Stop me if you've heard this one before - it's close to the end of a quarter and a trio of the U.S.'s largest steel companies, Steel Dynamics (Nasdaq:STLD), Nucor (NYSE:NUE) and AK Steel (NYSE:AKS), have revised guidance lower. This has been an all-too-common phenomenon recently, even if investors still seem relatively confident about full-year performance. Although there is still a case to make that some individual steel stocks are too cheap today, it's worth wondering how many disappointments the sector will absorb before investors lose confidence. (For more, see Earning Forecasts: A Primer.)
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A Trio of Cuts
Within about 24 hours of each other, Nucor, AK Steel and Steel Dynamics all substantially lowered their guidance for first quarter earnings. Steel Dynamics dropped guidance by about 50% relative to prior expectations and Nucor's revision was similar in magnitude. For AK Steel, the magnitude of the revision was similar to Steel Dynamics in terms of cents per share (about 16 cents), but also means a quarterly loss instead of the expected profits.
Is Aggregate Demand Holding Up?
Both of the mini-mills (Steel Dynamics and Nucor) reported similar issues in the quarter - lower-than-expected margins and growth capped by increasing imports and domestic supply. AK Steel, though highlighted that while it experienced reasonable pricing strength (up 6% sequentially), shipments were going to contract by a like amount (down 7% sequentially).
All in all, it looks like shipment growth is a challenge right now. Raw material inflation shouldn't have been much different than expected, so it sounds to me like the margin issues may tie back to capacity under-utilization. Said differently, there's solid steel demand out there from machinery makers and so on, but supply growth (particularly imports) is limiting the shipment growth for these companies and lower-than-expected utilization hits margins hard.
AK Steel has recently announced another $50 per ton price hike for flat-rolled carbon steel, but time will tell if that holds. Announcing the price hike is only part of the battle, and Nucor's recent $30 per ton hike for sheet steel may be a little closer to what will actually stick in the market. That said, it does look like the industry is establishing a floor for prices for this next phase of the cycle.
As has been the case for a while, the real question is whether domestic construction demand will improve enough to take up that remaining excess capacity. Commercial construction is a big consumer of steel and while new office buildings may not be going up, there are a variety of energy infrastructure projects underway and/or on the drawing board. At the same time, a quick look at Alcoa (NYSE:AA) and Freeport-McMoRan (NYSE:FCX) shows relatively little joy in the broader industrial metal sector.
The Bottom Line
Considering how these stocks have performed lately, investors were likely already responding to the intra-quarter trends in steel prices and the chatter about increasingly short lead times on orders. Moreover, there were some suggestions of optimism in these earnings revisions and management at Nucor and Steel Dynamics has tended to be fairly conservative in the past.
At today's prices, Steel Dynamics looks like the best bargain of the three. AK Steel arguably has more leverage and upside to a better-than-expected steel market later in 2012, but Steel Dynamics looks like the better risk-reward value today. Although Nucor is best of breed, the safety premium that seems baked into these shares takes a lot of the upside out of the story at today's prices. (For additional reading, check out 5 Must-Have Metrics For Value Investors.)
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At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.