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Industry Analysis: General and Integrated Steel
The Steel Industry, as covered by Value Line, is broken into two groups, the Steel (General) and the Steel (Integrated) Industries. The former is largely a collection of recyclers, manufacturing semi-finished carbon steel from scrap (which is found principally in discarded auto bodies), steel processors, and steel distributors. In the so-called nonintegrated steel manufacturing process, ferrous scrap is melted down to produce semi-finished steel in electric arc furnaces. The Steel (Integrated) Industry consists of companies that use iron ore and coal, as well as scrap, to produce carbon, semi-finished steel. This is an older process that has undergone many refinements over the past quarter century.
Within these two parts of the same aggregate industry, one will find stocks for growth and income, speculative growth, and well-defined growth. As for the individual companies, investors will, as noted, come across producers, processors, and distributors, as well as providers of raw materials, such as iron ore.
Steel companies are, by nature, capital and labor intensive. The older, integrated mills are also, in most cases, encumbered by burdensome legacy costs, notably pensions and retiree health care tabs. It was such legacy costs, along with earlier recessions, that caused a number of formerly large and venerable integrated producers to fall permanently by the wayside over the past two decades.
Stock market risk runs the range from average to excessive, with consequent Safety ranks of 3 (Average) to 5 (Lowest). Notwithstanding usually decent finances, there are typically no conservative investments in either steelmaking group. Susceptibility to the excesses of the business cycle, along with the history of widespread individual failure, suggests that investors with a considered aversion to risk seek their fortunes elsewhere.
Opportunities for significant capital appreciation, however, also exist, together with the aforementioned high level of risk. Steel is clearly a captive of the business cycle, and often a late cycle one. Thus, when a recession befell the nation in the fourth quarter of 2007, bringing untold misery to countless industrial and consumer sectors, the steel sector continued to go on its own merry way for nearly a year, with peaking profits inked by a number of mills throughout much of 2008. It wasn't until the final quarter of that year that steel inevitably succumbed to the ravages of recession.
As the nation began to climb out of that economic abyss, for a while, the metals industry continued to grapple with sluggish demand and a weak pricing structure. Following a severe downturn, the road back to financial health is often a long and arduous one.
The industry's performance is determined by the economic health of not only this country, but of an increasing number of metals producing nations abroad. Whereas the fate of the steel industry was largely a domestic affair three or four decades ago-save for select competition from Japan and Western Europe-this sector is now fully global in nature and dollar dependent. It is critical for investors to be mindful of the economic developments abroad, as well as at home.
A Mature Industry
The steel industry is not, by definition, a growth industry, although there are individual companies that can fit within that category. It is a mature sector, where the remaining global players are generally seeking to obtain a larger slice of a stagnant pie. To be sure, as populations grow and developing nations become more industrialized, the call for steel will inevitably rise. On the other hand, there has been a long trend toward competing products, notably aluminum and plastics, taking over from steel. Thus, there are increases and decreases in metals consumption going on concurrently.
Overall, the steel market is not growing on a secular basis, although ups and downs are seen within the business cycle. As such, it is imperative that the metals producers gobble up market share, notably at the expense of less-well-endowed competitors. This is a highly competitive industry, with competitors often located both stateside and overseas.
The Value Line Page Format
The steel industry is a garden-variety industrial segment, and its page has a standard industrial format. When one looks at the steel page, it is imperative to focus on the footnotes section at the bottom, where write-offs and other unusual items are located, to assess whether and how often the particular company in question has had its earnings history interrupted by assorted charges and gains.
We also recommend that interested investors look at the level of depreciation and the magnitude of capital spending. The latter is often a sign of a company's intent on remaining competitive. Given the highly variable nature of profit flows, it is important to assess the amount of debt on the balance sheet. Clearly, profits can be a hit-and-miss affair. As such, when the business cycle turns against a steelmaker, heavy financial leverage can be a warning sign that earnings will falter badly.
At one time, many of the old-line integrated steelmakers paid out hefty dividends and their stocks, as a result, were often considered income plays. A number of the steel companies that remain still pay out competitive dividends, especially in the nonintegrated group. However, earnings are volatile enough that income should not be a major consideration here.