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Why Was It So Profitable To Invest In Steel Producers In Q2 2016?

Steel production includes about 450 companies all over the world. The total capitalization of these companies is approximately $42.7 trillion, according to the Bloomberg. The majority of companies use two key materials to produce steel: iron ore and coking coal. Then, after applying some work to these materials, they sell the finished goods (rolled metal, cast iron, slabs, etc.).

This is the simplest operating model for a steel company. The rest depends on how well a particular company manages and structures the process. The average usage of these materials is rationed as 3:1, iron ore to coking coal, respectively.

The price of iron ore (IOE1) reached a peak in the beginning of May at the price of $87.50 per a metric ton. At the beginning of 2016, the price was only at $55.84. At the present time, it is about $68.9. Despite the fall, the price is still up 23% since the beginning of the year.

The next step in this analysis is determining the price fluctuation of the coking coal (CKC1). At the beginning of the year, the coal traded at $95.26 for a metric ton, also declining from the April high of $103.05 per ton. Now it trades at $94.08. The annual change of this commodity has been approximately -1.24%

Finally, let us analyze the price for the finished goods. Here, (HRC1) we can see a stable uptrend. The steel futures started the year at a price of $391 per ton, while now they trade around $570. The +45.78% change is quite substantial for such an illiquid asset. It gave a brilliant opportunity to increase the steel industry`s profit margins. To sum up, the weighted average increase of inputs was around +17.24%, while the increase in prices of final goods is around +45.78%. The approximate gain for steel producers should be around +28.5%, simply explained by the market condition.

I think that this short-term uptrend will boost the steel producers’ valuation in the short-term as quarterly numbers come out. I think that the news will be substantial to create violent upward moves given that most steel companies have cut their dividends down to zero over the last year or so.

(Source: Bloomberg)

The graph above provides information about the TOP-10 steel companies filtered by market capitalization. Only a handful of companies have shown positive price dynamics and positive cumulative total returns: CHMF (Severstal PAO), NLMK (NLMK PJSC), Kiswire LTD, and Seah holding Inc.

The graph below illustrates the changes in historical and forecasted quarterly revenues for the same companies with. Special attention should be paid to second quarter of this year. The Bloomberg analysts have confirmed my thoughts about revenue growth and, as a result, an increase in dividends paid. In addition, if we will lookat previous years’ Q2 figures, we can see a trend backed by historical changes in the top line.

(Source: Bloomberg)

To conclude, I understand that my calculations are very simple and approximate. However, this simple method of determining what will likely happen to the future trends on the steel market has been confirmed and supported by the Bloomberg analysts’ opinions. 

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