WE HOSTED A CONFERENCE call featuring three scrap-industry panelists. The call focused on the near-term outlook for the U.S. scrap steel prices and the implications for the upstream U.S. steel producers.
After a well-known price increase in September (panelists believe $20-$30 per-ton price increase is likely in September), each of the three panelists predicted a decline in scrap prices during the fourth quarter. The fourth-quarter expected decline is driven primarily by expectations for increased scrap supplies and modest domestic demand growth. The panelists pointed to a lack of sufficient domestic demand necessary to drive mill-utilization rates sustainably higher, a potential moderation in export demand after the recent bounce in exports to Turkey, and the likelihood that the recent lift in scrap pries (up 38% in past 2 months) draws more supplies into the scrap yards.
However, one caveat to the weaker outlook...if Chinese steel production continues its recent re-acceleration, this could be sufficient to hold scrap prices steady, although even in this scenario, incremental upside to prices from here is limited.
The implications for upstream steel producers are not positive in our view. Given the tight relationship between scrap prices and finished steel prices, in our view if scrap prices decline in the fourth quarter, it suggests the recent lift in hot rolled coil (HRC) prices will also be short-lived, implying a near-term peak HRC price of about $630 per ton (versus recent trough of $560 per ton). To put this in perspective, the U.S. steel equities are trading on average at 5.0-5.5 times 2011 earnings before interest, taxes, depreciation and amortization (EBITDA), based on a $700 per-ton HRC price. While this is a reasonable valuation range for the steel equities in our view (not "cheap," but fair), the key is...if HRC prices end 2010 at about $600 per ton, there is more downside risk versus upside potential to 2011 estimates, given the low starting point in underlying prices versus our base-case estimate (i.e. $600 per ton versus our base case of $700 per ton), and excess capacity (both domestic and global) waiting to respond should prices eventually rebound.
Among the individual equities, in our view United States Steel (ticker: X) is most exposed to weaker-than-expected pricing, given the current relative valuation -- 5.4 times 2011 EBITDA versus 4.5 times 2011 EBITDA for AK Steel Holding (AKS) -- and given inherent EBITDA leverage for a given change in underlying prices.
Conversely, in our view Nucor (NUE) remains least exposed to declining finished steel and scrap prices, given mini-mill cost structure and embedded valuation.
After a well-known price increase in September (panelists believe $20-$30 per-ton price increase is likely in September), each of the three panelists predicted a decline in scrap prices during the fourth quarter. The fourth-quarter expected decline is driven primarily by expectations for increased scrap supplies and modest domestic demand growth. The panelists pointed to a lack of sufficient domestic demand necessary to drive mill-utilization rates sustainably higher, a potential moderation in export demand after the recent bounce in exports to Turkey, and the likelihood that the recent lift in scrap pries (up 38% in past 2 months) draws more supplies into the scrap yards.
However, one caveat to the weaker outlook...if Chinese steel production continues its recent re-acceleration, this could be sufficient to hold scrap prices steady, although even in this scenario, incremental upside to prices from here is limited.
The implications for upstream steel producers are not positive in our view. Given the tight relationship between scrap prices and finished steel prices, in our view if scrap prices decline in the fourth quarter, it suggests the recent lift in hot rolled coil (HRC) prices will also be short-lived, implying a near-term peak HRC price of about $630 per ton (versus recent trough of $560 per ton). To put this in perspective, the U.S. steel equities are trading on average at 5.0-5.5 times 2011 earnings before interest, taxes, depreciation and amortization (EBITDA), based on a $700 per-ton HRC price. While this is a reasonable valuation range for the steel equities in our view (not "cheap," but fair), the key is...if HRC prices end 2010 at about $600 per ton, there is more downside risk versus upside potential to 2011 estimates, given the low starting point in underlying prices versus our base-case estimate (i.e. $600 per ton versus our base case of $700 per ton), and excess capacity (both domestic and global) waiting to respond should prices eventually rebound.
Among the individual equities, in our view United States Steel (ticker: X) is most exposed to weaker-than-expected pricing, given the current relative valuation -- 5.4 times 2011 EBITDA versus 4.5 times 2011 EBITDA for AK Steel Holding (AKS) -- and given inherent EBITDA leverage for a given change in underlying prices.
Conversely, in our view Nucor (NUE) remains least exposed to declining finished steel and scrap prices, given mini-mill cost structure and embedded valuation.
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