The share prices of steel producers, such as ArcelorMittal and Nucor, have soared in recent months on the back of the reflation trade. Yet their share valuations have collapsed. Buying cyclical commodity stocks at low valuations is generally a bad bet. Equity markets seem to be calling a top on steel prices.
Inflation numbers have recently been strong. April data for both the US and UK have revealed big percentage jumps in consumer prices. Partly these increases reflect a rebasing effect due to worldwide lockdowns in many countries last spring, which deflated all asset and commodity prices.
Nevertheless, hard decisions are coming for manufacturers. These have seen key inputs such as steel and copper soar in price over the past year.
Consider the automotive industry. Each car uses about a tonne of steel. Manufacturers will buy on contract for the bulk of their needs one year in advance. The next negotiation is approaching next quarter. After about $600 per tonne of price increases in the past year, a 3 per cent mark-up in new car values should follow. With steel inventory at record lows, manufacturers may be price takers. Even the possibility that a small steelmaker such as Sanjeev Gupta’s Liberty Steel could close threatens supply.
But steel is just one part of a car. A spot index of auto inputs has doubled since last June, said Jefferies. Applying that, car prices could rise far more steeply, by 8 per cent on average.
ArcelorMittal has increased the cost of its main products in 10 of the past 11 weeks. Its market value has jumped more than a third this year. Yet its enterprise value to forward ebitda multiple has deflated to 3.4 times, near 10-year lows. Peers Nucor in the US and Korea’s Posco have undergone a similar compression.
Markets clearly doubt that commodities such as steel can keep increasing without demand destruction, or worse, big rises in interest rates. Investors should be watching valuation deflation every bit as closely as price inflation.
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Source: Economy - ft.com
