Another Quarter, Another Warning From Steel Dynamics

By Stephen D. Simpson, CFA | September 13, 2012 AAA

Tuesday evening marked a continuation of a pretty unfortunate trend for Steel Dynamics (Nasdaq:STLD), as the company once again revised its quarterly guidance lower. Although Steel Dynamics' situation may not be identical to other domestic steelmakers, it would seem that investors would continue to do well in approaching these stocks with caution for the time being.

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Another Lower Number
Continuing a trend that has been going on for more than a year, Steel Dynamics' management lowered guidance for the third quarter. This revision was relatively steep, as management is now targeting an adjusted range of 1 cent to 5 cents, versus the prior average estimates of 9 cents to 14 cents. Management cited volume weakness in both sheet steel (more than half of the company's production) and SBQ (special bar quality). Although steel prices haven't been too bad of late (and a lot of STLD's sheet is spot-priced), it appears that customer confidence continues to wane and they're content to run down their inventory levels.

On the SBQ side, I'm not sure what to make of the news. SBQ is used in automobiles, heavy equipment and engineering projects (civil and commercial construction). The domestic autos have been seeing pretty good production and shipment levels, but companies like Deere (NYSE:DE) and Caterpillar (NYSE:CAT) have definitely been lowering their guidance of late, while commercial construction remains pretty soft.

On a somewhat more positive note, management did indicate that metal recycling and fabrication results should be stronger - the former getting a benefit from declining scrap costs.

Is This Going to Be the First of Many?
If conditions are weakening at Steel Dynamics, it's natural to ask if Nucor (NYSE:NUE), Commercial Metals (NYSE:CMC), AK Steel (NYSE:AKS) and United States Steel (NYSE:X) are looking at tougher times as well. My suspicion is that they are, but not necessarily for the same reasons or to the same extent. Nucor, for instance, does have some vulnerability if Steel Dynamics' experience with SBQ is a market-wide phenomenon, while Commercial Metals will probably be relatively better off given its leverage to recycling and long products.

As for United States Steel and AK Steel, they're both vulnerable to the overall steel market. Excess global supply is limiting margin leverage, and the differentials between U.S. and Chinese steel prices have widened out pretty noticeably. Consequently, that may pressure the domestics' ability to maintain prices (as customers could import the cheaper Chinese steel).

Likewise, as iron and met coal prices decline, it could put more pressure on pricing (as input prices decline, commodity steel producers lower prices to stay competitive, which puts downward pressure on prices for U.S. Steel and AK Steel). This may or may not show up in the third quarter, but it's well worth watching.

The Bottom Line
Although I still believe Steel Dynamics is a good company within the steel sector, I'm just not all that interested in steel or aluminum companies today - despite what looks to be some reasonably cheap stocks. Diversified miners like Rio Tinto (NYSE:RIO) and other miners like Freeport McMoRan (NYSE:FCX) seem to be in better shape today and might be better stocks to consider in the short term.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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