Strength Test: Could U.S. Steel's 1Q16 Earnings Justify Its Rally?
The steel industry
In the previous parts of this series, we’ve looked at the different factors supporting the price hikes by US steel companies. A combination of all of these factors has improved market sentiments. This, coupled with an inventory restocking by service centers (RS) and end users, has helped US steelmakers such as Nucor (NUE) and AK Steel (AKS) raise their base selling prices.
Unfortunately, the global steel industry is not completely out of the woods yet. According to the WSA (World Steel Association), Chinese steel demand is expected to contract again in 2016. The WSA expects global steel demand to also fall this year, as can be seen in the graph above. Moreover, rising steel prices have ensured that Chinese steel mills produce more of the metal. Last month, Chinese steel exports surged as a result of overproduction by Chinese steel mills. However, because the market sentiment turned positive, steel companies’ stocks rose sharply despite the higher Chinese steel exports.
The positive sentiment could help US steel mills raise their spot offers even further, which will enhance U.S. Steel Corporation’s (X) earnings capacity. However, since a substantial part of these price hikes are driven by sentiments rather than fundamentals, we could see a reversion later this year. Apparently, other metals, including aluminum and copper, have already pared most of their 2016 gains.
To be sure, there are plenty of events that could change market sentiments this year. Brexit concerns, the Fed’s hike, and rising geopolitical tensions are just some of the risks facing global markets this year. If market sentiments turn for the worse, steel companies would find it hard to raise steel prices. Moreover, although there seems to be a short-term scarcity of steel in the US markets (VOO), global markets are still flush with steel.
If the upward momentum in spot steel prices loses pace, U.S. Steel’s valuation could start to look bloated. We’ll have to wait for a couple of months to see how much further US steel mills can raise steel prices before buyers turn to international suppliers for lower prices. For steel industry developments, please visit Market Realist’s Steel page.
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