U.S. Steel Imports Could Surge

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Steel prices in China fell sharply on Monday amid reports of reduced lending to the country's property sector. Steel prices in China have already been trading at a significant discount to those in the U.S. This resulted in a surge in steel imports into the U.S. last month, given strong demand for automakers. Given the latest development in China, the spread between steel prices in China and the U.S. could widen further, which is bad news for the likes of U.S. Steel (NYSE: X  ) , AK Steel (NYSE: AKS  ) , and Nucor (NYSE: NUE  ) .

Steel prices drop
Steel futures in China dropped to $540 a ton on Monday after reports in the Chinese media that some banks have curbed lending to sectors related to the property market. Although banks in China are yet to confirm the reports, the news sent steel and iron futures down sharply.

Chinese authorities have been looking to cool down its property market as they look to rebalance the economy from investment to consumption-led growth. Monday's reports come after last week the People's Bank of China (PBOC) issued repos to drain funds from the market to curb credit growth.

There have also been reports that several steel mills are entering into trade financing deals with state-owned iron ore traders as banks have reduced lending to property-related sectors. Steel mills are apparently using iron-ore as collateral, which explains the recent surge in Chinese iron ore import. The latest report further confirms the difficulty faced by property-related sectors in obtaining funding.

U.S. steel imports could surge
Chinese steel mills, which are stretched financially, have been curbing production in order to reduce the glut. According to the World Steel Association, China's crude steel production for January 2014 fell 3.2% on a year-over-year basis. However, given the overcapacity, steel mills will face significant pricing pressure -- especially as Chinese authorities' efforts to cool down the property market will have a negative impact on steel demand.

Already, Chinese steel prices have been trading at a significant discount to those in the U.S. and elsewhere. As per data from CRU last month, the average price difference between U.S. and Chinese steel rose to $159 per ton. Given the substantial discount, it is actually cheaper to import even after taking into account transportation costs. This, coupled with a strong demand for steel in the U.S., led to a surge in steel imports into the U.S. According to the Commerce Department, steel imports rose 23% on a year-over-year basis last month. Imports could rise further following the latest development in China.

Bad news for U.S. steelmakers
The surge in imports from China is bad news for U.S. steelmakers, as it would have a negative impact on prices. Steel prices in the U.S. have already fallen from around $680 a ton last month to around $640 a ton. Not surprisingly, the pricing concerns have also pushed steel stocks lower. In the past week, U.S. Steel has fallen more than 10%, AK Steel has fallen nearly 10%, and Nucor has fallen more than 2.50%. All three stocks are also down for the year so far, with U.S. Steel and AK Steel, given their weaker balance sheet when compared to Nucor, posting substantial losses.

Steel demand in the U.S. is expected to remain strong as the economy continues to recover. However, as I discussed in a previous article, this has already been priced into steel stocks after the rally seen in the second half of 2013. Things are likely to get tougher for U.S. steel companies from here on due to pricing pressure. Nucor's stronger balance sheet means that the company is in a better position to absorb the shocks. It will be interesting to see if the cost-cutting measures implemented by AK Steel and U.S. Steel during the downturn help them in offsetting the impact from lower prices.

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Varun Chandan

I have a Master in Finance degree from IE Business School in Madrid. I use the top-down approach when it comes to investing. I like to analyze macroeconomic factors and how they impact individual companies.

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