Steel Stocks Rise on Growing Demand

Steelmaker stocks have made a winning start to the year, with all five major players beating the market, but the future performance of the industry is likely to depend on how well domestic steel demand can bounce back.

Russian bourses have undergone a correction since reaching their peak in mid-January, brought on by worrisome news from the United States, China and southern Europe. The ruble-denominated MICEX Index is down 4.8 percent since the beginning of the year, while the dollar-denominated RTS Index is off 5.6 percent.

Meanwhile, the "big five" Russian steelmakers, which collectively account for 80 percent of the industry, all have exceeded the market. Since the beginning of the year, Mechel shares have risen 29.9 percent, Magnitogorsk Iron & Steel Works has increased 14.6 percent and Severstal, the country's biggest steelmaker by output, has shot up 25.1 percent. Shares in Evraz Group, traded on the London Stock Exchange, have risen 9.9 percent this year. Even Novolipetsk Steel, which has fallen 4.2 percent for the year, came in above the indexes.

"It's quite common for Russian steelmakers to outperform the market," said Nikolai Sosnovsky, a metals and mining analyst at UralSib. Investors presume that high oil prices lead to increased budgets and more construction in Russia, Sosnovsky said.

Weighing on steelmakers throughout 2009, however, was a heavy debt load. Severstal, Mechel and Evraz have all been handicapped by massive debts incurred by expensive precrisis acquisitions in the United States and elsewhere.

But while investors punished the steelmakers for the poor state of their balance sheets in 2009, now that the steel companies have emerged from the crisis, investors will likely start focusing more on cash flow, said Boris Krasnozhenov, a Renaissance Capital metals and mining analyst.

So demand, not debt, is likely to be the driving force for steel stocks in 2010.

Demand from booming economies such as China largely supported the steel industry as domestic demand stalled and the construction sector ground to a halt. But foreign markets are tough: Competition from East Asia keeps export prices low, and steelmakers can make better margins selling domestically. So the degree to which domestic demand can recover is likely to have an influence on the industry's performance over the coming year.

The Russian steel market "is extremely export-oriented," said Alexander Pukhayev, a metals and mining analyst at VTB Capital. It sells its steel to China — which has been tightening lending and business expansion policies in recent weeks — as well as South Korea, the Middle East and the United States.

Domestically, the industry has been slowly revived by strong demand from pipe-making, shipbuilding and bridge-building sectors, Krasnozhenov said. But for a full revival, construction has to rebound from the submerged levels of the economic crisis — and the state of that sector won't be clear until April, when seasonal demand recovers because of the onset of spring.

Domestic demand is perhaps 15 percent to 25 percent below its precrisis level, and it is unlikely to climb back for another year or two, Pukhayev said.

"The recovery is not very clear," he said. And that may mean investors will be hedging their bets on steel come spring.