The American Steel Industry Still Likes the Future of Auto Sales

The U.S. steel industry is in a rut, but that doesn't mean the business is all bad.

Reuben Gregg Brewer
Reuben Gregg Brewer
Dec 19, 2015 at 9:45AM
Energy, Materials, and Utilities

Shares of AK Steel Holding Corporation (NYSE:AKS) and United States Steel Corporation (NYSE:X) are down around 95% since peaking during the 2007 to 2009 recession. Based on that, you'd think there was no good news at all in the moribund steel industry. But you'd be wrong: U.S. steel giants are benefiting from a strong auto sector.

A downer of an industry
It would be easy to look at the performance of key steel industry players and come to the conclusion that the industry is in deep trouble. You wouldn't be wrong; chronically low steel prices, increasing pressure from imports, and high costs at the legacy mills that dominate AK Steel and U.S. Steel's businesses are a big problem. AK Steel, for example, last posted positive earnings in 2008. It's been all red ink since that point. U.S. Steel managed a profit in 2014, but otherwise it's been all losses since 2008, too. It looks like 2015 will be another losing year for both mills, by the way.

AKS Chart

AKS data by YCharts.

To be fair, steelmakers with more modern plants that use scrap steel and electric arc furnaces have done much better. Steel Dynamics (NASDAQ:STLD), for example, lost $0.04 a share in 2009 but has otherwise been profitable. That doesn't mean the mill's businesses has been immune to the steel market's malaise, just that some steel players have handled the downturn better than others. And it proves that there are some bright spots even in a struggling industry.

Digging deeper
In fact, if you are willing to dig deeper than the company level, one area that's been particularly bright, even for the most out-of-favor steelmakers, is autos. U.S. Steel CEO Mario Longhi, in a somewhat understated comment, explained during the third quarter conference call that, "The automotive market continues to be a very good market for us." AK Steel CEO James Wainscott was a bit more excited, stating, "We have continued to observe a very solid automotive market for our carbon and stainless steel products." Steel Dynamics CEO Mark Millett mentioned in his company's call that, "Automotive has continued forecasted strength."

AK Steel's Wainscott dug a little deeper into the product line to give some color, explaining, "As a company, for the third quarter of 2015, we set an all-time record in terms of shipments to automotive customers." And it was the company's "second-best quarterly auto chrome shipment level in our company's history." (The best quarter for chrome was the first quarter of the year.) This is really good news for AK Steel in particular, because roughly half of its sales are to the auto industry. But it's clear that autos are a strong point for all of the big U.S. steelmakers.

AK Steel's auto industry reach. Image source: AK Steel.

A bigger takeaway
But there's more to understand here. For example, Steel Dynamics' Millett noted that autos have historically made up 25% of the U.S. market for steel. AK Steel's Wainscott again adding important flavor: "While no market is perfectly nor permanently insulated from import pressures, it's safe to say that the automotive sector has historically been served by domestic producers and that's due to quality, service and just-in-time delivery factors."

So, as an investor, your takeaway from all of this is twofold. First, the struggling U.S. steel industry has been benefiting from continued strength in the auto sector, which has historically been a somewhat protected domestic market. That's true pretty much across the board for the steelmakers and is a positive that's been hidden by other industry issues. You'll want to key in on this when you dig deeper into these companies.

However, this is also a risk. For weaker steelmakers like AK Steel that are heavily reliant on the auto sector, a falloff in the U.S. auto market could have a devastating impact on financial results. Such a move could potentially turn a struggling company into an insolvent one. (For reference, only about 15% of U.S. Steel's production goes to the transportation sector.) So be excited by this bastion of strength today, but be mindful of what a changing industry dynamic could lead to.

In the end, the steelmakers aren't a good investment option for risk-averse investors. There are very real problems in the industry. However, that doesn't mean the industry is down for the count and the strength in the auto sector is a prime example of a silver lining on this dark cloud. You'll just want to keep a close eye on that silver lining to make sure it doesn't start to tarnish.