US Steel, Alliance Steel Drop, as UBS Picks Winners, Losers

“Steel demand is heating up” in the US, says UBS analyst Matt Murphy. Some steel stocks, however, are ready to cool down, he says

Reuters

When it comes to steel demand, the world is looking good. Murphy explains:

We anticipate strong steel demand growth in 2014, led by a pick-up in nonresidential construction as well as ongoing growth in automotive and manufacturing sectors. Growth will continue in 2015 and reach pre-recession levels by 2016.

Prices, however, do not:

On the supply side, the global steel industry will remain overcapacity, and given our falling iron ore price forecast we expect steel prices to fall from the current $650/t spot price to less than $600/t by H2/14 while metal spreads to scrap should generally be maintained near-term and begin expanding in 2016.

That dynamic means that companies that can benefit from construction strength and cut costs will outperform others. For that reason, Murphy keeps Nucor (NUE) and Steel Dynamics (STLD) at Buy. He wasn’t so kind to Reliance Steel (RS), US Steel (X) and AK Steel (AKS), which were all cut, though for different reasons.

When it comes to Reliance, it’s all about valuation. Murphy writes:

Its model of consolidating service centers has consistently been accretive, as RS normally buys smaller companies at lower multiples using low-cost debt. Within the metals service center industry, RS is a best-in-class operator with a top-tier management team, high inventory turns and EBITDA margins. However, we view the current stock price as fairly valued given our falling steel and aluminum price outlook and its impact on absolute profits. We rate Reliance Steel a Neutral and our $75 PT is based on an 8.0x EV/EBITDA (2015) multiple.

US Steel gets a downgrade to Neutral from Buy thanks to an increase in competition. Murphy explains:

As an integrated steel producer, X has been burdened by high fixed costs in the weak steel markets of recent years and high legacy liabilities due to low discount rates. We expect US Steel to benefit from reduced pension liabilities in 2014, while also improving margins through cost reduction and revenue maximization efforts currently underway. However, we remain concerned about increasing competition in X's most profitable segment, Tubular goods, and we only see sector capacity utilization reaching higher levels in 2016, meaning margins could remain weak in the medium term.

And AK Steel? It gets cut to Sell from Neutral:

The company has suffered from weak margins and high leverage, compounded by debt and high legacy liabilities. AKS is benefitting from an improving US auto sector; however, it will be some time before it can realize any benefit from its raw materials integration strategy, which is underway. The largest issue we see for AKS is the cash drag from required pension payments notwithstanding an improving economy and rising interest rates

Nucor has gained 1.2% to $51.32 and Steel Dynamics has risen 0.6% to $18.40, while Reliance Steel has dipped 0.5% to $75.11, US Steel has dropped 2% to $23.52 and AK Steel has fallen 2.7% to $3.95.