European stainless steel producers' profits look set to shrink in the normally strong second quarter as prices for their products fall and customers opt to work off stocks rather than make fresh purchases.
On top of that, expectations of further weakness in prices for nickel - a key ingredient in many stainless steel grades - will keep stainless buyers hesitant in the next few months.
As a result, stainless steel mills' bottom lines are unlikely to improve in the third quarter as demand remains fragile, and not just for seasonal reasons.
These gloomy expectations are symptomatic of an industry that is also suffering from chronic over-capacity; a problem it has yet to tackle.
"Seasonally, Q2 tends to be one of the strongest of the year, but this year I expect profits to be weaker than in Q1," said UniCredit analyst Jonathan Schroer.
"This will mainly be due to more hesitant purchasing by distributors, who have been waiting to see if nickel prices and therefore stainless steel transaction prices will fall further," he added.
Some two-thirds of nickel is consumed in the making of stainless steel. Nickel prices play a key part in determining the prices for stainless steel, which ends up in anything from buildings and washing machines to cutlery.
European stainless mills calculate prices for their products by adding a monthly alloy surcharge to recoup the cost of the raw materials they buy. The nickel price is the largest component of that surcharge.
"They (stockists) don't want to be buying stainless when the alloy surcharge on it values nickel at $23,000 a tonne or so if there is a possibility the nickel price may fall further," said Hatch's stainless steel consultant Rob Cartman.
"And it probably will go down, given the market expectations of nickel surpluses later this year."
Nickel on the London Metal Exchange was trading at about $22,500 a tonne on Monday, down about 20 per cent since Feb. 21, when it hit highest so far this year at $29,425 a tonne.
On top of that, a lower alloy surcharge marks down the value of producers' inventories, so analysts expect steelmakers to post inventory-related losses in the second quarter.
Stainless steel demand has been so weak in the past few months that Acerinox, the world's largest producer, decided to cut output in Europe. It is also planning to lay off some employees at its Gibraltar plant.
"In Europe booking and enquiries are lower (than earlier this year)," said Juan Garcia, a spokesman for the company.
"Our capacity utilization is currently at 70 per cent, but we are cutting it to about 65 per cent."
Morgan Stanley analyst Carsten Riek said demand in Europe would not return to the levels seen prior to the global economic crisis until 2014.
Production, on the other hand, hit a record high in 2010, and analysts expect it to set new records in 2011 and 2012.
"There will be growth in demand in the EU in 2011 versus 2010, but it still means there will be over-capacity," said Peter Fish, managing director of UK-based consultancy MEPS International.
Until drastic measures are taken to shake up Europe's crowded market, the problem will continue to eat into profitability.
The first steps have been taken.
Some producers are relying on rationalization to make their assets more profitable, more flexible and more attractive for potential mergers or acquisitions.
Top world steelmaker ArcelorMittal spun off its stainless steel division, renamed Aperam, and listed it at the beginning of this year.
It has also cut capacity at one of a plant in France.
"We have stopped 7 per cent of our capacity in January at our Isbergues finishing plant," said a company spokesman.
"We hope our competitors will take similar measures ... If everybody contributes and works on capacity, the industry will be in a better situation."
ThyssenKrupp, Germany's biggest steelmaker, is also mulling options such as a market listing or tie-ups for its stainless steel arm.
After a few underwhelming quarters, Finnish stainless steelmaker Outokumpu appointed in April a new chief executive officer in a bid to stop spiralling losses. The company announced it would implement cost-saving measures including cutting hundreds of jobs.
"Outokumpu's short-term agenda includes reviews of both non-core and loss-making assets," said Paivi Lindqvist, vice-president of communications and investor relations.
But with aggressive competition from Asia, more serious action must be taken, and quickly, before the European stainless steel industry starts to crumble.
"Probably the first-quarter performance has helped to temporarily delay the inevitable in Europe for a bit, which is that some factories need to be closed or relocated," Cartman said.Report Typo/Error
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