Declining readings in China’s PMI index should set alarms ringing in various sectors, especially metals, because it suggests that manufacturing activity is slowing down. Steel, for example, is used in several industrial applications. China is also the main importer of steel in the world. Therefore, I recommend investors to steer away from these companies now.
Low industrial activity equals low steel demand
According to its most recent earnings report, its revenue declined 10% to $4.59 billion, but its net loss shrunk from $219 million, or $1.52 per share, to $73 million, or $0.55 per share. The company pays 1% in dividend to shareholders.
These metrics are not appealing to the value-oriented investor. By the end of the quarter, its free cash flow contracted from $237 million to $117 million. If the free cash flow continues to shrink, the chances of United States Steel Corporation (NYSE:X) initiating a share repurchase program are minimal. Also, I would not expect for the dividend to be hiked any time soon.
The large exposure of United States Steel Corporation (NYSE:X) to China may be harmful to the company. Not only is it harder for United States Steel Corporation (NYSE:X) to export its products to China, but China’s domestic steel production is creating a large surplus. This steel surplus is finding its way to markets in the U.S., Europe, and Australia. Therefore, your portfolio needs to reduce its exposure to this company if you own it.
If steel production companies are struggling, I would recommend you to steer away from coke companies as well.
Low steel production equals low coke demand
SunCoke Energy Inc (NYSE:SXC) reported falling revenue and net income in its most recent earnings report. For the three months ending June 30, its revenue fell from $460 million to $403 million. In addition, its net income contracted from $22.7 million, or $0.32 per share, to $5.5 million, or $0.08 per share.
Its free cash flow declined from $66 million to $28 million due to an investment in the Visa Inc (NYSE:V) and SunCoke Energy Inc (NYSE:SXC) joint venture in India. Although the company will ramp up its coke production, a slowdown in China would put pressure on coke prices. Therefore, I would not expect revenue to rise significantly until the demand for steel starts to pick up.
