The March 26 Barron's column by Alan Abelson caused some concern this week, mostly due to its reference to some tariffs that are due to expire on steel imports over the next two weeks unless extended. These are the old tariffs left over from the Asian crisis, which were set in 1999 and are scheduled to expire now. We believe almost everyone expects them to expire, but there will still be the headline impact which a short-seller focuses on. If the tariffs expire, as expected, we see little impact on steel prices in the US because of (1) near capacity run rates for steel mills in Brazil and Japan, (2) strong local demand there (Toyota production rates are up 11% and Nissan and other carmakers in Japan have complained of low steel supply), and (3) the fact that there are much better pricing opportunities for steel in Asia and Europe than in the US at the moment. We estimate that even excluding the small tariff penalties in place from the old restrictions, global steel traders would still lose money on the Asia to US steel trade.
The Barron's article also focused on US Steel (X - OP/A) as the best steel stock to short sell, partly due to a sharp rise in iron ore and other raw materials. We see X as probably the wrong pick because X, somewhat unique to the industry, is actually LONG most raw materials. And, although not the company's stated intentions at this time, X could become even longer, and a bigger seller of iron ore, with relatively modest investment. Bottom line: the 71.5% iron ore hike is bullish for X, not bearish. In addition, also somewhat unique to the sector, X has exposure to oil country tubular goods (i.e. drill and other energy pipe), which is becoming a very strong market, and also should benefit from rising unit volume at its low cost central Europe mills. Consequently, we see X as having one of the best chances for upside earnings surprises in the near term.
We think Barron's got the China comments wrong too. We believe inventories in China have been declining for a year, and are actually at low levels. Steel production in China has also been under control recently, with the China Iron and Steel Association (CISA) a quasi-government steel trade organization, predicting "only" 300 million tonnes of production in 2005. That level would be up about 11% from 2004 and below most market forecasts. It would also ensure China does not become a net exporter near term, although we believe it would be physically impossible to sustain net exports from China before 2009. Market prices for steel have been rising in Asia mostly due to the improving China market, in our view. Today, China announced that it would eliminate the VAT tax rebate on exports of semi-finished steel products like blooms, billets and slab, which should reduce further the likelihood that it becomes a net exporter. The vast majority of its net exports in 2004 were semi-finished, and we believe most of that reflected inventory drawdown.