The steel industry has been on a ride worthy of the roller coasters made with its product.
Year to date, the Dow Jones U.S. Iron & Steel index is up 26.5 percent, but over the past year, the index is down 5.8 percent, with a big dip in the middle. Share prices for steelmakers have been whipsawed since 2014 amid the vagaries of China’s steel appetite, demand from the domestic automotive, construction and energy sectors and a trade battle over low-priced imports.
Experts differ as to whether now is a buying opportunity and even whether steel stocks are worthy long-term investments or shorter term trades.
Here’s a look at the pros and cons of putting money into the steel sector.
Pros. Steel stocks’ bounce recently is a move off extremely low levels, and now could be a good time for longer term investors to get in, as there is more potential for demand to rise than to fall, says Macquarie Securities analyst Aldo Mazzaferro.
Between now and the third quarter, he sees American steel stocks surprising Wall Street with better-than-expected earnings.
The nature of the industry could be in favor of investors, says BB&T Capital Markets analyst Garrett Nelson. It looks like earnings will improve this year and next, he says.
An advantage to investing right now is demand will start to improve at some point, even as supply is already keeping steel prices elevated and helping company earnings, says Credit Agricole Securities analyst David Lipschitz.
Although demand remains soft, U.S. companies have been helped by tariffs imposed on some foreign steel producers and could see a 15 percent increase in shipping volume, Mazzaferro says.
“Very rarely do you get a double-digit move,” he says.
Cons. The biggest concern for investing in steel companies right now is that their stock has had its move higher, Mazzaferro says.
A lot of expected gains have already been priced into the stocks, Nelson says.
Other risks include weaker economic data from China and changes in steel prices, says Lipschitz, who is bearish on the sector. For example, there could be an influx of steel from swing importers like Japan, Turkey and Spain if steel prices continue to rise, Mazzaferro says.
When to invest? Charles Bradford, president of New York-based metals and mining research firm Bradford Research, says the industry will increasingly face headwinds as the Federal Reserve raises interest rates. High rates will likely strengthen the dollar, which would make steel exports more expensive and imports more attractive.
[See: 8 Easy Ways to Make Money.]
Bradford recommends buying when price-earnings multiples are high because that’s when the earnings portion is at its lowest and the stock prices are probably at their bottom. “The time to buy these stocks is when they really look bad,” he says. “If the Fed raises interest rates and dollar goes up that will give you another chance.”
Those who do want to hold onto steel stocks have to consider capital structures and the economic cycle, says KeyBanc Capital Markets analyst Phil Gibbs. Steel stocks tend to do well at the beginning and end of U.S. economic cycles, he says.
American steel stocks to consider. Steel Dynamics (STLD) and Nucor Corp. (NUE): Gibbs thinks these companies, which make steel from recycled scrap, could increase market share by producing the metal more cheaply than higher cost producers who have been forced to take manufacturing capacity offline.
Steel Dynamics also has a good mix of value-added steel products and a variable cost structure, he says. Nelson says the company has generated a lot of cash flow over the past months and its balance sheet will continue to improve.
The company is Nelson’s top pick because it is operating with an industry leading capacity utilization and, along with Nucor, would be able to make accretive acquisitions when other companies may be struggling, Nelson says.
Like Steel Dynamics, Gibbs sees Nucor as able to grow its market share and dividends. He also likes its cash position for either reducing debt or making acquisitions.
Mazzaferro sees Nucor, as well as Steel Dynamics, as all-weather stocks.
Nucor and Steel Dynamics are safer bets because their main input material is scrap steel, giving them more variable costs and allowing them to keep margin even if steel prices fall because scrap prices will fall as well, Nelson says.
AK Steel and United States Steel Corp. (X): Gibbs considers these companies to be riskier bets, but they could offer more upside if oil heads to $60 a barrel, the dollar weakens 10 percent and China decides to curtail production. Of the two, he likes AK Steel better because of its free cash flow generation.
Mazzaferro has AK Steel at an outperform rating, but says it is more risky because of its debt load, and it needs a stronger market for long-term profitability.
Lipschitz says if the price of steel falls, companies that make steel using their own iron ore as a key ingredient, such as U.S. Steel, don’t fare as well as the recyclers, who will pay less for scrap steel.
Just getting started?
Newbie investors shouldn’t shy away from individual stock ownership. There are a variety of advantages to holding individual stocks in your portfolio. These include the ability to tailor your portfolio to your values and beliefs – and avoid so-called “sin stocks.” Other advantages include more control over costs, tax and estate planning. Finally, an individual investor can be nimble, quick and decisive in their buys and sells, versus a mutual fund manager who often needs committee approval on portfolio shifts. Here are eight stocks to consider for a starter portfolio.
General Electric Co. (ticker: GE)
(SEBASTIEN BOZON/AFP/Getty Images)
Smart investment choices are those with strong businesses – like GE – that attract the best talent and possess sustainable long-term earnings power, says Henry To, partner at Newport Beach, California-based CB Capital Partners. “With GE now getting rid of most of GE Capital, and other non-core assets such as NBC Studio, the firm’s returns on equity should rise comfortably above 15 percent in the next 18 months as the focus returns to its industrials segment: power and water, oil and gas, energy management, aviation and transportation.”
Monsanto Co. (MON)
Monsanto is an innovator and dominant player in the global agricultural biotechnology industry. “Monsanto’s long-term growth story is underpinned by the ongoing rise in aspirational spending and protein consumption in large-population countries such as China and India,” To says. “For Monsanto, this is vital as the demand for its products, such as genetically modified seeds and agricultural productivity products, such as Roundup, is determined by demand for crops such as corn and soybeans, which are vital to the growth of the global cattle industry.”
CVS Health Corp. (CVS)
(Justin Sullivan/Getty Images)
CVS is an integrated health care provider with unique business structure in the industry. “CVS Health provides the cheapest price in generics in the industry, low-cost primary physicians with its Minute Clinics, retail presence and specialty drug distribution to long-term care facilities and nursing homes,” says David Yepez, portfolio manager at Exencial Wealth Advisors in Oklahoma City. “We believe the company will continue to benefit from the aging of the population in America.”
Walt Disney Co. (DIS)
Disney is a media conglomerate that monetizes its characters and franchises across multiple platforms including movies, home video, merchandising, parks and resorts and musicals. “The management team has shown great discipline and skill at allocating capital. Disneyland Shanghai and the Star Wars franchise should continue to provide growth for this company for the foreseeable future,” Yepez says.
Mark Zuckerberg’s company is the leading social network company in the world. “By organizing information about users, their social connections, and their activities on the Internet, Facebook has a lucrative database that is highly valuable for advertisers,” Yepez says. “Facebook is also becoming better at monetizing mobile advertising and is entering new areas such as virtual reality and messaging. In summary, Facebook is building the foundation to transform online advertising.”
Fluor Corp. (FLR)
Fluor is a global engineering and construction firm in the industrial sector. Kelley Wright, managing editor at Investment Quality Trends newsletter, likes Fluor based on its current dividend yield level. Through decades of analysis of high quality dividend-paying stocks, Wright found that stocks move between high-yield and low-yield prices areas that signal buying and selling opportunities. “The historically repetitive area of undervalue yield for FLR is 1.6 percent. Based on the current dividend of 84 cents, the undervalued price for FLR is $53.”
American Express Co. (AXP)
American Express is a global charge and credit card payment company. Wright calls AXP stock undervalued at $64 per share, and its dividend yield of $1.16 and 1.80 percent makes this a top pick. “The dividend yield is at a historically repetitive high area and its internal economic value, meaning what the company is worth versus how Wall Street has it valued, is very attractive,” he says.
Wal-Mart Stores (WMT)
Wal-Mart operates retail and wholesale discount stores under the names Wal-Mart and Sam’s Club. Wright says this company is undervalued based on its current dividend yield versus historical levels. “Based on the current dividend of $2, the undervalued price is $80,” Wright says.