Nucor Corporation’s Guidance Highlights the Major Concern for Steel Companies

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Nucor Corporation (NYSE: NUE  ) shares edged higher on Tuesday even as the company gave downbeat guidance for the first quarter. In fact, Nucor was not the only steel stock that posted gains on Tuesday. Shares of AK Steel (NYSE: AKS  ) , and United States Steel (NYSE: X  ) also rose sharply after reports that the world's largest steelmaker, ArcelorMittal (NYSE: MT  ) , was raising the price of its hot rolled coil.

The steel rally
Steel stocks had rallied in the second half of 2013 amid hopes that the downturn in the industry was about to end in the wake of an improving economic environment in the U.S. But 2014 has been a disappointing year for steel stocks so far, with shares AK Steel, United States Steel and Nucor down sharply for the year. On Tuesday, though, steel stocks were boosted by reports that ArcelorMittal had raised the price of its hot rolled coil to $33 per hundredweight ($660 per ton).

AK Steel, which earlier this week completed a new $1.1 billion credit facility, was the best performer. The stock gained 6.54% to finish at $6.52. However, it is still down more than 20% for the year. United States Steel shares finished 5.42% higher at $25.50. Nucor shares edged higher, but the gains were limited as investors weighed the price increase against the company's disappointing guidance.

Nucor's disappointing guidance
Nucor said on Tuesday that it expects first-quarter earnings to come in below its earlier forecast. The company expects earnings per share to be between $0.30 and $0.35, compared to fourth-quarter 2013 EPS of $0.53.

Nucor said that the larger factor impacting its first-quarter earnings was the extremely cold weather in the U.S. Indeed, cold weather has been the main reason behind a slowdown in economic activity in January and February. The construction market, a key end market for steelmakers, has been one of the areas of the economy affected by the cold weather. This was highlighted by January's construction spending data, which showed an increase of just 0.1%. Spending on nonresidential projects slipped 0.2%. This was, however, offset by a 1.1% increase in spending on residential projects. But, the residential construction market itself has been weak recently, as highlighted by the housing starts data for February.

According to figures released by the Commerce Department on Tuesday, housing starts slipped 0.2% to a seasonally adjusted annual rate of 907,000 units in February. This was after an 11.2% decline in January. Apart from the cold weather, the housing market seems to have been affected by a rise in mortgage rates. But, a slowdown in residential construction activity shouldn't bother Nucor and other steelmakers too much. In fact, the building permits data, which is forward looking, showed a 7.7% increase for the month of February. The data suggests that residential construction activity could pick up going forward and much of the slowdown was mainly due to the cold weather and not high mortgage rates. Nucor, meanwhile, noted that it continues to see small but noticeable improvements in the nonresidential construction markets.

The big worry for steelmakers
While the cold weather has been the larger factor impacting Nucor's first-quarter earnings, the company should be more worried about cheap imports from China. As I have noted in a previous article, U.S. steel imports could surge as Chinese policymakers' efforts to cool down the country's property market will lead to a supply glut in the country's struggling steel sector.

The impact of rising imports has been highlighted by Nucor's first-quarter earnings guidance. Apart from the cold weather, the company blamed the weak guidance on imports. The company said that import levels have continued to negatively impact pricing and margins at its bar and steel mills. Chinese steel has been trading at a significant discount to the U.S. A slowdown in China has pushed prices down even more. According to the China Iron and Steel Association (CISA), steel prices in the country fell to their lowest level in more than eight years in mid-March.

Given this scenario, the U.S. market could be flooded with cheap Chinese steel. Indeed, a surge in steel imports remains the major worry for U.S. steelmakers. 

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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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