Steel storms: Wild cyclical whiplashes

With steel being traded globally, the risk of dumping excess capacity in other markets becomes a distinct possibility.

The Financial Times recently reported that European steelmakers have urged trade officials to address the surge in Chinese steel exports, which have driven European prices below production costs. China, despite curtailing steel production since 2015, is on track to export over 100 million tonnes this year, the highest since 2016.

Year-to-date, `flat steel' prices (HRC, in $) have dropped 21 percent in China, 19 percent in Europe, and 35 percent in the US. `Long steel' prices (rebar, in $) have fallen 15 percent in China and 17 percent in the US, despite trade restrictions like dumping duties and quotas imposed by the EU and the US specifically targeting Chinese steel.

Before we  examine the cyclical nature of the industry and strategies for investing in the sector, let's take a quick look at a related story that sheds light on this.

Born in 1950 in Sadulpur, Rajasthan, Lakshmi Mittal  moved to Calcutta as a young boy. His father began with steel trading and later established a small rolling mill, which his older brother expanded into an integrated steel mill in the 1960s. In his mid-20s, Mittal, feeling restless, made his first acquisition in Indonesia in 1972. This marked the founding of Ispat International, which he funded by selling shares in the India-listed company and leveraging Indian government schemes.

Over the following years, Mittal expanded his operations to Trinidad and Tobago,  and in the 1990s, shifted focus to eastern Europe and the former Soviet Union, acquiring plants in Poland, Romania, Kazakhstan, and Ukraine. By the early 2000s, Mittal Steel had emerged as one of the world's largest steel companies.

However, this was not enough for Mittal. He continued acquiring plants in Mexico, South Africa, and France, and in 2006, he made an audacious €18.6 billion hostile bid for Arcelor, the second-largest steelmaker at the time.

Guy Dolle, the then CEO of Arcelor, fiercely opposed the takeover, as detailed by Ousey and Bouquet in the book Cold Steel. Arcelor employed aggressive PR campaigns, enlisted the support of France, Luxembourg, and Spain, mobilised shareholders, and sought a white knight in Russian steelmaker Severstal to foil Mittal's bid.

Mittal’s counter-strategy was straightforward: engage shareholders and raise the bid, ultimately to €26.9 billion. In the end, Mittal succeeded, creating ArcelorMittal, the world’s largest steel manufacturer with over 100 million tonnes of capacity.

By 2008, ArcelorMittal’s market cap soared to an astounding €130 billion—a near-fairytale story of a boy from rural India creating billions of euros of wealth in just half a century. However, if the story ended there, it would not fully capture the true cyclicality of the steel business. Today, ArcelorMittal’s market cap is just under €20 billion—less than what it paid to acquire Arcelor over 15 years ago. This raises the question: why are steel cycles so volatile?

There are several reasons. First, super-cycles occur when developing countries industrialise and consume steel at unprecedented scales. For example, China’s steel consumption surged from 129 million tonnes in 2000 to 823 million tonnes by 2014, dramatically increasing its global share in steel production from the mid-teens to over 50 percent. The early 2000s were strong years for steelmakers until interrupted by the global financial crisis. Capacities built for such rapid growth continue to flood the market long after the boom ends, creating prolonged cycles.

Within these super-cycles, mini-cycles occur due to capacity constraints. A new steel plant typically adds 6–12 million tonnes per year (mtpa) of capacity, requiring $6–10 billion in capital investment. While capacity is added in large steps, demand grows more gradually, leading to mismatches between supply and demand.

Lastly, steel's role as a significant employment generator makes it a priority for governments. With steel being traded globally, the risk of dumping excess capacity in other markets becomes a distinct possibility. In response, various countries protect their domestic industries by imposing duties and quotas, thus contributing to an additional regulatory layer .

Do these vagaries make such businesses fundamentally unviable? There are two perspectives. One is to look at Tata Steel’s share price in 2020, which was similar to its price in the early 2000s, and conclude that it will never generate positive returns, given no returns in over two decades.

By viewing it that way, you would have missed the 2021 rally, when Tata Steel generated higher net profits than Tata Consultancy, with its stock price increasing fivefold in under three years. A better approach is to recognise that even during the 2000-2020 period, Tata Steel's share price tripled on three occasions. While timing the exact bottom or top is unrealistic, being part of the cycle can still generate substantial returns. The key is acknowledging the inherent cyclicality of such businesses.

The ideal time to invest in these businesses is when it seems as though the world is collapsing and even the management has thrown in the metaphorical towel. You may find yourself buying at high price-to-earnings (PE) multiples, as earnings have plummeted. However, one must be prepared to sell at low PEs as well—when the cycle turns, share prices often do not rise as fast as earnings, luring many investors into waiting for a catchup that never materialises, leaving them trapped in the downturn.

Lastly, there is a valuable lesson here for both the management and investors. For the former, it is crucial to understand that the strategies that brought success today may not be effective in driving growth over the next decade. As investors, we must recognise that while the cyclical nature of the steel industry is widely acknowledged, most businesses, sectors, and market cap indices—whether large or small—also follow cycles. Our investment philosophy must adapt accordingly to these realities.

Jigar Mistry is the co-founder of Buoyant Capital.

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