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5 Steel Stocks Heating Up on Jobs Plan

One of the most hated industries is getting some love, on expectations President Barack Obama's job-creation planwill boost infrastructure spending.

Steel stocks have fallen, on average, 20 percent this year, ranking 130th out of 154 industry groups on the S&P 500 Index. Wednesday, those shares—including AK Steel and U.S. Steel —jumped 7.1 percent, the fourth best among sectors. Standard & Poor's Equity Research said the gains may continue into next year.

The White House is said to be supporting another big spending push on infrastructure efforts, which means greater demand for steel in bridges, airports and public buildings, just as the steel market is heating up after a long, deep cyclical trough. But investing in the steel industry isn't for the faint of heart as it's a mature, fragmented and competitive industry, and it has big exposure to other highly cyclical industries such as cars and construction.

Worker in an Alcoa plant.
AP
Worker in an Alcoa plant.

Steel stocks have outsized long-term returns for investors who are patient. The average annual increase over 10 years is an incredible 26 percent, according to Morningstar.

S&P industry analyst Leo Larkin told TheStreet in an interview there was a big sell-off on steel and materials stocks in 2009, when shipments dropped to the lowest levels since 1982. Since then, industry inventories have been whittled down, and fundamentals have improved. And now demand has "gradually come back with a pretty good balance," he said.

"Despite weak U.S. GDP growth in 2011's first half, domestic steel shipments rose 6% for the period," he said in his research note, "with solid gains registered by the industry's three key markets. Shipments to the auto industry rose 14 percent, while shipments to the construction and distributor markets advanced 6.1 percent and 9.8 percent, respectively."

"Longer term, we think the industry will benefit from greater pricing power stemming from further expected consolidation, a lower cost structure, and a secular decline we see in the U.S. dollar," Larkin said in his research note.

"If there's any push at all from the economy it would add" to the attractiveness of steel industry, Larkin said in the interview, just before news of a potential new round of government spending was reported.

Larkin's top pick is Reliance Steel & Aluminum , which he gives a "strong buy" rating.

Morgan Stanley analysts also suggest nibbling at the sector, saying in a research note to clients: "We would invest selectively, and recommend AK Steel for stock-specific reasons and Nucorp as a defensive play with considerable upside."

What follows are synopses of five highly rated steel companies that Standard & Poor's cites in a research report on the state of the industry:

Reliance Steel & Aluminum isn't a metal maker, but is the largest metal distributor in North America, even though it has only a 7 percent market share.

Its "close proximity to its customers, broad product mix, and quick delivery enable sticky customer relationships that are less price sensitive, with 85% recurring revenue," wrote Larkin. "A successful growth strategy and efficient decentralized operating model have made Reliance a top performer in the industry."

Reliance Steel & Aluminum gets a "strong buy" and five stars from S&P, which says: "Given the fragmented nature of the metals-distribution industry and what we consider Reliance's strong finances, we see the company continuing to grow via acquisitions," which will enable the company to continue growing its earnings and to raise its dividend or buy back shares.

For fiscal 2011, analysts estimate Reliance will earn $4.55 per share, S&P says, and that will grow by 23 percent to $5.60 per share next year.

Analysts give it two "buy" ratings, six "buy/holds" and two "holds," according to an S&P survey.

Reliance Steel & Aluminum's shares are down 20 percent this year, but over 10 years they have a 12 percent average annual return.

Steel Dynamics gets a "buy" and a four-star rating out of five from S&P, while Morningstar gives it a five-star rating, its highest.

Steel Dynamics is a low-cost manufacturer as it produces steel mainly from scrap metal, which lowers operating leverage and increases flexibility in its operations. "The company has been able to adjust production to meet demand more quickly than many of its competitors, lessening the impact on its profits," S&P said.

The company's second-quarter profit doubled to $99 million, or 43 cents per share, handily beating analysts' estimates.

S&P analyst Larkin wrote that, "we estimate a 35 percent revenue increase for 2011 on another rise in volume and the average steel price. We think earnings troughed in 2009 and 2010, and we expect further improvement in 2011 and 2012."

For fiscal 2011, analysts' consensus estimate is that it will earn $1.50 per share and that that will grow by 31 percent to $1.96 per share next year.

Analysts surveyed by S&P gave it three "buy," seven "buy/hold" and four "hold" ratings.

The company's market value is $2.6 billion. Its shares are down 31 percent this year, which given the optimistic outlooks, suggest they may have bottomed. Its 10-year average annual return is 16 percent, but the past few years returns have been highly volatile.

U.S. Steel, the country's second-largest steel company, gets a four-star rating from S&P.

The ratings firm said that "following a revenue advance of 57 percent in 2010, we look for a 15% gain in 2011 on further increases in tons shipped and steel prices."

Contributing to its long-term earnings outlook is a gradual decline in pension and health-care costs, S&P added.

The company produces steel in capital-intensive blast furnaces that use iron ore and coke as primary raw materials. In the U.S., the company is 80 percent self-sufficient in coke and almost completely self-sufficient in iron ore. This vertical integration gives it a cost advantage over its competitors as it sources the majority of its raw materials at cost and mitigates cost volatility.

U.S. Steel's shares are down 50 percent this year, and it's not out until 10 years where returns turn positive. But S&P has a $49 price target on the company now, about a 75 percent premium to its current price.

For fiscal 2011, analysts estimate U.S. Steel will earn $1.63 per share and that will grow by 175 percent to $4.49 per share in 2012.

Analysts' ratings are all over the block, with one "buy," six "buy/hold," seven "hold," one "weak/hold" and one "sell," according to an S&P survey.

Nucorp, the biggest U.S. steel manufacturer by production, gets a four-star "buy" rating and a $50 price target, a 47 percent premium to its current price, from S&P, which says its mills are among the most modern and efficient in the country.

S&P said that "following a 42% increase in revenue in 2010, we look for a 28% advance in 2011 on another rise in shipment volume and prices."

Analyst Larkin estimates earnings per share of $2.91 this year versus 2010's 42 cents per share. "For the long term, we see earnings rising on industry consolidation, acquisitions and better control of raw material costs," it said.

It recently made an entry into the into the raw-material business with an acquisition, giving it vertical integration.

Analysts surveyed by S&P give it four "buy" ratings, five "buy/holds," six "holds" and two "weak/holds."

Nucor's shares are down 18 percent this year, but it has a 10-year average annual return of 15 percent. It has a market value of $11 billion.

AK Steel gets a four-star rating from S&P, with a "buy" recommendation and a $17 price target, about double its current price. The ratings firm says "long term, we view AK Steel as a special situation turnaround. (It) has reduced funded debt and underfunded pension and health-care liabilities."

AK Steel's share-price record is abysmal. With a market value of $968 million, AK Steel shares are down 50 percent this year and 40 percent during the past three years.

"It also has cut its health-care and retiree costs, thereby mitigating a sizable cost disadvantage versus other domestic steel rivals," said S&P.

The company produces flat-rolled carbon, stainless and electrical steels, and tubular products, so it has a wide customer base.

According to S&P's survey of analysts, the average earnings estimate for 2011 is 57 cents, and that jumps by 137 percent to $1.35 per share next year.

The ratings firm's survey found two "buy" ratings, seven "buy/holds," three "holds" and three "weak holds."

Shares of the $975 million market value company are down 50 percent this year and 40 percent during the past 12 months.

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