If you haven’t kept up to date on how the steel industry is tracking, I’ll explain it in two words. Not well. The most obvious Aussie steelmaker in trouble is Arrium. They were a textbook case of what can go wrong in a business.
What happened to Arrium wasn’t solely due to the state of the industry. The current situation facing the steel industry added to their woes. Steel prices have fallen by as much as 60% this year. And iron ore prices have been extremely volatile as well, due to speculative trading.
Rather than pointing fingers and playing the blame game, let’s recap why events have turned out as they have.
It all starts with supply and demand. If a product or service is in high demand, relative to supply, prices increase. If the opposite happens, prices decrease.
While some like to complicate what’s been happening, the steel industry’s troubles boil down to this — excess supply.
For years, China fuelled its economic growth through infrastructure and industry spending. This undertaking required steel. But now that Chinese policymakers have moved away from infrastructure led growth, were does the excess steel go?
China has huge stockpiles of steel sitting waiting to be used. So, with this excess supply, the price of steel has plunged accordingly. And since iron ore is tied closely with steel production, it too has hit lows of US$40 a tonne this year.
But as the economy keeps churning along, and with prices having somewhat stabilised, there is one Aussie steelmaker making headlines…but not for positive reasons.
This morning, BlueScope Steel [ASX:BSL] shares opened up 10.2%, to $6.46 per share. The Aussie steelmaker has continued their strong start to the year; it’s up 41.31% in 2016.
Source: Google Finance
The share price climb was in direct response to an earnings upgrade for the second half of 2016. BlueScope expect earnings before interest and tax (EBIT) to be $61 million higher than their previous guidance in February.
Expectations of EBIT of around $270 million were strengthened by BlueScope’s strong performance.
‘The stronger performance has been driven largely by earlier delivery of targeted cost reductions, higher steel and iron ore prices, better than anticipated Australian domestic steel dispatches and better than expected margins in the international business,’ BlueScope said in an announcement.
Should you buy BlueScope at this price?
BlueScope’s expected earnings upgrade has now already been priced in. This means that, if actual EBIT for the second half aligns with expectations, shares might only react slightly. Anyone that invests in BlueScope now either believes the stock will outperform, or they think the steel industry is set for a rebound.
If you agree with the latter, now might be the best time to get in. Investors are staying away from steelmakers as prices are still depressed. Effectively you could be taking advantage of depressed prices that could go up in the future.
However, supply doesn’t seem to be slowing. Britain and other nations have tried reasoning with China. Yet they seem adamant to pump out steel. So if you believe steel is something to get into right now then you will need to have a long term view on the situation.
What seems obvious to all investors can sometimes be lost in the hype of buying cheap stocks. Always keep the risks in mind, and plan for worse scenario.
Junior Analyst, Money Morning
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