The Common Fate of Recovery and Industry

Two eight-letter words that both end in "ry" … surely they must go hand in hand.

All kidding aside, until we view "recovery" and "industry" (as in our industrial base) to be mutually dependent within our present predicament, I suspect that neither will be well sustained. I have been rooting riotously for this purported recovery to flourish from green shoots into rooted trees, but the steel industry's look ahead into fourth-quarter business conditions harkens an unfortunate step backwards from the relative progress observed in the third quarter.

Steel Dynamics (Nasdaq: STLD  ) kicked off third-quarter earnings for the domestic steelmakers with a 64% decline in net earnings from the corresponding boom-time period in 2008. Impaired demand pounded revenues for a 54% decline in sales. A sequential comparison to the second quarter yields more relevant insight, however, and confirms for now the bottom declarations heralded throughout the industrial sectors during the previous earnings season.

Sequentially, Steel Dynamics improved from a $16 million loss to a $69 million gain. A spike in demand from automotive manufacturing (let's call it the "cash for clunkers catalyst") -- and unanticipated strength from metals recycling -- powered a 48% surge in revenue from dismal second-quarter levels.

Larger competitor Nucor (NYSE: NUE  ) was less fortunate, stymied by the persistent drag of high-cost inventories purchased before the collapse in industrial activity in 2008. Although the company reported its third consecutive loss, with a 58% year-over-year revenue decline, the steelmaker's poignant observations mirrored those of Steel Dynamics. Nucor's 24% decline in volumes shipped is counterbalanced by a 24% sequential increase over second-quarter volume.

Nucor reports that the domestic steelmakers collectively progressed from 46% capacity utilization in the second quarter to a lofty 69% in the third quarter. That brings us nowhere near the 92% utilization reported by Korean counterpart POSCO (NYSE: PKX  ) , but it's a great start.

OK, so we can confirm that conditions for the sector truly improved from the worst levels observed in the second quarter, but what about the fourth quarter? Steel Dynamics pointed to "fairly dismal" conditions in the non-residential construction sector, and weak pricing for recycled metals ahead, warning of a drop in the works for fourth-quarter earnings.

Nucor struck a familiarly cautious tone, adding: "We believe real demand is in for a long, slow recovery." Just as Commercial Metals (NYSE: CMC  ) observed back in June, the destocking of steel inventories that ultimately fed an uptick in steelmaking activity has still not been replaced by any measurable recovery in sustainable end-user demand. Like Steel Dynamics, Nucor also warned of lower production rates in the fourth quarter. Corroborating clues from the bellwether coal industry, including recent results from rail operator CSX (NYSE: CSX  ) and miner Peabody Energy (NYSE: BTU  ) , strengthen the case.

I cannot sugarcoat this unfortunate industrial outlook. The widespread optimism that sprang from cautious bottom declarations by industrial bellwethers last quarter is running head-first into an anvil of contrary indications throughout these important sectors. I encourage Fools to exercise caution among domestic industrial equities for the time being.

Do you have a real feel for steel? Clear improvement from the worst levels to date is a welcome sight, but this Fool cautions against premature celebration. To keep track of the complex set of factors affecting domestic industries, join the free Motley Fool CAPS community and ask 140,000-plus fellow investors what their research suggests.

Fool contributor Christopher Barker is the Nat King of Coal and the wild boar of iron ore. He can be found blogging actively and acting Foolishly in the Motley Fool CAPS community under the user name TMFSinchiruna. He tweets. He owns shares of Peabody Energy. POSCO is a Motley Fool Income Investor pick. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.


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12/19/2014 4:12 PM
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