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Hamilton-based Stelco, the country’s largest publicly traded steel producer, announced on July 25 that it expects lower steel prices to hit its financial results for the second half of the year.CARLOS OSORIO/Reuters

Investors in steel stocks should expect some tough times ahead as recessionary threats dampen sector sentiment and prices continue to roller coaster.

While some analysts remain bullish on the sector given prices remain elevated compared with historical levels – and demand is high in key sectors such as autos and housing – others expect steel prices to plummet as economic growth slows.

“Historically, when you look at recessionary periods, steel gets completely annihilated. I fail to see how now is any different,” says Maxim Sytchev, an analyst at National Bank Financial.

And while second-quarter earnings are coming in strong from U.S. producers, “the back half is going to be very different,” he says. Canada’s Algoma Steel Group Inc. ASTL-T is scheduled to report its latest earnings on Wednesday, while Stelco Holdings Inc. STLC-T will report on Aug. 10.

Hamilton-based Stelco, the country’s largest publicly traded steel producer, announced on July 25 that it expects lower steel prices to hit its financial results for the second half of the year. It said third-quarter adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) would be “materially below” the second-quarter numbers and weaken further in the fourth quarter if steel prices continue to drop.

The benchmark hot-rolled coil (HRC) spot price hit a record US$1,945 a short ton last August, owing to a supply-demand imbalance, in particular a shortage of scrap metal used to produce the key commodity used across most industries, including automotive, construction, energy and consumer goods.

The record price was more than four times higher than the multiyear low recorded in August, 2020. The price of HRC then dropped to US$900 at the start of this year, as supply started to pick up, but then surged to US$1,500 as Russia, the world’s third-largest steel exporter, invaded Ukraine, another top 10 exporter of the commodity. The price has since fallen again to about US$850, amid weakening demand. The World Steel Association says global steel output fell 5.9 per cent in June compared with a year ago.

John Anton, economic director at S&P Global Market Intelligence, notes demand for steel is softening, production is falling and prices are sliding.

Mr. Anton says his firm’s research shows the steel industry is normally the hardest hit in a recession, based on historical data. However, he says there are a couple of “wildcards” in the current environment, including low inventory on the auto dealer lots and a housing shortage, which could help prop up demand for steel, even in a recession.

Stelco shares closed Tuesday at $35.53 on the Toronto Stock Exchange, down more than 37 per cent from a record high of $56.99 in March. The stock saw a slight boost on July 27, a day after the company said it would buy back nearly 44 per cent of its outstanding shares in a substantial issuer bid.

Ian Gillies, an analyst at Stifel GMP, says the buyback “makes sense,” but believes it’s unlikely it will be fully subscribed. While the $32.34 offer price is an 8.6-per-cent premium to the previous day’s closing price, it’s below the stock’s year-to-date volume-weighted average price of $40.62, Mr. Gillies wrote in a note.

He also cited a lack of clarity around participation by significant shareholders, including Fairfax Financial Holdings Ltd. The buyback could “complicate” the company’s ability to make investments in carbon reduction strategies, he adds, at a time when carbon taxes are set to rise in Canada.

Mr. Gillies has a hold rating on Stelco and a $39 price target “predicated on our view that negative estimate revisions are forthcoming, and we will become more positive on the stock as we see earnings momentum re-emerge.”

Among nine analysts that cover Stelco, four have a hold and five a buy, according to FactSet, and the average price target is $52.97.

David Ocampo, an analyst at Cormark Securities, has a buy rating on Stelco and a $59.50 price target, which he recently lowered from $66. In a July 26 note, he wrote that Stelco is “well-prepared” to generate good cash flows through the remainder of the year despite lower steel prices.

Mr. Ocampo also has a buy rating on Sault Ste. Marie, Ont.-based Algoma Steel and recently lowered his target price on the stock to $18.25 from $21.50, citing lower steel prices. Algoma shares closed at $11.63 on Tuesday, down 33 per cent from $17.27 in November, about three weeks after it returned to the public market.

Mr. Gillies of Stifel recently initiated coverage of Algoma with a “hold” and $16 price target, noting that its investment in a $700-million capital investment to convert its basic oxygen furnace to a more environmentally friendly electric arc furnace will increase its capacity and reduce its risk related to a rising carbon tax in Canada.

According to FactSet, among the five analysts that cover Algoma, four have a buy recommendation and one a hold, and the average price target is $18.10.

The company announced on Tuesday the completion of a $400-million share buyback, or about 27.9 per cent of its float.

Mr. Gillies said both Algoma and Stelco are “well positioned for economic turbulence, which is another key differentiator compared to prior cycles.”

And while both stocks will be challenged in the coming months, Mr. Gillies expects Stelco has the best chance of outperforming over the next 12 months, while Algoma’s corporate strategy, in particular its investment in expanding capacity, “better de-risks the business over the medium term.”

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