Merrill Lynch Identifies Top Steel Picks for Big Upside

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Last week was rather strong for U.S. steel mills. After all, a 10% gain after mid-quarter guidance from Nucor Corp. (NYSE: NUE) and Steel Dynamics Inc. (NASDAQ: STLD) is impressive considering the post rate hike market action. Merrill Lynch recently hosted a dinner with steel market participants from mills, service centers and trading houses in Chicago around the Platts North America steel conference. The firm is rather bullish on several top steel stocks.

According to the Merrill Lynch views, there are several issues driving the steel bulls here. One is positive sentiment on demand and another is that scrap prices look soft to sideways heading into April. Steel scrap prices were cited as being undervalued relative to alternatives. Another driving force is that new steel sheet capacity is not viewed as a threat and hot rolled coil could be tight. There is also a prevailing skepticism over Chinese supply containment efforts.

Merrill Lynch’s Timna Tanners and P.T. Luther pointed to better demand from nonresidential construction and energy in particular. U.S. service center inventories as a ratio to shipments also rose in February versus January, but they were well below the historical average (from 2.2 to 2.3, versus 2.8 on average).

The team’s report noted that Nucor and Steel Dynamics’ commentary about renewed growth in nonresidential construction can bode well for Commercial Metals Co. (NYSE: CMC). Also noted was that the firm’s China colleague expects potential for prices to rise further and that could support another U.S. sheet price hike. The team said:

It was surprising to us this past week to see steels respond poorly to Nucor guiding to a 50% higher EPS value than consensus. A weaker oil price seemed to have a knock-on effect to other commodities, despite the fact that supply-side dynamics are completely different. We think investors are still too skeptical on the second half (of 2017) market conditions, and that a more disciplined Chinese market and solid global demand can support more stability in metal prices. More stability can support better valuation multiples, in our view. We continue to prefer AK Steel, Alcoa, and Teck Resources.

These are the five top Merrill Lynch steel stocks named in the report:

AK Steel Holding Corp. (NYSE: AKS) is rated as Buy at Merrill Lynch, and the recent share price of $8.31 compares to the Merrill Lynch price objective for the stock of $13. The consensus target from Thomson Reuters was last seen at $9.78, and the 52-week trading range is $3.31 to $11.39.

Commercial Metals is rated as Buy and has a $24 price objective (versus a recent price of $19.06). The 52-week range is $14.58 to $24.64, and the shares have a consensus price target of $21.11.

Nucor is also rated as Buy and has a $76 price objective at Merrill Lynch. Nucor’s 52-week range is $44.81 to $68.00, and the consensus price target is $67.00.

Steel Dynamics is rated as Buy with a $45 price objective at Merrill Lynch (versus a recent price of $36.34). The 52-week range is $21.57 to $40.17 and the consensus price target was last seen at $41.69.

United States Steel Corp. (NYSE: X) is also rated as Buy, and Merrill Lynch has a $40 price objective. U.S. Steel has a 52-week range of $12.77 to $41.83. The consensus price target is $37.15.