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Do Downbeat Views Point to a Tough Q3 for US Steel Stocks?

Anindya Barman

After reaping the benefits of higher domestic steel prices last year, American steel makers are bearing the brunt of weakening steel prices and demand this year. Moreover, recent profit warnings from some of the major U.S. steel makers have raised concerns about a possible weak third quarter for the U.S. steel industry.

Is a tough third-quarter earnings season in store for U.S. steel stocks? Let’s have a look.

Weak Q3 Guidance from Major U.S. Players

Some of the prominent U.S. steel producers came up with weaker-than-expected earnings guidance for the September quarter this week. U.S. steel giant, Nucor Corporation NUE, on Monday, issued disappointing guidance for the third quarter.

The steel producer expects earnings in the band of 75-80 cents per share for the third quarter, reflecting a sequential decline from $1.26 in the second quarter and a fall from $2.13 recorded in the year-ago quarter.

Nucor expects performance in the steel mills unit to sequentially decline in the third quarter mainly due to lower prices for sheet and plate steel. The company stated that it sees stability in most of the end use markets that it serves. However, automotive, power transmission and agricultural products markets remain weak.

Steel Dynamics, Inc. STLD also provided weak view for the third quarter as it expects lower profits in its steel operations in the quarter. The steel maker expects earnings for the quarter in the band of 66-70 cents per share. That is a decrease from 87 cents per share recorded in the previous quarter and $1.69 per share it earned a year ago.

The company expects earnings from its steel operations to be lower sequentially in the third quarter mainly due to reduced profitability from its sheet steel operations. The company attributed the decline in profitability to lower average steel prices and shipments that more than offset reduced scrap costs.

Moreover, United States Steel Corp. X issued underwhelming guidance for the third quarter yesterday. It expects to record adjusted loss per share of roughly 35 cents for the quarter. The company expects lower steel prices and higher-than-expected decline in scrap prices to hurt its Flat-Rolled segment through the second half of 2019. It will continue to idle its two U.S. blast furnaces at least through the end of 2019. The company also noted that market conditions have continued to weaken in Europe.

Downbeat third-quarter guidance from these major companies reflects tepid underlying fundamentals of the American steel industry.

Sliding Steel Prices, Weak Demand to Dent Q3 Results?

The 25% tariff on steel imports, which the Trump administration imposed in March 2018, largely helped U.S. steel companies to rack up solid earnings last year. The tariffs provided a boost to U.S. steel prices in 2018, driving profits and cash flows of American steel makers.

The trade actions also helped domestic steel industry capacity break above 80% (the minimum rate required for sustained profitability of the industry) last year after remaining below that level for years. The tariffs drove up production capacity of U.S. steel producers amid lower imports. Improved capacity also provided a boost to U.S. steel production.

The tariffs led to a spike in U.S. steel prices during the first half of 2018. However, the momentum was short-lived as U.S. steel prices tracked downward in the back half of the year and continued to retreat this year.

The benchmark hot-rolled coil steel prices went downhill through the second quarter of 2019 and continued their slide in the third quarter, partly due to demand weakness. Prices are now well below their peak level of roughly $920 per short ton (st) reached in July 2018. They are down nearly 40% from the high levels reached last year. In fact, U.S. steel prices have now fallen back to the levels seen prior to the tariff announcement.

Higher U.S. steel production, partly driven by restarted mills, has contributed to the sharp decline in U.S. steel prices this year. Uncertainties surrounding global economic growth and concerns over a slowdown in steel demand in China (the world’s top consumer) amid a slowing Chinese economy are other factors to blame for the decline.

Waning steel demand is another concern. Slowdown across major end-use markets such as automotive, construction and energy are hurting steel demand. Demand has softened across the United States and Europe. Moreover, a cooling Chinese economy amid trade tensions with the United States has triggered a slowdown in steel demand across major steel end-use markets — construction and automotive — in China.

As such, lower U.S. steel prices will likely put downward pressure on selling prices of American steel makers and crimp their margins in the third quarter. Softening end-market demand may also hurt profitability.

Although some of the U.S. steel makers have recently taken steps to reduce capacity in the wake of declining domestic steel prices, the move is not expected to result in a meaningful recovery in prices anytime soon given the oversupply in the market and weak domestic steel demand.

Meanwhile, U.S. steel stocks have been out of favor for most of this year. Notably, shares of major domestic steel companies such as U.S. Steel, Nucor, Steel Dynamics and AK Steel Holding Corp. AKS have been on a roller-coaster ride in August. Falling steel prices, softening demand across major markets and heightened trade tensions weighed on steel stocks last month.

Nevertheless, shares of these companies gained ground this month on hopes of easing U.S.-China trade tensions. China, earlier this month, said that it would exempt some U.S. products from a recent round of additional tariffs. The United States also agreed to delay a planned increase in tariffs on some Chinese imports. The de-escalation instilled positive sentiment and provided a thrust to U.S. steel stocks this month. While the countries prepare for another round of negotiations next month, a potential trade truce would augur well for U.S. steel companies.

AK Steel carries a Zacks Rank #2 (Buy) while both U.S. Steel and Steel Dynamics have a Zacks Rank #3 (Hold). Nucor is a Zacks Rank #4 (Sell) stock.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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Click to get this free report Steel Dynamics, Inc. (STLD) : Free Stock Analysis Report United States Steel Corporation (X) : Free Stock Analysis Report AK Steel Holding Corporation (AKS) : Free Stock Analysis Report Nucor Corporation (NUE) : Free Stock Analysis Report To read this article on click here. Zacks Investment Research