Steel is a key building block of the modern world, going into everything from vehicles to buildings to household appliances. Steel demand is set to be robust, with a boom in mega projects (like data centers), each worth at least $1 billion. There have now been $1.4 trillion worth of mega projects announced since 2021, all of which will make heavy use of steel. But steel stocks are cyclical, so make sure you stick with companies that can best weather the full steel cycle. Here's what you need to know.
The old way and the new way
There are two broad ways to make steel, blast furnaces and electric arc mini-mills. Blast furnaces have been around for a very long time. They use metallurgical coal and iron ore to create primary steel. These mills are vital to the world's steel production, but blast furnaces are very expensive to operate. When steel demand is strong, blast furnaces tend to make a lot of money because they operate at high utilization rates. When steel demand is weak, they often lose money -- sometimes quite a bit of money -- because they aren't selling enough steel to cover their operating costs.
The newer method of making steel, electric arc mini-mills, uses scrap metal and electricity. These mills are far easier to ramp up and down with demand, so they can operate profitably even as steel markets pull back. Electric arc mini-mills alone aren't enough to supply the world with the steel it needs, but the more-modern technology has a clear edge on the profitability front.
Steel stocks to avoid, unless you want to play the cycle
Cleveland-Cliffs (NYSE: CLF), once a supplier of iron ore to the North American steel industry, bought its way into the steel sector by acquiring several large regional steel makers. Its portfolio of mills is dominated by blast furnaces. Iconic United States Steel (NYSE: X) was founded when the only technology available was blast furnaces. Today, it's branching out to include electric arc mini-mills as it looks to provide a broader product line to customers. That's better, but still not great.
Both these companies are likely to see huge earnings advances in good times, but the bad times in the steel industry will likely be quite painful, financially speaking, thanks to the steel-making technology they use.
U.S. Steel is also in the middle of a cross-border acquisition drama. There are both financial and political angles to the company's plan to be bought out by a Japanese competitor. Most investors would likely be better off avoiding what could be a very dramatic and headline-grabbing stock.
Two stocks to buy for the long term in the steel sector
That brings us to Nucor (NYSE: NUE) and Steel Dynamics (NASDAQ: STLD), both of which use more modern electric arc mini-mills. From this perspective, their businesses are likely to be more consistent through the cyclical steel industry's ups and downs. They won't likely be as profitable as U.S. Steel or Cleveland-Cliffs in good years, but they won't be as unprofitable during bad years, either. In fact, Nucor and Steel Dynamics have a pretty impressive history of remaining profitable through the entire steel cycle, with only rare exceptions.
Nucor is the older, larger, and more diversified of the two companies. It's more of a slow-moving giant. Steel Dynamics is the upstart, with a faster growth rate (for the steel industry) and an expanding reach, both geographically and with regard to product offerings. Conservative investors will probably prefer Nucor, while more growth-minded types will likely find Steel Dynamics appealing.
Although one could use any number of metrics to highlight these companies' consistency, one of the easiest is dividends. Nucor is a Dividend King with a huge 51 consecutive annual dividend increases under its belt. That's pretty incredible given the steel sector's cyclical nature, speaking directly to its ability to reward investors while managing through good and bad times. Steel Dynamics is a much younger company, founded by former Nucor employees, with a streak of 13 consecutive annual dividend increases.
There's opportunity in steel, but choose wisely
Given the large-scale construction boom in North America that's starting to ramp up, investors might be thinking about jumping into the steel sector. To be fair, there are countercurrents here, notably from an increasing flow of low-priced imports that are depressing prices. But that isn't exactly a new phenomenon, so don't let it dissuade you from looking at the steel sector.
If you do want to put some money into steel stocks, the best options for long-term investors are likely to be Nucor and Steel Dynamics. Their businesses are advantaged relative to peers, and they have a proven track record of rewarding investors through the entire steel cycle.
The best part? Both Nucor and Steel Dynamics are between 20% and 30% below their recent highs. Now appears to be an attractive time to consider these leading steel makers for your portfolio.
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Reuben Gregg Brewer has positions in Nucor. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
2 Top Steel Stocks to Buy in September was originally published by The Motley Fool