Steel: It’s the Same as Before Only Different

  /  Jan 1, 2018  /  

We hold a bright outlook for the domestic steel industry in 2018. There is a backdrop for improving demand spurred by the 2017 Tax Cuts and Jobs Act. Lower corporate income tax rates and the ability to expense capital investments will free up cash flow and incentivize durable goods, equipment and machinery purchases. Steel supply will remain tight due to limitations on low-priced imports. Tariffs already in place established a meaningful buffer. In addition, the Trump Administration has been clear about its willingness to enforce current trade laws and find (and maybe use) obscure laws like Section 232 to “protect” domestic producers. Now that the tax bill has passed, it is expected that the government will be able to pass a bipartisan infrastructure spending bill in 2018 that will boost metals demand, particularly if there are Buy America provisions. Steel and scrap prices will be supported by a weaker U.S. dollar. Anticipation of easing of fiscal stimulus in Europe and Japan is being priced into the market. In addition, financial markets are expecting inflation to rise as tight labor markets collide with a rebound in domestic manufacturing. Foreign manufacturers may find the U.S. more attractive with lower tax rates, low energy costs and higher barriers on imports, and relocate factories.

2018 is starting on firm ground. Automotive markets are solid (maybe not record levels) but demand and production should continue near recent levels. Construction spending is hovering near peak levels and energy markets rebounded from catastrophic levels with continuing demand anticipated. Escalation in demand from recent levels should create a floor for pricing in the coming months. If domestic producers try to push prices up too fast and the spread between domestic and international prices widen, imports will return and, as in the past, prices will fall. However, if played right, the domestic steel industry could be in for a strong year of sustained profits.

We believe 2018 will be a seller’s market for steel assets. We expect valuations will be elevated by higher EBITDA with limited multiple compression. Large public and private service centers are still seeking strategic expansion opportunities. Private equity might be less aggressive than in the past due to limitations on the ability to deduct interest expense, but they still have ample dry powder to invest.