Two Views (and Raised Targets) t’s time to digest gains in Stelco Inc. (STLC-T), said Scotiabank analyst Michael Doumet in downgrading his rating on the steelmaker to “sector perform” from an equivalent of a buy rating.
Stelco shares have surged over the past year and continued to rise even this past summer when equity markets struggled to find further lift. But Mr. Doumet believes the surge in steel prices that has been propelling the shares is likely to take a breather, and steel could even be subject to a retracement in price similar to what has been seen in the lumber market.
“Steel prices have risen for 12 consecutive months, climbing an average of 13% per month and a total of 330% since the trough. As a low-cost producer, Stelco has been ideally positioned to reap the benefits – and, as a result, the shares have been the best performer in our universe of coverage. We expect extended lead-times and strong pricing to persist through 4Q21 (potentially into 1Q22) – but, we believe steel prices are increasingly subject to significant downside risk – somewhat similar to what was seen with lumber and, more recently, iron ore,” Mr. Doumet said in a note to clients.
He believes the risk/reward is now more balanced, and raised his price target only modestly to C$55 from $52.50. He previously had a “sector outperform” rating on Stelco shares.
“When compared with pricing in other regions, North American steel prices remain an outlier,” he explained further. “Increased domestic production and imports are likely to narrow the supply deficit in the coming months. Barring any unplanned outages, we expect prices to peak in the near term and normalize through the 2H22. As supply/demand becomes more balanced, we expect prices to fall at a relatively fast rate . In the next twelve months, we expect steel pricing to revert back to ‘normal’ as supply and demand are expected to be equilibrium in 2022. Our L-T HRC price assumption is US$650/nt, above the 10-year average of US$625/nt.”
But income investors should note that dividend payouts could be on the way, or the company may choose to return capital through more share buybacks, he said.
“Following its recent share repurchase, we expect Stelco to rebuild its cash balance and to, once again, be in a position to return capital to shareholders in 4Q22. At that point, depending on the steel price outlook and share price, the company could (i) issue special dividend, (ii) repurchase shares, and/or (iii) keep excess cash for optionality.”
BMO, meanwhile, believes Stelco has further upside, and raised its price target to C$70 from C$65.