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July 14, 2010, 3:14 p.m. EDT

Are Falling Steel Prices Baked Into Stocks?

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J.P. Morgan Securities

WE THINK MOST COMPANIES in our North American metals and mining coverage universe will lower their second-half guidance due to the recent metal price declines, but, in our opinion, the market is already discounting such earnings revisions.

Falling steel prices, recent idlings by ArcelorMittal /zigman2/quotes/202790215/composite MT +1.85% (ticker: MT) and [private company] Severstal NA, and below-consensus midquarter updates from Nucor /zigman2/quotes/201889722/composite NUE -0.61% (NUE) and Steel Dynamics /zigman2/quotes/203426966/composite STLD +0.21% (STLD) have all created concern that too much production has been brought online. We think the recent slowdown in demand has been driven more by cautious steel buyers reacting to falling scrap prices, macro concerns, and the approach of the summer seasonal shutdowns, and think it will ultimately continue to improve throughout the year. This rebound in combination with production discipline from the steel mills and elevated global raw-material costs should continue to push steel prices and earnings higher. U.S. Steel /zigman2/quotes/200069642/composite X -1.90% (X) should benefit the most from an environment of elevated steel prices and raw-material costs given its integration while Nucor's and Steel Dynamics' (though more variable cost) exposure to the flat-rolled markets should support earnings. AK Steel Holding (AKS) will likely see a squeeze from higher iron-ore costs and restatement of the first quarter.

Allegheny Technologies' /zigman2/quotes/202946054/composite ATI -5.39% (ATI) and Carpenter Technology's /zigman2/quotes/207656013/composite CRS -5.64% (CRS) earnings in the second quarter should continue to benefit from improving end-market demand and rising nickel surcharges (which were up quarter over quarter in April-June and lag nickel prices by two months). However, with average nickel prices declining in May and again in June, surcharges should be down in both July and August, and we think this movement could cause buyers to delay purchases and wait for lower prices. Haynes International /zigman2/quotes/207389326/composite HAYN -1.86% (HAYN) should improve on last quarter's unexpected return to profitability as cost restructuring and increasing volumes offset pricing pressures.

The focus of Cliffs Natural Resources' /zigman2/quotes/205424168/composite CLF +0.93% (CLF) second-quarter call will likely center around updated earnings sensitivities of the North American Iron Ore segment to current iron-ore pellet prices. Unfortunately, some contracts are in arbitration while others are being provisionally priced until final negotiations are settled. As a result, we are lowering our second-quarter EPS to $1.96 from $2.58 to account for these delays. We also project the North American Coal segment will finally turn a profit in second quarter, a potentially positive development given the segment's prior history, although execution of the recent INR acquisition is critical. Globe Specialty Metals /zigman2/quotes/208451301/composite GSM -1.56% ' (GSM) fiscal fourth-quarter results should only show modest quarter-over-quarter improvement as above-average production costs at Niagara and Selma and little improvement in realized pricing (as most of it was set before spot prices started to improve) are all likely to weigh on earnings. Our 24 cents second-quarter estimated EPS for Thompson Creek Metals /zigman2/quotes/206142241/composite TC +9.45% (TC) is based on an average realized molybdenum price of $17/pound, which was roughly the average price for moly over the March-May time frame. However, third-quarter results will likely come down with the recent moly price weakness.

GrafTech International's (GTI) quarterly results should center on an update of the Seadrift Coke and C/G Electrodes acquisitions announced last quarter; we forecast flat quarter-over-quarter EPS in the second quarter, in line with consensus. Dynamic Materials /zigman2/quotes/202925937/composite BOOM +4.33% (BOOM) should report a modestly profitable quarter, although we suspect investors will be looking for commentary to support the significant earnings ramp expected in the second half of 2010. Service centers Reliance Steel & Aluminum /zigman2/quotes/203068587/composite RS -0.18% (RS) and Metals USA Holdings /zigman2/quotes/205022124/composite MUSA -0.13% (MUSA) should see higher quarter-over-quarter earnings from higher prices and rebounding volumes, but will likely temper their pricing outlook.

- - Michael F. Gambardella
-- Tyler J. Langton
-- Brian P. Ossenbeck

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The opinions contained in Investors' Soapbox in no way represent those of Barrons.com or Dow Jones & Company, Inc. The opinions expressed are those of the newsletter's writer(s).

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