Steel in Limbo Until Cycle Turns

 | Jul 10, 2013 | 12:00 PM EDT
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There's little to like about the steel sector these days. The industry is plagued with about 200 million metric tons of current overcapacity. Steel forms the building blocks of cities and economies; when those economies aren't growing, steel demand is hard to come by.

Steel is a major global commodity and the global economy isn't really humming well enough to spike a surge in steel demand. You won't find many people touting steel stocks, me included. On the other hand, I've been investing long enough to know that it's not a bad idea to keep watch on what Wall Street hates the most.

Remember housing stocks two years ago? Builders FirstSource (BLDR), a name I pitched back when shares were trading below $2 now sits above $6. Lennar Corp (LEN) is up nearly 100% over the past two years while giants Home Depot (HD) and Lowe's (LOW) have absolutely crushed the S&P 500 over the same time period. 

Remember oil refining a couple of years ago? Nobody would touch the stocks despite their trading at deep discounts to book value. Many refiners now are up threefold, or more. 

Looking at the steel industry, I see firms like ArcelorMIttal (MT), the largest steel company in the world, trading at $11. Two years ago, the stock was trading for over $40; five years ago shares were sitting near $100. At current prices ($11.60 at Tuesday's close), the company is being valued at less than 50% of book value. Sure, the demand for steel assets is pretty dead today. But when the cycle turns, those assets will be reappraised. 

While steel is suffering all over the world, domestic producers may have found a little light. U.S. Steel (X), for example, is actually investing a lot of money in new plants that produce specialty engineered steel products. These are sought by end markets such as the auto industry. In many cases, the price per ton is 30% above plain steel. Auto makers will pay up for such specialty products because they increase safety and efficiency. The new plants are doubly profitable because they are being staffed with a non-unionized workforce.

Earlier this week, Alcoa (AA) continued its string of dismal results. Tucked inside the awful earnings release was growth in the engineered products division, which sells engineered aluminum products to the aerospace industry. I think the same angle has to be pursued in the steel business. 

South Korea's POSCO (PKX) now trades for $66 and yields 4%. Shares were trading above $120 before the cycle bust. POSCO is still immensely profitability and trades at 11 times earnings. Back in the U.S., Ampco-Pittsburgh (AP) is a small-cap that stands out because of its net debt free balance sheet. The company boasts a market cap of $200 million, $13 million in debt and over $80 million in cash. Some of that cash is supporting a 4% yield. Not surprisingly, shares trade for $20, near a 52-week high of $21.

During the coming weeks and months, I will be digging deeper into individual names that may stand out. Commodity cycles can be long and painful, but the upside potential than can accrue when the cycle turns can be quite lucrative. 

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