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Credit Suisse Downgrades American Steel Sector On Supply, Interest Rate Concerns

Credit Suisse Downgrades American Steel Sector On Supply, Interest Rate Concerns

The volatile steel sector has yet to obtain the stamp of approval from sell-side firms despite expectations that President Donald Trump's tariffs could lend support. 

Ahead of the third-quarter reporting season, Credit Suisse downgraded the U.S. steel sector from Overweight to Market Weight.

The Analyst

Analyst Curt Woodworth has the following ratings and price targets for some of the steel and mining stocks in Credit Suisse's coverage universe:

  • United States Steel Corporation (NYSE: X): Maintained Outperform/price target reduced from $48 to $40.
  • Nucor Corporation (NYSE: NUE): Downgraded from Outperform to Neutral/price target reduced from $77 to $74.
  • Steel Dynamics, Inc. (NASDAQ: STLD): Downgraded from Outperform to Neutral/price target reduced from $55 to $51.
  • Cleveland-Cliffs Inc (NYSE: CLF): Downgraded from Outperform to Neutral/price target increased from $11 to $13.
  • AK Steel Holding Corporation (NYSE: AKS): Maintained Outperform/price target increased from $6 to $7.

The Thesis

Increasing supply into the sheet market and concerns over rising interest rates that are hurting demand are the twin reasons behind Credit Suisse's downgrade of the steel sector, Woodworth said in a Monday note. (See his track record here.) 

Even as additional capacity is expected to come online from U.S. Steel, ArcelorMittal SA (NYSE: MT) and others, domestic steel production recently hit a four-year high, the analyst said, citing AISI data. Production rates are up by an annualized 6 metric tons, he said.

At the same time, HRC prices continued to slide, Woodworth said.

Credit Suisse also sees risks stemming from a potential rollback of tariffs due to the likelihood of the U.S. and Canada's NAFTA deal winning approval in early 2019.

Electric arc furnace capacity expansions are expected to flood the market by 2020-21, according to Credit Suisse. The firm also expects downstream rolling capacity to ramp up in 2019-20.

Capital allocation by  steel companies has disappointed relative to investors' "wish lists," Woodworth said. 

The analyst noted a surge in capex in 2018 — with the possibility of more to come in 2019 — and an increase in M&A activity.

Although the analyst is in favor of a higher internal rate of return growth spend, he said the companies should have more balanced capital returns.

The pace of share buybacks could also disappoint, Woodworth said. 

These factors could temper investor excitement in the sector, limiting the potential for multiple expansion given the peak margins and cycle fears, the analyst said. 

Credit Suisse's upbeat stance on U.S. Steel and AK Steel is due to expectations for upside to Street estimates for those companies on the basis of better 2019 contract pricing and more attractive valuations relative to historical forward multiples, Woodworth said. 

The Price Action

The VANECK VECTORS/STL ETF (NYSE: SLX) was up 0.38 percent at $44.37 at the time of publication Monday. 

Related Links:

Morgan Stanley Double Downgrades US Steel, Makes Bullish Turn On 2 Rivals

Citi Turns Bullish On US Steel After 25% Sell-Off


Related Articles (AKS + CLF)

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