Report
Andrew Lane
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Morningstar | U.S. Steelmakers Issue Soft 3Q Guidance as Falling Steel Prices Portend Lower Profits

Having reviewed a flurry of guidance releases from U.S. steelmakers, we've softened our 2019 outlook for industrywide profits. Per the commentary provided, broader steel demand remains fairly steady except for a pocket of weakness associated with the automotive end market. Metal margins have contracted in recent months amid materially lower steel prices and a non-commensurate decrease in input costs. Additionally, we remain cautious about the industry's long-term prospects, as we expect steel demand to wane in China as global overcapacity persists. Further, a bevy of new capacity announcements from existing operators will drive a gradual contraction in the premium for U.S. steel prices above world export prices. We hold this view even though U.S. Steel has announced plans to idle two U.S. blast furnaces.

Although U.S. steelmakers are now trading at low valuation multiples relative to historical levels, we don't believe the group offers attractive upside potential on a risk-adjusted basis and we'd encourage investors to seek out greener pastures.

U.S. Steel's guidance release was the most noteworthy across the industry, as the company announced it will idle two U.S. blast furnaces (Great Lakes B2 and Gary Works south) and another in Slovakia (#2). Both idlings have been deemed temporary until market conditions improve. However, given our long-term outlook that market conditions will deteriorate further over our explicit five-year forecast period, we anticipate that they will remain idle for an extended period of time if they are not ultimately decommissioned. As reflected by the company's massive asset revitalization program, U.S. Steel is struggling to reduce its unit production costs. EBITDA per ton for its U.S. flat-rolled operations remains well below that of its largest competitors that operate minimills. As it pertains to the company's second-quarter performance, profits are likely to come in lower than previously anticipated. Management had previously guided that adjusted EBITDA would be flat from $285 million in the first quarter but is now guiding to $250 million. Having lowered our near-term profit outlook, our fair value estimate declines to $15 per share from $19. Due to the company's elevated financial leverage, even a modest change to our profit outlook has an outsize impact on our fair value estimate. Our no-moat rating is unchanged.

Nucor issued weaker guidance versus the company's prior expectations. Management had previously indicated that earnings should be flat sequentially but now expects a roughly 25% sequential decline to a range of $1.20 to $1.25 per share. The company cited service center destocking, increased domestic supply, and a planned outage at its Trinidad DRI facility as key drivers of lower profitability. Although service center destocking and the DRI facility outage represent fleeting headwinds, we remain concerned about the long-term implications of growing steel production capacity in the U.S. and the impact it will have on pricing. As a result, we've slightly reduced our near-term profit outlook for Nucor. Additionally, we've increased the company's cost of equity and cost of debt to 11% and 8%, respectively, to align our assumptions with those assigned to U.S. minimill operators Steel Dynamics and Commercial Metals. Accordingly, we've reduced our fair value estimate to $47 per share from $50. Our no-moat rating is unchanged.

Commentary from Steel Dynamics about its second quarter guidance was similar to that provided by Nucor. The company's steel operations are expected to deliver lower sequential profits amid lower steel prices an inventory destocking. Management highlighted particularly weak profitability from its long products operations. Having tempered our near-term profit outlook, our fair value estimate for Steel Dynamics falls to $33 per share from $35. Our no-moat rating remains intact.

Schnitzer Steel Industries' third quarter preliminary earnings release was largely in line with the company's prior guidance. Having updated our valuation model, our $19 per share fair value estimate and no-moat rating are unchanged. Amid modest margin contraction stemming from our forecast that lower scrap prices will take hold, we expect a further profit decline for Schnitzer. Shares remain safely above our fair value estimate, trading in 2-star territory.
Underlying
Schnitzer Steel Industries Inc. Class A

Schnitzer Steel Industries is engaged as a recycler of ferrous and nonferrous scrap metal, including end-of-life vehicles, and a manufacturer of finished steel products. The company has two segments: Auto and Metals Recycling, which acquires and recycles ferrous and nonferrous scrap metal for sale to foreign and domestic metal producers, processors and brokers, and procures salvaged vehicles and sells serviceable used auto parts from these vehicles through a network of self-service auto parts stores; and Cascade Steel and Scrap, which produces a range of finished steel long products using ferrous recycled scrap metal and other raw materials.

Provider
Morningstar
Morningstar

Morningstar, Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. The company offer an extensive line of products and services for individual investors, financial advisors, asset managers, and retirement plan providers and sponsors.

Morningstar provides data on approximately 530,000 investment offerings, including stocks, mutual funds, and similar vehicles, along with real-time global market data on more than 18 million equities, indexes, futures, options, commodities, and precious metals, in addition to foreign exchange and Treasury markets. Morningstar also offers investment management services through its investment advisory subsidiaries and had approximately $185 billion in assets under advisement and management as of June 30, 2016.

We have operations in 27 countries.

Analysts
Andrew Lane

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