The steel industry remains on a slow road to recovery. Notwithstanding a few lingering headwinds, the industry ended the third quarter on a positive note, racking up a market-thumping return.  
 
The Zacks Steel Producers industry gained around 7.5% in the September quarter, higher than the S&P 500’s corresponding return of roughly 3.8%. While the overall demand fundamentals for steel remain healthy, the industry is still challenged by sustained overcapacity. The global steel industry continues to reel under the effects of excess capacity – the biggest obstacle to persistent growth and profitability.   

Meanwhile, U.S. steel mills remain impacted by low capacity utilization and a more pressing problem – renewed flood of cheap imports. A surge in steel imports have put downward pressure on U.S. steel prices during the third quarter.

Steel Demand Poised for Steady Recovery

The steel industry is poised to benefit from solid demand in the United States and emerging markets this year. The World Steel Association (WSA) – the international trade body for the iron and steel industry – expects global steel demand to expand 1.3% in 2017 following a 1% rise in 2016.

A cyclical upturn in steel demand is expected to be supported by an ongoing recovery in the developed economies along with an accelerating growth momentum in the emerging and developing economies.

The United States is expected to lead growth in the developed world thanks to strong fundamentals, measures related to fiscal stimuli and rising infrastructure spending. Steel demand in the United States is expected to rise 3% this year.

Demand in emerging and developing economies (barring China) is also expected to rise 4% this year.

Too Much Steel Poses a Concern

The global steel industry continues bear the brunt of a surge in production in China – the world's biggest steel maker. According to WSA, global crude steel production went up 4.9% year over year during the first eight months of 2017.

Output from China, which accounts for around half of the global production, climbed 5.6% year over year during the first eight months of the year. Production from the country also shot up 8.7% year over year to a monthly record of 74.6 Mt in August.

China’s steel juggernaut continues to gather steam notwithstanding the global production glut. Steel mills in the country are ramping up production to take advantage of a spike in domestic steel prices that translates to higher profits for the industry.

Nevertheless, production cuts are expected later this year as Beijing pushes forward with supply-side structural reform to streamline its burgeoning steel sector. China, earlier this year, announced plans to cut its steel production capacity by around 50 million metric tons in 2017 in a bid to reduce overcapacity and control pollution.

Imports Still Haunting U.S. Mills

The American market continues to be inundated with cheap steel imports from overseas producers despite a raft of punitive trade actions. According to a recent report from the American Iron and Steel Institute (AISI), total and finished steel imports for the first eight months of 2017 shot up 20.6% and 15.5% year over year, respectively. Year to date, finished steel import market share is estimated at 28%, which is higher than 26% clocked in full-year 2016.

While positive rulings in trade cases (resulting in levy of heavy tariffs) against China last year led to a decline in Chinese steel exports to the United States, imports from other countries remain at above historical levels.

U.S. steel producers, Nucor Corp. (NUE - Free Report) and Steel Dynamics, Inc. (STLD- Free Report) recently provided lower-than-expected earnings guidance for the third quarter saying that high levels of steel imports have put pressure on domestic steel prices during the quarter.

Continued import pressure has not allowed steel pricing to keep pace with higher raw material costs during the third quarter. U.S. hot-rolled coil steel prices retreated in September and some analysts expect prices to weaken through the balance of the year. High import levels are likely to keep U.S. steel prices in check.

Can Section 232 Bring Relief?

U.S. steel makers are pinning their hopes on President Trump imposing new restrictions on imported steel. Steel stocks got a shot in the arm in April 2017 after the Trump administration ordered an investigation under Section 232 of the Trade Expansion Act of 1962. The Section 232 probe is aimed at determining whether the imports pose a threat to national security and also gives the President the power to impose broad tariffs or quotas on imported steel.

However, the Trump administration has delayed the release of the report on the Section 232 probe, which was initially expected at the end of June 2017. U.S. Commerce Secretary Wilbur Ross in an interview told Bloomberg last month that a decision on steel tariffs has been delayed until after the completion of the tax reform. The U.S. Department of Commerce has until mid-January 2018 to conclude the investigation.

A delay in the Section 232 probe has triggered a spike in steel imports into the American market in the recent months. While the findings from the Section 232 steel investigation are due, a positive outcome from the probe will give the Trump administration the opportunity to take broad-based trade actions against cheap imports. This would provide a significant thrust to steel prices and give domestic steel makers more pricing power.

5 Market-Beating Steel Stocks

The steel industry fared well in the September quarter outperforming the broader market, notwithstanding the headwinds still plaguing the industry as discussed above. With the help of our Zacks Stock Screener, we have shortlisted five steel stocks that have gone up 10% or more during the third quarter and have outperformed both the Zacks Steel Producers industry’s and S&P 500’s corresponding gains.

Brazil-based Gerdau S.A. (GGB - Free Report) is a leading long steel producer in Latin America. The company’s shares gained 12.5% in the third quarter. Gerdau, a Zacks Rank #2 (Buy) stock, has an expected earnings growth of a whopping 2,000% for the current year.

Olympic Steel, Inc. (ZEUS - Free Report) , based in Bedford Heights, OH, processes and distributes flat-rolled carbon, stainless and tubular steel products. The stock has gained 12.9% in the third quarter. Olympic Steel, a Zacks Rank #3 (Hold) stock, has an expected earnings growth of a staggering 2,862.5% for the current year. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Headquartered in Pittsburgh, PA, United States Steel Corp. (X - Free Report) makes and markets a variety of steel mill products, coke and taconite pellets. Shares of U.S. Steel rallied 15.9% in the third quarter. This Zacks Rank #3 stock has an expected earnings growth of 194% for the current year.

South Korea-based POSCO (PKX - Free Report) , a Zacks Rank #3 stock, makes hot and cold rolled steel products, heavy plate and other steel products for the construction and shipbuilding industries. The stock has gained 10.9% in the third quarter. The company has an expected earnings growth of 116.5% for the current year.

Headquartered in Luxembourg, Ternium S.A. (TX - Free Report) is a leading producer of flat and long steel products. The company, carrying a Zacks Rank #3, gained 10.1% in the third quarter. Ternium has an expected earnings growth of 25.9% for the current year.