Jefferies Steel Performance Benchmark

Key Takeaway

With earnings season fading in the rear view mirror, we look to assess the relative performance of our Euro & US steel coverage. High hopes for the US in early 2017 have disappointed as Euro steelmakers’ margins strongly outperformed YTD and expectations for Q4 are similarly skewed as Euro steelmakers benefit from robust spot conditions (Ex 3). But, recent US price hikes provide a positive backdrop into 2018. Reiterate top picks MT, VOE, TKA, STLD, NUE and X.

Euro steel market: winners and losers.After years of weakening margins, the Euro steel market returned to life in 2017 and EBITDA/t hit $100/t in Q3, stable QoQ, well above the post-global financial crisis ave of $75/t and nearing the long-term ave of $105/t. While steel mills under coverage have seen shipments grow just 1% YTD, import penetration has finally begun to subside with a meaningful mix-shift away from “worst actor” sources, supporting spot HRC metal spreads 24% above historical ave (peaking at 38% premium in Oct), and with additional margin expansion within premium galvanised steel. Q3 results continued to highlight the stand-out performance of VOE Steel, which has reported sector-leading margin expansion despite being viewed as more defensive/less leveraged. SZG Plate-Section, meanwhile, stands out with the most disappointing marginperformance in our Euro coverage, offsetting otherwise robust results in Strip Steel. As we move through Q4, we are increasingly confident earnings should reflect the strongest sector margins since 2011 as solid spot conditions gradually benefit P&L, with MT likely a key winner. Rising iron ore/coal prices have recently begun to pressure margins, but we expect this inflation to ultimately strengthen steelmakers’ hands going into 2018 contract negotiations.

US steel market: finally at an inflection? Despite high hopes, the US steel market has been a laggard this year as flip-flop trade and infrastructure policy invited both higher import penetration (+14% YTD) and a lingering inventory overhang, weighing on steelmakers’ pricing power despite shipments +4% YTD. As a result, US steel sector EBITDA/t fell $21/t QoQ in Q3 to $102/t, still above the long-term ave of $86/t but lagging the margin expansion seen in other regions. Despite Q3 headwinds, STLD stood out as a relativeout-performer with the strongest and broadly most stable margins. While Q3 marked a spot market trough (which will weigh on Q4 P&L) recent weeks have seen metal spreads move strongly higher for a variety of products including HRC (+25%) and rebar (+29%) (Exhibits 13-15). And, with Dec scrap expectations increasing, we continue to believe a third flat steel price hike of $30-40/t is likely before year-end; Integrated mills X, MT and AKS are most positively leveraged. Lastly, following a lacklustre year vs Euro peers, US steel equities may benefit into 2018 from potential tax reform, driving both higher earnings/FCF as well as a potential demand boost should tax cuts truly drive a pick-up in corporate investment.

Stainless steel market: headwinds shifting. Q3 earnings season marked a deep trough in the Euro/US stainless market with sector ave EBITDA margins plunging $162/t QoQ and $73/t YoY to $166/t as an earlier drop in raw materials led customers to destock, hitting steelmakers with lower shipments, weakening base prices and inventory write-downs. Conditions have generally stabilised in recent months and margins should strongly recover in Q4 (ave +$136/t QoQ), but investor sentiment has again weakened for two key reasons. First, chrome/nickel prices have again fallen following a temporary recovery. Second, US production growth from ATI-Tsingshan may at best halt the recent base price recovery and at worst reenact the painful period led by OUT1V‘s own ramp-up. We view APAM and ACX as best positioned within stainless but continue to prefer carbon steelmakers.

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