At no other time in modern U.S. history has a new administration intervened so directly in the business environment.
Whether you agree with President Trump’s policies or not, it’s difficult to ignore that the new administration is reshaping the American economy.
Positioning in those industries before the good times begin could be one of the strongest investment themes over the next four years.
President Trump reiterated his call for a $1 trillion infrastructure plan in his recent speech to Congress. He also reinforced his pledge to boost American manufacturing with a mandate that requires new energy pipelines to be made with domestically-produced steel.
In that mandate, the President may have signaled one of the best investments of the year and made one group some of the top stocks of 2017.
Steel Benefits From Increased Demand And Decreased Competition
Not only could U.S. steel producers get a sales boost from pipeline projects already approved, but any major infrastructure improvement could mean a surge in non-residential and construction steel. Steel gets a further boost in demand from aerospace as President Trump seeks to increase defense spending by $54 billion.
In addition to strong domestic demand growth, U.S. steel producers could see an easier competitive environment as the new administration focuses its sights on steel imports.
The Commerce Department announced a final finding of its anti-dumping investigation in January, affirming complaints that China has subsidized its industry to sell steel products in the United States for less than the cost of production. Tariffs of between 64% and 191% on Chinese steel imports into the United States have already been levied, but the new administration may go even further to shift demand to domestic producers.
Finding The Best-Of-Breed Steel Producers
While everyone in domestic steel could benefit from the improved environment, finding the top steel stocks of 2017 means looking at segment demand within steel. Construction accounts for approximately 42% of U.S. steel demand, followed by automotive (27%), machinery (9%), energy (7%) and appliances (5%).
Construction, machinery, and energy all stand to benefit most from proposed policies in Washington. The one downside to steel stocks could be a reversal in the auto market.
Automotive sales have been strong for several years and reached a record of 18.4 million units in 2016. January 2017 sales slipped to 17.3 million vehicles on an annualized rate and a stretched market for motor vehicle loans could weigh on sales this year. The total amount of motor vehicle loans outstanding bulged to $1.1 trillion in the fourth quarter of 2016 and dealers have had to relax standards to draw new buyers.
This means that the best picks are those steel companies with limited exposure to automotive steel.
Steel Dynamics (Nasdaq: STLD) is my top pick in steel, with an attractive valuation and strong upside. The company has a relatively small footprint in automotive steel, accounting for just 15% of sales, with the bulk of revenue (36%) going to the construction market. Shares are relatively cheap at 19 times trailing earnings. Per-share profit is expected to increase 38% to $2.64 per share over the next year, driving my $53 price target.
Nucor (NYSE: NUE) is the largest domestic steel producer (it sports a market cap of $20.1 billion) and is involved in every phase of the value chain. Nucor uses electric arc furnaces which are less labor- and energy-intensive and allow the company to compete as a low-cost producer.
While the company has been building its automotive business, total tonnage sold to the auto market still only accounted for 7% of total tons produced in 2015. Despite a relatively high valuation of 27.9 times trailing earnings, I like Nucor and think shares could bounce to $76 per share on a 61% expected increase in earnings to $3.63 per share over the next year.
AK Steel Holdings (NYSE: AKS) is a smaller producer at just $2.7 billion and the most heavily dependent on the auto industry. Nearly two-thirds (60%) of the company’s sales go to the automotive market, so it may not benefit as much from infrastructure spending. Shares already trade at 24-times trailing earnings.
At the same time, profits are expected to surge 114% to $0.75 per share over the next four quarters. Bear in mind that any weakness in auto sales or the continued replacement by aluminum in car manufacturing could lead the company to disappoint on earnings.
United States Steel (NYSE: X) has struggled to remain profitable over the last year, posting a $1.79 per-share loss. The company uses blast furnaces which operate at a higher cost than arc-furnaces, putting it at a price disadvantage in a very price-sensitive market. United States Steel books 17% of its revenue from the auto market and has a sizable pension liability that may weigh on cash flow over the next few years.
Risks To Consider: Shares of U.S. steel producers have risen rapidly since the election and price appreciation may slow if real demand does not pick up.
Action To Take: Position in shares of domestic steel producers as demand increases from government policies. Focus on steel companies with a higher percentage of sales going to construction segments. If the present administration carries through on policy goals, expect steel stocks to perform as some of the top stocks of 2017.
– Joseph Hogue
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Source: Street Authority