Stressed Out: Hot Steelmaker Stocks Can Quickly Turn Cold, Analysts Caution

 | Mar 23, 2016 | 1:05 PM EDT
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This article is part of a Real Money series on 20 companies investors should consider adding to their distressed watch list.

Shareholders of U.S. steelmakers are in the midst of a sensational year but the bulls on Wall Street should take caution, some analysts say. Overcapacity in China and the precarious spike in metal prices could quickly spell trouble for the U.S. market -- especially if the recent rebound in crude oil prices takes another dip.

Pittsburgh's U.S. Steel (X) and Ohio's AK Steel (AKS) and TimkenSteel (TMST) -- all members of Real Money's "Stressed Out" watch list -- have delighted their shareholders in 2016, each more than doubling their market cap.

The optimistic consensus of late appears to have been that U.S. producers can kick their mills back into high gear, as margins widen off higher steel prices and oil-and-gas customers return as crude prices allow them to meaningfully restart production. Shares have also been buoyed by the prospect that harmful cheap imports from China will wane in the face of steep import tariffs recently announced by the Justice Department.

But that sunny outlook may be misleading, according to Morningstar analyst Andrew Lane.

"We view the recent rally in steel prices and shares as unsustainable," he said in a Wednesday phone interview with Real Money. "We've seen handful of incrementally positive data points in Chinese steelmakers and a handful of modest but positive factors, but expect to see steel prices fall further in the second half of the year."

Even where prices currently stand, its going to be very difficult for steelmakers to turn a profit, he said. And punitive trade restrictions on China will open the global market up to more players to than just the U.S., and the new tariffs don't address petitions submitted against the cheap flow of steel imports from other competing nations.

"The petitioners, including AK Steel, ArcelorMittal (MT), Nucor (NUE), SSAB, Steel Dynamics (STLD), and U.S. Steel, were undoubtedly hoping for more punitive margins on imports from Japan, Korea, the Netherlands, and Turkey, none of which exceeded 12%. In the initial petition, filed Aug. 11, 2015, alleged duties across these countries ranged from 19% to 201%," a team of Morningstar analysts wrote in a recent report. "As a result of these mild penalties, we anticipate that import volumes from these countries are unlikely to decline materially. This is critical, given that these four countries accounted for 70% of total 2015 import volumes across all seven targeted countries and 78% in 2014."

Meanwhile, in a Wednesday report titled "That Escalated Quickly," Credit Suisse chose Steel Dynamics and U.S. Steel as their top sector picks in 2016, but emphasized that a sustainable recovery will depend on China's ability to handle oversupply in order to boost prices in the second half of the year.

"The global steel market is quickly rebalancing following the fallout in 2015 from the energy market, significant destocking, and distressed exports from China," the analysts said. "In the past several weeks global hot-rolled call prices have recovered to (about) $370/tonne with global cold-roll call prices approaching $500/tonne. ... The real test will be in the second half in China if infrastructure and property fixed-income assets can shift to a cyclical tailwind (vs. headwind today)."

For more on Real Money's 20 distressed companies to watch:

Stressed Out: Introducing Real Money's Distressed Index

Stressed Out: AK Steel Leads Surging U.S. Steelmakers

Stressed Out: Sprint Is Collapsing Under the Weight of Its High-Yield Debt

Stressed Out: Why the Big Steelmakers Are Tanking Today

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