Do February Indicators Offer Signs of Hope to Battered Steel Industry?
The steel industry’s capacity use
The capacity utilization rate is a key indicator of the steel industry’s health. In simple terms, the capacity utilization rate refers to actual production as compared to the maximum production possible using existing plants.
Running production plants at less-than-optimal capacities also makes the cost of production higher. The reasoning is quite intuitive. Fixed costs are distributed among fewer units, so the costs per unit go up. According to analysts, steel companies’ profitability is negatively impacted if plants operate at less than 80% utilization rates.
Capacity use fell in 2015
The US steel industry has operated at a capacity use ratio below 80% since November 2014. Last year, capacity utilization use was ~77% in January. However, the ratio was on a falling trend last year in line with the production slowdown. The US steel industry ended 2015 with a dismal capacity utilization ratio of ~60%. Overall, the average capacity utilization use in the US steel industry was ~70% last year.
Lower capacity utilization negatively impacted steelmakers like U.S. Steel (X) and AK Steel (AKS) in 4Q15.
Capacity utilization picks up
Now, as the steel production has picked up somewhat, as we saw in the previous part, the capacity utilization rate is back in the ballpark of 70%. Though it’s still quite less than optimum levels, the uptick in capacity utilization rate will help steelmakers in 1Q16. If we see service centers restocking their inventory and US steel demand also stays strong, capacity utilization use could go up further. Of course, the basic assumption is steel imports won’t rise from the current levels.
Last year, US steel prices fell prey to imports as well as the broader weakness in metal prices. In the next part, we’ll explore how the steel prices are playing out in 2016.
Investors looking to diversify the risk of investing in a single security can also consider the SPDR S&P Global Natural Resources ETF (GNR). Almost a quarter of GNR’s holdings are invested in steel and other metal companies. Together, BHP Billiton (BHP) and Rio Tinto (RIO) form 6.3% of GNR’s portfolio.
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