25 May 2021

Steel on its way to green

Looking at prices five years back, the Steel sector has another 20% to go before it reaches its early 2018 peaks. That puts in perspective the 90% gain since last November when markets suddenly kicked into risk-taking mode.

Obviously one may dream of even more in a combination of even stronger demand and cost bases under control after years of trimming. After all, back in mid-2008, the sector used to be worth 4x more. So there is headroom for bulls.

A long-term view of Steel: painful

There are good reasons too to think that the industry business model has changed. Call this change the green steel implications/carbon taxes. Like all carbon-intensive businesses, Steel has to pivot away from traditional manufacturing relying on a free input (clean air) and reinvent processes under the aegis of governments and clients willing to buy an ESG compliant product.

That, de facto, makes the Chinese supply uncompetitive as it cannot match the environmental constraints, at least for now. Seeing such blue-blooded European signatures as Daimler, Agnelli, Wallenberg, SSAB all sharing R&D type capex on a new Swedish venture aiming to churn hydrogen-based steel is a good summary of the change of perception and priorities in this industry.

One also may entertain hopes stemming from China’s brutal pressure on its steelmakers to abide by pollution regulations or else. Immediate cuts in output ensued and demand for more carbon-efficient quality iron ore is also a confirmation that steel may no longer be sold on prices alone. That is a turning point that will be made even clearer when the EC implements its border carbon taxes.

If and when steel becomes green (presumably a protracted perspective as long as it relies on very expensive H2), it is likely to be less of a cyclical commodity too as the excess capacities will be pruned rapidly as a consequence and as pricing mechanisms are less volume dependent. In short, Steel may become a beneficiary of the greening up efforts and European steel groups have the combined market presence and technologies to lead that twist in the business model.

For now, the sector’s valuation numbers are leaving risk-takers in limbo if they pay attention to fundamentals. Earnings expected to bounce back massively in 2021 (from €-5bn in 2020 to €7bn) would be losing steam from 2022 (see table).

Steel's valuation fundamentals

The twist in the business model would also challenge the view that deep cyclicals are bought when their P/Es are skyrocketing and sold when they are low. Now would no longer be the point of exit after the sharp share price rebound (and still low P/Es). There may be long-term good news. For now, it is happy that both industry heavy-weights are good value.

ArcelorMittal enjoys unique benefits from scale (including in the R&D department) and offers a 16% upside while Thyssenkrupp remains a paradoxical story (40% upside potential) as it planned to exit steel but has the technology to be greener than most as its vast IP toolbox also leads to mastering large-size electrolysers to churn hydrogen.

Steel may be a 21st century proposition after all.