Goldman Sachs - Steel - Sell in May, go away [GS]

Goldman Sachs - Pan Asia Steel: Sell in May, go away

Stock performance getting ahead of fundamentals
We believe the recent enthusiasm for the steel sector to be somewhat premature, and advise investors to take profit now. Even going beyond the outlook for the next couple of quarters (where we expect sequential deterioration in earnings), we believe the outlook for all of this year, and next, is far from robust. We lower our sector stance to Cautious from Neutral and make adjustments to earnings, price targets and ratings.

Huge amount of idled capacity means swift supply-side response. We base this assertion on the fact that much of the sector’s utilization rate is sub-par. We believe the first signs of demand stability and price rise will bring a lot of dormant capacity back on line, depressing prices again. We foresee excess capacity in the industry till 2012, leading to under-utilized capacity and hence, sub-par profitability.

We also believe that some of the positive news flow on the sector (such as data coming out of China) may abate in the coming months. Channel checks with traders indicate a lot of nervousness in the spot markets. The volumes remain weak, and every rebound in steel prices appears to scare buyers away.

April has been very generous to the sector
Despite the middling outlook, Asian steel stocks have benefited in recent weeks. The sector is up 31% over the past month, outperforming the market by 21%; YTD, the sector has outperformed the market by 15%.

We expect steel prices to go through short cycles. We expected such a s-t recovery in December 2008, which prompted our tactical upgrade then. In fact, we expect a similar spot price recovery now in 2Q, but we believe that the markets are already pricing it in. Valuations are already above mid-cycle multiples, when the cycle’s recovery to mid-cycle levels is far from certain, in our view.