Are Steel Stocks Out of the Woods Yet?

To say steel stocks have taken their investors on a wild ride in 2013 would be an understatement. After crashing over the first half of the year, many steel stocks are rebounding, and have regained the bulk of the losses. At the same time, underlying results continue to be relatively unimpressive. Business conditions for many steel companies are worse now than at this point last year. Therefore, investors may be understandably questioning whether the rally in steel stocks is for real.

Is steel finally making a comeback?
One steel stock surging in the past few months is U.S. Steel , fresh off its third-quarter earnings report which revealed measurable progress for the beleaguered company. U.S. Steel shaved its net loss in half in the third quarter, versus the same period last year.

Shares of U.S. Steel, along with its competitors, have soared over the past few months on broad optimism that brighter days may be on the horizon. At the same time, it appears a dose of caution is warranted. U.S. Steel's results may not have been as bad as feared, but the company's fundamentals have deteriorated through the first nine months of 2013. U.S. Steel booked a $242 million operating profit in the first nine months of 2012, but has swung to a $1.6 billion operating loss in the same period this year. This was due to a massive $1.7 billion goodwill impairment charge.

Another high-flying steel stock is Nucor , but again, we see a case of a rallying stock price along with worsening fundamentals. Metrics across the board have deteriorated for Nucor through the first three quarters of 2013 as compared to last year. For example, Nucor realized a 6% drop in average sales price per ton through the first nine months, along with a 5% drop in sales and 14% lower earnings per share.

Ditto for Steel Dynamics , whose stock price has climbed to $19 per share, up from $15 per share as recently as July. Importantly, Steel Dynamics appears to be the only steel stock of this group whose financial results have actually improved this year. Steel Dynamics has actually grown earnings per share by 25% through the first three quarters of the year, which at least demonstrates a much more convincing recovery.

Fourth quarter outlooks leave a lot to be desired
The rally in steel stocks would be more believable if steel companies were widely projecting strong fourth quarters ahead, but that is mostly not the case. For example, U.S. Steel isn't likely to show significant progress in the upcoming quarter. Of its two core segments, flat-rolled and tubular, neither is expected to produce a blowout quarter. Management expects break-even results in the flat-rolled business and results in the tubular segment that are comparable to the third quarter.

As far as Nucor is concerned, management cautions investors to expect lower fourth-quarter shipping volumes as a result of seasonal factors. In addition, extended planned outages will crimp productivity, and all told, Nucor projects lower earnings in the fourth quarter as opposed to the fourth quarter of 2012.

Steel Dynamics followed up with its own cautious outlook for the remainder of the year. Although management points to strength in the automotive and manufactured goods markets, which should buoy results, broad concerns linger. Specifically, management notes the prolonged fiscal uncertainty in the United States as reasons to not expect superb fourth-quarter results.

The bottom line: Curb your enthusiasm for steel stocks
Steel is a highly cyclical industry, which means steel stocks should perform best when the broader economy is growing strongly. Unfortunately, the global economy simply isn't firing on all cylinders yet, and the underlying results of these steel companies prove that. The non-residential construction market in the United States is far from a full recovery, and economic woes in Europe persist. Therefore, it seems reasonable to wonder whether the rally in steel stocks may be premature.

Steel companies are still struggling to keep margins afloat, due to a very tough pricing environment. Furthermore, planned outages are keeping a lid on production. Add it all up, and there are plenty of reasons to believe the rally in steel stocks may be short-lived.

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Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends Nucor. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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