Shares of US Steel (NYSE: X) and others in the steel sector are stronger Wednesday following positive comments Morgan Stanley analyst Evan Kurtz, who sees a paradigm shift in the industry and, as a result, upgraded the sector to Attractive and raised company price targets by an average of 40%.
The firm's top picks in the sector are Overweight-rated US Steel and Steel Dynamics (NASDAQ: STLD). Kurtz raised his price target on US Steel from $35 to $60 and his Steel Dynamics price target from $21 to $28. Meanwhile, he raised his price target on Equalweight-rated AK Steel (NYSE: AKS) from $5 to $10 and Nucor Corp. (NYSE: NUE) from $58 to $62. Underweight-rated Schnitzer Steel Industries, Inc. (NASDAQ: SCHN) had its target cut from $28 to $25.
Kurtz sees a runway to mid-cycle. "We believe the era of significant mini-price cycles in the US is ending and the steel market is approaching healthier mid-cycle conditions. Utilization has just reached ~80%, with more upside to the ~85% typical at mid-cycle."
On the paradigm shift, Kurtz said, "Mini-cycles stemmed from poor pricing discipline, import order patterns, lean inventories, and short lead times. We believe the impact from the first two will be muted by consolidation and new trade restrictions. Improved supply-demand will alter the inventory and lead time environment. We expect these changes to lead to higher operating rates, less volatile pricing, and better fixed cost absorption. On average, our price target moves factor in a 15% improvement in mid-cycle EBITDA and a 6% increase in mid-cycle multiples."
Five factors cited for the industry upgrade were:
1) Further consolidation
2) A return of capacity utilization to the 80%+ range
3) New import duties and potential for further cases
4) Improving underlying demand
5) A structural increase in service center inventories
Elaborating on industry consolidation, he notes there have been two major M&A transactions that materially increased market share concentration among flat-rolled mills. ArcelorMittal and Nippon Steel & Sumitomo Metal acquired ThyssenKrupp Alabama, while AK Steel and Steel Dynamics each acquired one of Severstal North America’s two mills. They expect consolidation to continue, with Gallatin Steel reportedly up for sale according to Steel Market Update. The analyst views consolidation as healthy for the steel industry and sees Gallatin being a strong match for either Steel Dynamics (regional fit) or US Steel (head start on EAF strategy). The analyst likens steel industry consolidation as similar in nature to the recent transformation of the airline industry.
Overweight price target of $60.00 (from $35.00)
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