How Will a Trump Presidency Affect Steel Stocks?

By Jason

Aggressive defense of steel manufacturing isn't the most important thing investors should consider. Image source: Alex Hanson.

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Since the election of Donald Trump as president of the United States on November 8, steel stocks have been on an absolute tear. Here's how shares of Nucor Corporation (NYSE: NUE), Commercial Metals Company (NYSE: CMC), United States Steel Corporation (NYSE: X), AK Steel Holding Corporation (NYSE: AKS), and Steel Dynamics, Inc. (NASDAQ: STLD) have moved since November 7:

NUE data by YCharts.

Needless to say, Mr. Market is buying into a Trump Administration that says it will be tough on foreign competition against American manufacturing. And it's hard to argue that any domestic industry has been as hard-hit by foreign trade than steelmakers.

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Can Trump really boost American steel? Will his aggressive steps to renegotiate trade deals and stamp out unfair competition from overseas be a boon for steel companies and their investors? The answer is that it could, but there are factors at play completely out of the control of whoever resides in the White House.

Let's take a closer look at the factors that affect steelmaking, and what investors should consider when deciding how -- or even if -- to invest in this industry.

The Trump trade platform and the current environment for steelmakers

From very early in his candidacy, Trump's promise to "make America great again" has been largely built on bringing manufacturing jobs back to the U.S. A common refrain from Trump on the campaign trail was that the country has been "losing badly" on trade for years. And while this matter may be up for debate, there's no denying that American steelmakers have suffered in recent years under a flood of illegal imports.

This quote from Nucor CEO John Ferriola in January sums up the pressure imports have put on the domestic steel industry(emphasis mine):

Here's how steel stocks have done since the start of 2014 (excluding the recent post-election run-up):

NUE data by YCharts.

Bottom line: The industry has struggled during a period of very high consumption, and in no small part because of a large amount of illegal imports.

But the current administration hasn't been standing still on this issue. Antidumping and countervailing duties have been put in place against some of the biggest offenders, and steel imports have fallen since the beginning of the year, while prices have rebounded.

At the same time, there's still "work to be done," as Ferriola put it recently. There are more trade cases pending related to a number of steel products not protected against dumping. Furthermore, some foreign producers are attempting to bypass duties by passing their products through third-party countries. If Trump is serious about taking steps to support American manufacturing, this is an area his administration would focus on.

Here's what matters as much as trade policy

Trade policy is only one part -- and historically a small one -- of what affects returns for steelmakers. Steelmaking is an expensive endeavour with high fixed costs, and it's also very cyclical in nature. In other words, steelmakers can be very prone to quickly turning from huge profits to wide losses when demand turns. They aren't the most nimble of companies at the best of times.

For this reason, successful investing in steelmakers is often a product of thinking defensively and protecting against the downside risks.This may be particularly true under a Trump administration with plans to aggressively fight for American manufacturing.

The upside is that more domestic manufacturing would boost the economy -- the "rising tide lifts all boats" theory. The downside is that a heavy-fisted approach at foreign trade could actuallyharmdomestic manufacturing if it weakens access to foreign markets. It could also lead to higher prices on many items, reducing domestic consumption because of inflation, and harming manufacturers that count on volume to drive efficiency and keep costs low.

Bottom line: Steelmakers with the most cost flexibility and a history of low-cost production have typically done well, while their competitors have struggled mightily:

NUE Total Return Price data by YCharts.

The table above shows the total returns for AK Steel, U.S. Steel Corporation, Steel Dynamics, and Nucor Corporation since theS&P 500peaked in late 2007. As you can see, nearly a decade later, AK Steel and U.S. Steel share prices are far below the market peak -- and even farther below their all-time highs reached about a year after the market peak. Nucor and Steel Dynamics, on the other hand, have made investors money, though even Nucor has trailed the market peak-to-peak.

A commonality for Nucor and Steel Dynamics is steady positive cash from operations, whereas AK Steel and U.S. Steel have seen their operating cash flows swing wildly (and even into negative territory.):

NUE Cash from Operations (Annual) data by YCharts.

Nucor, Steel Dynamics safest, best long-term choices

Sure, when economic demand is very strong, U.S. Steel and AK Steel's facilities may be able to produce more steel more cheaply, generating massive profits at the peak, but when the steel cycle inevitably turns down and demand slows, it will be much harder and will take much longer for those companies to bring their fixed costs down. And that can erase huge gains much more quickly than you can imagine.

So, while the Trump administration could indeed accelerate a leveling of the playing field against steel imports, there's no guarantee those actions will improve the American economy or lift demand for steel higher. And history has been very clear: Investors in inflexible steelmakers have been hammered when the cycle turns down.

Nucor and Steel Dynamics, on the other hand, have built their steelmaking operations around far more flexible mills and furnaces. They may not be as profitable at the peak as others, but they'll be able to respond much more quickly to demand in every part of the cycle -- and avoid the same losses their peers struggle with.If you want to make money in steelmakers, don't ignore this reality.

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Jason Hall 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.