2023-11-07 03:06:42 ET
Summary
- Steel Dynamics' strong performance is driven by its Steel Fabrication segment, but declining steel prices and a potential economic recession in the US may lead to a significant decline in operating profit.
- Global steel production is growing, particularly in Asia and Africa, but US manufacturing activity is expected to decline, putting pressure on steel prices and production.
- Prices for hot-rolled steel and steel fabrication products have already started to decline, and construction starts in the US are also decreasing, indicating a potential downturn in the industry.
Investment Thesis
Shares in Steel Dynamics (STLD) are currently trading at historically high levels. This strong performance has been driven by the company's Steel Fabrication segment, which accounts for only 20% of revenues but contributes a significant 60% of operating profit.
However, prices for specialty steel products have started to fall as a result of the recent decline in steel costs due to the relatively slow pace of construction and infrastructure projects. Given the impending economic recession in the US, it is likely that prices for hot-rolled steel and steel fabrication will face further downward pressure, resulting in a significant decline in EBIT. We therefore recommend selling the stock.
The steel market
According to the World Steel Association , global steel production has returned to growth. In August, it climbed by 2% y/y due to higher steel output in Asia, particularly China, on the back of rising investment in infrastructure. African countries have also exhibited growth, with production there jumping by 16% y/y to 1.5 mln tons, and so did the CIS region, where production expanded by 10.7% y/y due to increased production in Russia.
We expect that, as US manufacturing activity fades ( capacity utilization in the manufacturing industry fell below 80% again in September), the demand for steel in the country will decline, which will put pressure on its prices and production. US steel production already slipped by 3.8% y/y over the first eight months of this year.
Financial results outlook
The average price of hot-rolled steel in the US dropped even lower and reached $794 per ton in 3Q 2023. The reason was workers' strikes at auto companies. We assume that hot-rolled steel prices in the country have now reached their sustainable medium-term levels of around ~$700 per ton.
Prices of steel fabrication products have started to decline faster in response to the slowdown in the construction industry.
In September , construction starts (infrastructure) declined by 9% y/y to a seasonally adjusted annualized amount of $345 bln. Road and bridge construction fell by 15% y/y, and environmental construction fell by 29% y/y. However, not all sectors saw declines: Other construction starts rose by 4% y/y and construction of utility and natural gas facilities rose 14% y/y.
Nonresidential construction starts declined by 4% y/y in September to a seasonally adjusted annualized amount of $459 bln. Commercial starts increased by 6% y/y, driven by a rising number of data centers and retail stores. Urban institutional building completions fell by 8% y/y in September, despite an increase in educational building completions.
Residential housing starts fell by 6% y/y to a seasonally adjusted annualized amount of $394 bln in September. Single-family housing starts rose by 1% y/y, while multi-family starts fell by 17% y/y, reflecting how high interest rates made housing unaffordable.
Following the turnaround of the construction index and amid high inventories built up by producers, prices of steel fabrication products fell by 13% m/m and 25% y/y to $3897 per ton, down from our forecast of $4126 per ton. Given the faster cooling off of prices for the raw materials, we have lowered the forecast for the price of steel fabrication products from an average of $4350 per ton to $4112 per ton for 2023, and from $3228 per ton to $2931 per ton for 2024.
We are lowering the EBITDA forecast from $4149 mln (-24% y/y) to $3706 mln (-32% y/y) for 2023, and from $3213 mln (-13% y/y) to $3184 mln (-14% y/y) for 20243 due to the reduced forecast for sales prices in the steel fabrication segment.
As a reminder, operating income is poised to drop following the turnaround in prices for special steel products, which will weigh on the company’s valuation in the future, despite the stabilization of STLD’s core steelmaking business.
We are lowering the target price of the shares from $82 to $77 due to:
- the reduced EBITDA forecasts for 2023 and 2024;
- the shift of the valuation period from 4Q 2023 – 3Q 2024 to the period from 1Q 2024 – 4Q 2024, as our baseline valuation accounts for a future decline of prices in 2023-2024 by averaging the fundamental estimates for 1 year ahead.
We are maintaining the rating for the shares at SELL. Previously , we have stated that prices for special steel products, following the reversal in the cost of steel, began to decline driven by the low-digit rate of construction and reconstruction of infrastructure projects. After 3Q23 we saw that the decline rate of prices exceeded our expectations that was the main factor of lowering target price for STLD.
Conclusion
We believe it's premature to consider investing in STLD stock at this time. A key reason for this caution is the potential for US steel and specialty steel product prices to decline more than expected during an economic downturn. Such a scenario could adversely affect the company's financial performance and the value of its shares.
For further details see:
Steel Dynamics: Still Too Expensive