Despite Revised Forecast, Steelmakers Still Overvalued

We've updated our steel price forecast to better align our estimates with changes to the steelmaking cost curve stemming from higher input costs. To arrive at our annual world export steel price forecasts, we employ a cost benchmarking approach by which we estimate the unit costs of the marginal producer of steel and set prices in line with this figure.

Relative to our prior forecasts, which pointed to declining steel prices (in real terms) each year through the end of the decade, we now expect prices to rise in 2017 before declining in real terms through our midcycle forecast. The 2017 price increase is driven primarily by cost support stemming from higher iron ore, met coal, and scrap prices.

Although our 2017 price forecast is roughly in line with consensus, our medium-term forecasts and midcycle outlook are well below consensus. This is driven mainly by our bearish outlook for Chinese fixed-asset investment and the presence of structural overcapacity.

Because the benefits of higher steel prices will be largely offset by higher raw materials costs, the impact on our steelmaker fair values is very modest. U.S. Steel and AK Steel are the biggest beneficiaries thanks to their varying degrees of raw material self-sufficiency but still remain materially overvalued. Accordingly, we think minimill operators will be better able to best navigate the looming "lower for longer" steel price environment, a dynamic that is reflected in price-to-fair value ratios across our steel coverage.

Overall, even after updating our steel valuation models, every steelmaker under our coverage is trading above our fair value estimate. For U.S. steelmakers, we contend that the benefits of trade protectionism, new political leadership, and the potential for higher infrastructure spending are already reflected by share prices. As a result, although the range of potential outcomes is likely wider than ever before, we see asymmetrical risk to the downside across the industry.

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