Credit Suisse Downgrades U.S. Steel Sector Despite Tariff Boon

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It seems almost inconceivable that Credit Suisse could be downgrading expectations for the US steel sector, as recently reported by Reuters.

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It feels counterintuitive that an industry buttressed by 25% import tariffs would not be riding the crest of a wave, particularly when you read one firm has just settled with its union, agreeing a cumulative 14% wage increase over a four-year period.

Surely that sounds like a firm making bumper profits. Indeed, the same article states, the company in question, U.S. Steel, posted a near 60% increase in pre-tax profits in the June quarter.

President Trump’s trade policy, coupled with a strong economy, has sent domestic steel prices soaring, and finally released a number of high-profile investments in new capacity said to total more than $3.7 billion to be started by the end of this year.

Big River Steel LLC, Carpenter Technology Corporation, ArcelorMittal S.A. and Attala Steel Industries are all set to join U.S. Steel in new investments spurred by the opportunity created by the import tariffs.

Even if, as seems likely, some kind of deal is carved out for Canada and Mexico now the revised NAFTA agreement has been agreed (now called the United States-Mexico-Canada Agreement, or USMCA), removal of the 25% tariff among the three is unlikely to decimate prices, as tariffs remain in place with the rest of the world.

Market leader Nucor is by all accounts doing very well, having booked its highest quarterly profits in the company’s history at $683 million in the second quarter, more than doubled the $323 million total in the second quarter of 2017. Third-quarter earnings, which Nucor reported Thursday, hit $676.6 million, up from $254.9 million in Q3 2017.

U.S. Steel, on the other hand, remains the laggard of the industry, and the markets know that.

Despite record prices — admittedly, we have seen softening since the summer — the company’s stock has continued to underperform, having lost some 40% since March 1, according to CNBC.

But back to Credit Suisse and its industrywide downgrade: is their downgraded view valid?

Much is predicated on oversupply, particularly if deals are struck to remove the tariffs on Mexican and Canadian steel. Although China is often cited as the tariffs’ target, in reality China has not been a major supplier to the U.S. for some years due to early action.

Apart from slab out of Brazil, Canada, Mexico and Russia have been the largest suppliers. If tariffs are removed for these countries, supply will definitely increase and domestic mills may have to reduce margins to fight for demand, which is theirs for the taking this year.

The fact that steel prices have softened this quarter suggests mills are already responding to the new normal.

Prices remain elevated from pre-tariff days, but mills are having to respond to the global price — plus the 25% tariff — environment. Domestic capacity utilization is over 70% — better than, say, China’s, which is hovering in the high 60s — but still far from the 80% and above level mills would like.

You have to hope for U.S. Steel’s sake the tariffs remain in place, not just for months but for years and that the administration does not agree to too many carve-outs.

If the barriers start to leak like a failing dam due to tariffs being removed on USMCA-origin metal and saddled with higher costs incurred by wage deals struck now or investments made on the back of strong current domestic prices, those higher costs (such as inflated wage agreements and debt as a result of significant new capacity investments) may prove too much to support in a lower market price environment.

Under such a scenario, maybe Credit Suisse has a point.

Consumers, naturally enough, are hoping that tariff barriers are removed — and quickly. Our own take is they will be disappointed. So long as the Trump administration remains in power, so too will the majority of the tariffs (at least with the rest of the world outside USMCA).

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We may have hit peak steel in the summer and be facing a winter of softer prices. However, the bar has been raised on price competition and domestic mills are likely to enjoy some advantage from that state of affairs for some time to come.

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