steel as part of his “America First” economic policy. While the announcement gave the major steel producers a brief bump, an escalating trade war and the fear it would tip us into recession pushed US steelmakers’ stock prices further and further downward. The worst performer, U.S. Steel (X), has seen 67+ percent of the value of its equity erased in the interim.
The question that must be asked whenever you see this much damage in a sector is whether the economic data support the bloodbath or if it’s overdone.
US Steel Industry Outlook in 3 Charts
Three of the biggest consumers of steel in the United States are the auto industry, manufacturers, and drillers. To get a reading on those three areas we can look at Domestic Auto Production, Industrial Production, and Drilling Activity.
Domestic Auto Production
Industrial Production: Manufacturing
Industrial Production: Drilling oil and gas wells
The reason the top publicly traded steel producers’ stocks have fallen so sharply is because of their high operating leverage. Most businesses that are cyclical have high operating leverage. When times are good and demand for their products is high, they print money. However, when demand weakens, their high fixed costs end up costing them a fortune if they don’t have enough throughput to cover their overhead.
In the steel industry, one of the biggest determinants of profitability is a metric called melt utilization. Given the energy intensity of making steel, the goal of every steel company is to have enough demand to keep the furnaces going at their highest capacity for as long as possible before the company has to shut them down for maintenance.
For example, Nucor’s average utilization rates of all operating facilities in its steel mills, steel products, and raw materials segments were approximately 85%, 68%, and 72%, respectively, in 1H19 compared with approximately 93%, 73%, and 76%, respectively, in 1H18. As a result, Nucor’s earnings before income taxes and noncontrolling interests was $205MM lower in 1H19 even though net sales were only down $36MM in 1H19 vs 1H18.
Utilization rates matter for steel companies.
US Steel Industry Outlook: Hard Times Ahead
It turns out the stock prices of the publicly traded steel companies are simply confirming the current economic data with a strong dash of pessimism thrown in for good measure. If you hang out with any steel CFOs, you’ll probably hear them bemoan the next six months since demand may not be strong enough for them to be confident in hitting their breakeven melt utilization rate.
Most of these companies stripped out unnecessary costs and pillaged their balance sheets back during the 2015 steel swoon, which was about the last time any of these companies’ stock prices traded this low. However, since cheap capital continues to be plentiful and the demand impact was largely caused by government intervention, there’s a strong case that government intervention will also help keep them in business.
The question for investors is whether the companies’ stock prices or the economic indicators in the three charts above will rebound first. Will the hard times be limited to the next six months or will a broader economic recession take hold and prolong the pain of the US steel industry even further? Personally, I think you need to see unemployment tick up or housing roll over before we start to see the manufacturing slump widen to the broader economy.