Steel Rebound: Four Stocks to Watch

The steel industry begins its first-quarter earnings season this week, and Wall Street will be hunting for recovery trends. Here are four steel stocks to watch.
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(Steel industry preview updated for quarterly results issued by Steel Dynamics and AK Steel on April 19 and 20, respectively.)

NEW YORK (TheStreet) -- No sector symbolizes industrial might more than steel.

For the companies that manufacture it inside U.S. borders, the last decade has been an eventful one, beginning with the industry's near collapse, encompassing its scaled-down resurrection, and ending again with a recession-induced punch to the gut.

In the meantime, China emerged as the unrivaled heavyweight champion of the steel-producing world as the government juiced its homegrown industry so that it could supply the rebar and I-beam and flat-rolled and tubular steel needs of a rapidly developing nation of 1.3 billion.

Now, with the decks cleared for a fresh decade, all eyes are straining to see whether the domestic steel industry can regain its breath. Most major steelmakers in the U.S. will report -- or have already reported -- first-quarter earnings this week and next.

The results so far have been decidedly mixed.

Steel Dynamics

(STLD) - Get Report

after the close on Monday

beat expectations and struck encouraging notes about 2010

.

AK Steel

(AKS) - Get Report

, on the other hand, met Wall Street's targets but said that

rising iron ore costs could pinch its profits in the second quarter and through the year.

Nucor

(NUE) - Get Report

will report results on Thursday.

U.S. Steel

(X) - Get Report

goes next week, on April 27.

In some ways, it's simple: To make a bet on steel stocks now is to make a market call. If you believe economic recovery is sustainable, go ahead and buy, many sector experts say.

It's a view encapsulated by the metals analysts at

Deutsche Bank

(DB) - Get Report

, who wrote in a report last week, "We continue to emphasize the early-cycle benefits of owning steel stocks."

Investors who buy now, however, may need to exhibit nerves (ahem) of steel.

Wall Street will be looking for the above-mentioned companies to offer soothing words when they report first-quarter results. (Steel Dynamics appeared to oblige Monday evening, while AK Steel's outlook was muddied by the rising cost of iron ore.)

Expectations may have been lifted ever so slightly on Monday, when data for March showed a healthy 5% increase in shipments compared with February, numbers that industry experts say is the

most positive sign for steel makers since the onset of the recession

.

If companies don't suggest that business is improving (outlooks will be qualitative and not quantitative), it will likely mean another post-earnings-report selloff in steel shares, similar to what happened in January after companies reported fourth-quarter results.

Plenty of questions and potential stumbling blocks remain for the industry. Can steelmakers hike prices enough to keep pace with the rising cost of iron ore, coking coal and scrap metal -- core feedstocks in the production of steel? What about that peculiar jump in steel imports in March? Are service centers and end-users of steel truly restocking their inventories? Have steelmakers added too much capacity too fast? (Industry utilization rates have reached 72% of total capacity, up from 45% a year ago.)

And, of course, there's the most fundamental bugaboo of all: is demand "real," as the industry experts like to phrase it? Some end-markets have strengthened, including car, appliance and heavy equipment makers. Others remain in the pits, construction foremost among them.

Recent comments from

ArcelorMittal

(MT) - Get Report

CEO Lakshmi Mittal, at a conference in iron-ore-rich Brazil, would seem to throw doubt on all the recent bullishness. U.S. and European steel industries, he said, will need as many as four more years to recover completely.

Some investors may have lost a bit of their appetite for steel stocks recently, given the

sharp run-up in most shares

from their February year-to-date lows. Most have outgained the

S&P 500

, especially U.S. Steel, which has risen 36% since Feb. 8. Nucor, meanwhile, has added 15% and Steel Dynamics 18% over the same period. The S&P has advanced 13%.

Leo Larkin, for one, metals analyst at Standard & Poor's, doesn't recommend buying any steel stocks at these levels. He bases his opinion purely on valuation. "It's always a question about how much of the good news is already reflected in the stock prices," he said.

In light of all this, here's a look at four stocks to watch for the coming steel-earnings season.

U.S. Steel

Just last January, after weeks of brightening sentiment among investors and industry watchers,

U.S. Steel delivered a profit-warning blow

that sent stocks in the sector reeling.

Many believed that the company hadn't been able to raise prices as much as it had hoped, the implication being that demand hadn't rebounded enough for the company to do so.

But then sentiment swung in the bullish direction. In addition to economic data that seemed to demonstrate a burgeoning U.S. economic recovery,

recent moves in the world iron-ore trade

appeared to make U.S. Steel shares especially a trendy investment.

U.S. Steel, scheduled to report its first quarter on April 27, has become a kind of darling among equities analysts, even though the company's stock has given back some of its late-winter/early spring gains. Since the first week of April, shares of U.S. Steel have fallen more than 17%.

More than any other domestic producer, U.S. Steel has a vertically integrated model. The Pittsburgh industrial icon doesn't need to buy iron ore. It owns its own "captive" mines, and therefore enjoys operating leverage whenever the price of raw materials rises.

When steel makers around the world lift prices for their products to reflect commodity inflation, those hikes drop straight to U.S. Steel's bottom line. The integrated model also gives the company a global competitive edge.

But don't expect any of that to show up in U.S. Steel's results yet. The company will still bleed red ink in the first quarter; analysts had to revise their forecasts in January, when U.S. Steel told Wall Street that its return to profitability would be delayed a quarter. Analysts, on average, are looking for the company to lose $1.40 a share, on revenue of $3.75 billion.

In the first quarter of 2009, U.S. Steel lost $3.84 a share, on revenue of $2.75 billion.

Bearish Leo Larkin thinks it will be worse than that. He's looking for a loss of $1.86 a share. Still, he says, he "would be surprised" if management didn't provide a fairly encouraging outlook for the rest of the year.

>> Who Owns U.S. Steel?: Bruce Kovner

Steel Dynamics

Steel Dynamics, which

reported earnings after Monday's closing bell

, is on course to become the second U.S.-based steelmaker (after U.S. Steel) to be 100% vertically integrated. That has some industry observers looking with favor on the company's short and long-term prospects.

An electric-arc furnace operator -- meaning that it forges its products out of recycled scrap -- Steel Dynamics has avoided the inventory and raw-materials-cost pitfalls that have weighed on Nucor, it's larger scrap-based rival, for most of last year.

The company has been able to keep those costs down, since it owns its own scrap yards.

And its ability to do so is set to improve even more. Working with Japan's

Kobe Steel

, the company plans to bring several plants online this year that will produce a substitute to pig iron, eliminating its need to purchase that feedstock on the open market.

As it turns out, Steel Dynamics late Monday turned in a fairly upbeat quarter. Though it offered no quantitative guidance, its CEO, Keith Busse, said that a "gradually improving economy with moderate strengthening of steel demand is resulting in firmer order backlogs for our mills."

Though he cautioned about a continued drag on earnings caused by the moribund construction business, "We now see a more stable and positive outlook for the coming quarter and second half of 2010," he said.

Nucor

Nucor, which produces more tons of steel than any other company in the U.S., emerged into profitability last quarter after a string of recession-induced losses made worse by snags in the management of its inventory of scrap and pig-iron feedstocks.

The company gave

first-quarter guidance in mid March

, forecasting a bottom line between breakeven and 10 cents a share, excluding an inventory-adjustment charge.

After revising their models, analysts have come in with a consensus EPS estimate of 8 cents on revenue of $3.6 billion for Nucor's first quarter, expected on Thursday before the opening bell. A year ago, the company lost 60 cents on revenue of $2.65 billion.

Despite the narrower profit guidance, Nucor was able to gladden investors with word that orders at its mills were trending higher by more than 20% from a year ago.

Nucor, which specializes in so-called "long products" such as rebar and beams, has exposure to the still-moribund construction industry. Still, the company's smaller automotive sheet-metal business has benefited from the modest rebound in car sales in the U.S.

Deutsche Bank's David Martin, more bullish on the company than his peers, wrote in a recent note to clients that Nucor "is poised to benefit from lower pig iron costs in 2010." Further, he said, "expectations are reasonably low for the company." His price target on Nucor stock is $53, which represents a 16% gain from its close on Friday.

AK Steel

AK Steel, which issued

in-line first-quarter numbers before Tuesday's opening bell

, nonetheless appeared to disappoint investors with word that the rising cost of iron ore could squeeze its profits next quarter and for the rest of the year.

That's because the company, though it does source some of its ore internally, doesn't have a fully integrated model.

Indeed, a major stainless steel producer and supplier to the auto industry, AK Steel is viewed as having less "margin expansion potential" than other companies in the sector, in the words of Deutsche Bank's Martin.

The iron ore worries put pressure on AK shares, which were declining by more than 5% Tuesday afternoon on heavy volume.

The subject of

takeover rumors

earlier this year, AK said it swung to a profit of 25 cents a share in the first quarter on revenue of $1.4 billion. A year ago, the West Chester, Ohio, company lost 67 cents on revenue of $922 million.

-- Written by Scott Eden in New York

RELATED STORIES:

>>AK Steel: Iron Ore Costs May Hurt Results

>>Steel Dynamics Sees Brighter 2010

>>U.S. Steel, Nucor, AK Steel: Steel Winners

>>Iron Ore Upheaval Reaches U.S.

>>BHP, Vale Blow Up Iron Ore Pricing

>>China Steel Group Urges Iron Ore Boycott

Scott Eden has covered business -- both large and small -- for more than a decade. Prior to joining TheStreet.com, he worked as a features reporter for Dealmaker and Trader Monthly magazines. Before that, he wrote for the Chicago Reader, that city's weekly paper. Early in his career, he was a staff reporter at the Dow Jones News Service. His reporting has appeared in The Wall Street Journal, Men's Journal, the St. Petersburg (Fla.) Times, and the Believer magazine, among other publications. He's also the author of Touchdown Jesus (Simon & Schuster, 2005), a nonfiction book about Notre Dame football fans and the business and politics of big-time college sports. He has degrees from Notre Dame and Washington University in St. Louis.