Value To Be Had In Steel

While most investor attention in the metals complex has gone towards gold and the other precious metals, the real long-term action could be in the base metals. The industrial metals, such as copper, provide the necessary building blocks for economic growth. After all, you can't use silver to run plumbing lines. With the emerging markets maintaining their expansions and building-out their infrastructure, the base metals will continue to be a great way to play that growth. However, with the recent commodity sell-off, value can be had in several of the base metals sectors. One such value can be had in the steel producers.

TUTORIAL: Commodities: Introduction

Rising Consumption
Globally, steel consumption continues to steadily rise as economic growth returns. According to industry group, the World Steel Association (WSA), finished steel consumption will rise 5.3% in 2011. Over, the next five years, industry groups estimate that the sector will finally reach pre-financial crisis levels. Huge infrastructure projects across the developing world, coupled with more modest growth in developed nations promise to boost the long-term demand for steel. China, the world's biggest consumer of steel products, will see demand rise by as much as 25% by 2015 versus 2010 demand levels. At the same time, Indian steel demand will rise by 14.3% by 2012. Consumption in Latin America is expected to reach almost 49 million tons this year and grow by 8.3% in 2012. (For related reading, see Investing in The Metals Markets.)

This bullish demand is in spite of the fact that steel prices have reached near-record levels in recent months. Prices for hot-rolled coil steel in January, reached more than $800 per ton.

However, the steel makers themselves aren't seeing the fruits of this higher demand and prices. Iron ore prices are up sharply, with most ore producers raising prices by 23%. This has caused the margins and gross profits for major steelmakers to fall. For example, Steel Dynamics (Nasdaq:STLD) recently issued an earnings warning, saying that second-quarter earnings per share would be around 22 cents per share lower than Wall Street estimates. With production and rising costs, many of the steel producers have seen their share prices fall hard over the past few weeks.

Nevertheless, many analysts believe that the slump in steel prices is starting to bottom out. Several steel companies have recently begun raising prices for beams and rolled products. Analysts at Morgan Stanley estimate that a sector-wide recovery will occur by the end of the summer. (Profit-margin ratios can give investors deeper understanding of the companies. For more, see A Look At Corporate Profit Margins.)

An I-Beam Portfolio
With the long term fundamentals for steel moving in the right direction and share prices currently depressed due to higher production costs, now may be the time to add the steel sector to a portfolio. Both the Market Vectors Steel ETF (NYSE:SLX) and PowerShares Global Steel (Nasdaq:PSTL) offer investors a way to add abroad swath of the sector to a portfolio. However, there are plenty of individual steel offerings that will benefit as well. Here are a few picks.

Even with higher production costs, analysts estimate that U.S. Steel (NYSE:X) will see profits of $3.67 a share in 2011. The company recently received an analyst upgrade from Goldman Sachs with a price target of $75 or about $30 higher than today's share prices. Analysts cited the producer's vertical integration into iron ore and attractive priced coking coal contracts for their upgrade.

North America only accounts for just 14.3% of global steel production. Some of the best values could be had in foreign producers. Brazil's Gerdau (NYSE:GGB), Korea's POSCO (NYSE:PKX) and Russia's Mechel (NYSE:MTL) all represent quality, low priced international leaders in the sector.

Finally, the deepest values in steel producers could be Japan's Nippon Steel (OTCBB:NISTY) and Sumitomo Metal Industries (OTCBB:SMMLY). Japan is the world's second-largest steel producer after China and the pair plans to merge into the world's second-largest steel company as way to leverage raw-materials costs. The two are extremely cheap due to Japan's earthquake woes.

The Bottom Line
While most investors have been focusing on the precious metals space, the steel sector could offer some real value. Stocks like Olympic Steel (Nasdaq:ZEUS) have traded downwards in the face of high production costs. However, with pricing beginning to firm and long-term steel demand rising, now is the best time to add the sector to a portfolio. (For related reading, see Using Base Metals As An Economic Indicator.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!