Economic growth in the United States finally appears to be gaining traction, evident by the fact that third-quarter gross domestic product grew at a 3.6% annualized rate. That figure beat expectations and represented the highest quarterly growth rate since the first quarter of 2012.
This is widely seen as great news for cyclical companies, such as those operating in the steel industry. Shares of major steel producers including U.S. Steel (NYSE:X), Nucor (NYSE:NUE), and Steel Dynamics (NASDAQ:STLD) have done quite well this year, as the market clearly anticipates a strong future.
Steel is extremely cyclical, which means the fortunes of the entire industry are closely tied to the economy. But while it seems that steel stocks may be on the verge of a major breakout in the aftermath of the GDP release, uninspiring outlooks from the companies themselves are a cause for concern. That's why investors should think twice before jumping into steel stocks.
Questionable outlooks reveal widespread uncertainty
Normally, it would seem obvious to turn bullish on cyclical companies during times of rising economic growth. Greater demand for things like automobiles and appliances, plus renewed activity in the oil, gas, and railroad industries, would all spell great things for U.S. Steel, Nucor, and Steel Dynamics. And, the news couldn't come at a better time for these companies, whose underlying businesses are struggling so far in 2013.
U.S. Steel's fundamentals have deteriorated so far this year. U.S. Steel booked a $242 million operating profit in the first nine months of 2012, but has swung to a $1.6 billion operating loss in the same period this year. This was due to a massive $1.7 billion goodwill impairment charge. Meanwhile, Nucor is also seeing worsening conditions in 2013. Specifically, it realized a 6% drop in average sales price per ton through the first nine months, along with a 5% drop in sales and 14% lower earnings.
However, both U.S. Steel and Nucor aren't giving investors much confidence as 2013 draws to a close, even amid a backdrop of improving U.S. economic growth. That's due to two main factors: economic conditions in Europe, and the commercial construction industry is not yet in a significant recovery.
U.S. Steel isn't likely to show significant progress in the upcoming quarter. The company's two main operating segments, flat-rolled and tubular, are expected to struggle to close the year. Management expects break-even results in the flat-rolled business and results in the tubular segment that are comparable to the third quarter. For its part, Nucor warned investors that fourth-quarter earnings are expected to fall year over year. This is due to planned outages, which will reduce productivity.
To give credit where it's due, Steel Dynamics is bucking the broader industry trend. Steel Dynamics has actually grown earnings by 25% through the first three-quarters of the year, which at least demonstrates a much more convincing recovery than its peers. And yet, Steel Dynamics can't provide a compelling outlook either. Management notes strength in the automotive market, but believes ongoing fiscal issues in the United States will weigh on fourth-quarter results.
Conclusion: Proceed with caution
Steel is cyclical by nature, and the harsh reality facing the industry is that many end markets, particularly in Europe, aren't back to normal. Demand is still sluggish in several key product categories and geographies for U.S. Steel, Nucor, and Steel Dynamics. This is why the fourth quarter is not expected to show significant progress for the steel industry, despite the encouraging GDP data.
That's why, even though it seems plausible to favor steel stocks in an environment of economic improvement, it's too early for the steel industry to claim victory. As a result, investors would be wise to think carefully before investing in steel right now.
Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends Nucor. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.