J.P. Morgan Cazenove reassessed its stance on the European steel sector, marking ArcelorMittal, SSAB A/B and Aperam SA as "overweight" while tagging shares of Voestalpine AG, thyssenKrupp AG and Outokumpu Oyj as "neutral."
In an Oct. 12 note, the bank said the sector at large remains under pressure amid ongoing macroeconomic uncertainty that has impacted demand for steel.
"European steel equities have underperformed materials peers and the wider market since the last result season, reflecting fading steel spreads and increasing macroeconomic risks," the analysts said.
"Important demand channels have also come under pressure, notably the European autos sector," the team said. "We expect these uncertainties to remain a focus into results and will frame investor positioning and management commentary and outlook."
To offset the potential headwinds the sector is facing, the team recommended high-quality names with valuation support and limited financial leverage.
ArcelorMittal was the top pick among carbon steel players. The shares are now trading at more than 40% below their historical multiples and were assigned a target price of €37 per share.
"We also identify [ArcelorMittal] with having stock-specific catalysts (Ilva, increased shareholder returns, etc.), which can drive a relative rerating over the next six to 12 months," the analysts said.
The company recently reached an agreement with Italian steel unions as part of its planned acquisition of Ilva International SpA.
Meanwhile, attractive free cash flow and valuation metrics were seen as positives for SSAB A/B, even though the company has relatively high financial leverage. "We believe expectations are low heading into the third quarter, which could result in relative outperformance," the team said.
The team is "underweight" on Salzgitter AG, another carbon steel player, as it awaits an early November update on the company's proposed acquisition of ArcelorMittal assets to be sold as part of the Ilva deal. The assets are expected to add about 1.5 million tonnes per year of galvanizing capacity to improve Salzgitter's product mix relative to domestic peers.
Among the stainless steel players, Aperam was the preferred pick over a six- to 12-month horizon, with valuation levels now about 4% below historical levels alongside solid free cash flow and balance sheet forecasts for 2019. However, the analysts said its exposure to the Brazilian market, which accounts for about 18% of group sales, could pose downside risks going forward.
More generally, J.P. Morgan Cazenove expects third-quarter results to show the impact of ongoing global uncertainty, a softening of steel spreads, negative sentiment from Europe's automotive industry, and a general shift in customer behavior as a result of tariffs.