This sector could offer ‘deep value’

Valuations in the steel industry have become so attractive that the sector is now in "deep value territory", according to analysts at Citi's investment bank.

In a note entitled "Back to the Future", Citi metal analysts led by Michael Flitton highlighted that, post-financial crisis, underlying demand for steel was improving, but the combined market capitalization of the European steelmakers it covers was "stubbornly close" to 2008 lows.

"Investors are increasingly focused on where the line in the sand is for valuation," metal analysts at Citi, headed by Michael Flitton, said in a research note on Wednesday. "Our analysis suggests we may now have crossed that line."

Two employees tie up steel bars at a steel-making plant in Ganyu, China.
ChinaFotoPress | Getty Images
Two employees tie up steel bars at a steel-making plant in Ganyu, China.

Citi focused on Dutch-listed company ArcelorMittal, which it said provided an opportunity for investors with a long-enough investment horizon. Steel firms Salzgitter and Voestalpine also featured in its "key picks."

The bank warned that its long-term valuation methodology was unlikely to signal an immediate recovery in steel sector equities. But it did suggest that the risk of a further reduction in price-to-earnings ratios—an important metric used to gauge a stock's worth—was low.

"Return expectations should therefore be the primary drivers of the shares from here with valuations a potential contributory tailwind," the analysts said.

French bank Societe Generale was also bullish on the sector. Analysts Alain William and Abhishek Shukla maintained their "buy" rating on ArcelorMittal last month, saying investors were probably underestimating European steelmakers' pricing power.

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Steelmakers' margins have improved in the first two quarters of the year due to input costs declining faster than steel prices, the SocGen analysts said.

However, Nomura had a "reduce" rating on ArcelorMittal and Voestalpine, with the view that falling iron ore prices will present a drag on earnings for the former in the coming quarters.

Iron ore has fallen to around $94 per dry metric ton (dmt), down from $134/dmt at the start of the year, according to Platts data—a significant fall which has put downward pressure on steel prices.

By Matt Clinch