JPMorgan Sees Cleveland Cliffs (CLF) and Steel Dynamics (STLD) as Top Steel Picks, Strong Cash Flow Provided by High Prices a 'Generational Opportunity'

June 16, 2021 7:39 AM EDT
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JPMorgan analyst Michael Glick has launched coverage on the North American steel sector today, in which he outlines Cleveland Cliffs (NYSE: CLF) and Steel Dynamics (NASDAQ: STLD) as Top Picks.

Speaking about the steel industry in 2021, Glick believes in a “higher-for-longer market” bearing in mind the pace of economic recovery in the US. Moreover, the analyst says that “extended mill lead times and low inventories through the system, longer term, new EAFs likely will add ~10-12% to sheet capacity, which along with imports, should ultimately catalyze a top in price.”

“Even assuming a pullback in pricing beginning in 2H:21, the cash flow windfall provided by prices provides a generational opportunity for integrated steel to de-lever, fund pensions, reposition the businesses for a low-CO2 world and generate returns through the cycle. Our coverage list should free cash flow roughly a third of its combined market cap over the next three years,” Glick wrote in a note sent to clients.

The analyst takes notes of a strong move in steel stocks lately with JPMorgan’s steel coverage already up about 50% YTD, while for instance, Nucor (NYSE: NUE) gained more than 90% YTD.

“The current pricing market is characterized by a historically tight supply/demand setup, with the only parallel perhaps being a brief period during the build-up of materiel leading into World War II. As the country and the world emerge from the pandemic—it’s difficult to see what can change to quickly reduce prices anywhere close to what used to be considered mid-cycle (~$625/t is the 10-year average for hot-rolled coil), which is what consensus estimates seem to embed in 2H:21/22e.”

“The U.S. is seeing accelerating demand across nearly all key steel-consuming sectors (construction, autos, machinery), which seems likely to continue as the country emerges from the pandemic, with the rest of the world, notably Europe, nearing a similar resurgence. There certainly is a question relative to demand in terms of a potential shift in consumption from products to services post-pandemic, which is a risk we’ll monitor closely,” Glick added.

The analyst has initiated coverage with “Overweight” ratings on CLF, Reliance Steel & Aluminum (NYSE: RS) and Stelco (STLC CN). NUE, Commercial Metals (NYSE: CMC) and Carpenter Technology (NYSE: CRS) are all started at “Neutral.” Coverage assumed on GrafTech (NYSE: EAF) and STLD also at OW, while US Steel (NYSE: X) has an “Underweight” rating.

“In terms of positioning within the equities, one item to consider is timing, and STLD has that in spades as its new flat-roll mill on the Texas Gulf Coast comes on at a time of historically tight supplies (within a few months). CLF also has that given its 2020 acquisitions and is positioned with ample flexibility in raw materials, particularly with the HBI plant—a key differentiator, in our view, and its negotiations on the auto side should help protect margins for that piece of business,” the analyst notes.

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