Cliffs Is Shaking Up the Steel Business in the U.S. It Might Not Be Enough.

Cliffs (ticker: CLF) announced plans on Monday to buy the U.S. assets of ArcelorMittal (MT). The transaction—following its purchase of AK Steel announced in 2019—could make Cliffs the second-largest U.S. steelmaker, with about 17 million tons of capacity.

The transaction takes the number of significant U.S. suppliers from five to four, KeyBanc analyst Philip Gibbs said in a research report published Monday. “This should be a general positive, all else equal.” Fewer producers, in theory, have more control over supply, which can mean more stability in commodity prices and more profitability.

Commodity industries with a large number of small suppliers often produce poor returns for investors. That has been the case in the U.S. steel industry. Shares of large U.S. steelmakers are down about 50% on average over the past two years. The S&P 500 and Dow Jones Industrial Average, for comparison, are up 13% and 4%, respectively over the same span.

Steel pricing has also been a problem. Benchmark steel prices have fallen from a high of roughly $950 a ton to about $550 over the past couple of years.

Weak demand from a pandemic-induced recession has hurt the supply-and-demand balance in the industry. But the U.S. steel industry is adding to its own woes by adding capacity in the face of falling demand. The counterintuitive approach to supply growth is a consequence of technology. Minimill producers such as Nucor (NUE), which for the most part remelt scrap steel, can make money at lower steel prices than traditional, blast-furnace steelmakers that make steel from iron-ore and coal products.

Nucor, for instance, is expected to earn about $2.21 a share in 2020. United States Steel (X), a traditional blast-furnace producer, is expected to lose almost $6 a share.

Bank of America analyst Timna Tanners wonders whether consolidation can avert a steel-making apocalypse. “If Cliffs were to permanently shutter this capacity, it could offset a glut of new [minimill capacity] we have warned of, aka Steel-mageddon,” she wrote in a Tuesday research report.

Averting that scenario won’t be easy. “We estimate 10 [to] 14 [million tons] of sheet/plate supply would need to shut to balance the market,” she wrote. “Would [Cliffs] acquire assets only to close most of them?” Tanners doesn’t think Cliffs will close capacity quickly, which is ultimately bad for steel prices.

GLJ Research analyst Gordon Johnson also doubts the deal will bring material change to U.S. steel markets. “Why triple down on also-ran blast-furnace steel mill capacity/technology…when [minimills] appear to be the way the industry is headed,” he wrote in a Tuesday research note.

Johnson rates Cliffs shares Sell and has a $2.51 price target. Overall, one-fourth of analysts covering Cliffs stock rate it Buy. The average Buy-rating ratio for stocks in the Dow is about 58%. The average analyst price target for Cliffs stock is about $6.

Tanners doesn’t cover Cliffs. But she isn’t too high on the outlook for most U.S. based steel producers. Tanners rates the stocks of U.S. Steel, Nucor and Steel Dynamics (STLD) the equivalent of Sell.

Tanners likes Ternium (TX) and Commercial Metals (CMC), rating them Buy. Ternium is a large producer of steel in Mexico. Commercial Metals is a U.S. based minimill producer.

Cliffs stock, after jumping 15% on Monday, was fading a little Tuesday afternoon, down 0.7% to $6.52. Still, the sector is up about 5% since the Cliffs-Mittal deal was announced. Investors, might not see much hope, but they see a glimmer.

Courtesy : Barrons