2 Top Steel Stocks to Buy in September

Steel is an essential element of the modern world, going into everything from vehicles to buildings to household appliances. Steel demand will be robust, with a boom in mega projects (such as data centers), each worth at least $1 billion. Starting in 2021, $1.4 trillion worth of mega projects have been announced, all of which will make heavy use of steel. But steel stocks are cyclical, so make sure you stick with companies that can best weather the entire steel cycle. Here’s what you need to know.

The old way and the new way

There are two broad ways to make steel, electric arc furnaces and mini-mills. Furnaces have been around for a very long time. They use metallurgical coal and iron ore to create primary steel. These mills are vital to the world’s steel production, but the blast furnaces are very expensive to operate. When demand for steel is strong, blast furnaces tend to make a lot of money because they operate at high utilization rates. When demand for steel is weak, they often lose money — sometimes quite a bit of money — because they don’t sell enough steel to cover their operating costs.

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The newer method of making steel, electric arc mini-mills, uses scrap metal and electricity. These mills are much easier to ramp up and down based on demand, so they can operate profitably even when steel markets retreat. Electric arc minimills are not enough to supply the world with the steel it needs, but the more modern technology has a clear advantage in terms of profitability.

Steel stocks to avoid unless you want to play the cycle

Cleveland-Cliffs (CLF -1.30%)once a supplier of iron ore to the North American steel industry, it bought its way into the steel sector by acquiring several large regional steel producers. Its portfolio of mills is dominated by blast furnaces. Iconic United States Steel (X 4.34%) was founded when the only available technology was blast furnaces. Today, it is expanding to include electric arc mini mills as it seeks to offer customers a wider product line. It’s better, but still not great.

Both companies are likely to see huge earnings growth in good times, but bad times in the steel industry are likely to be quite painful, financially, because of the steelmaking technology they use.

US Steel is also in the middle of a cross-border acquisition drama. There are both financial and political angles to the company’s plan to be bought by a Japanese competitor. Most investors would probably be better off avoiding what could be a very dramatic and exciting stock.

Two stocks to buy for the long term in the steel sector

That brings us to Nope (NOT -0.58%) and The dynamics of steel (STLD -0.29%)both of which use more modern electric arc mini-mills. From this perspective, their businesses are likely to be more consistent through the cyclical developments of the steel industry. They probably won’t be as profitable as US Steel or Cleveland-Cliffs in good years, but they won’t be as unprofitable in bad years either. In fact, Nucor and Steel Dynamics have a pretty impressive history of remaining profitable throughout the entire steel cycle, with only rare exceptions.

Nucor is the older, larger and more diversified of the two companies. It’s more of a slow moving giant. Steel Dynamics is the upstart, with a faster growth rate (for the steel industry) and an expanding reach, both geographically and in terms of product offerings. Conservative investors will likely prefer Nucor, while more growth-inclined types will likely find Steel Dynamics attractive.

While any number of metrics could be used to highlight the consistency of these companies, one of the simplest is dividends. Nucor is a dividend king with 51 consecutive huge annual dividend increases under its belt. That’s pretty incredible given the cyclical nature of the steel sector, speaking directly to its ability to reward investors while riding through good times and bad. Steel Dynamics is a much younger company founded by former Nucor employees with a streak of 13 consecutive annual dividend increases.

CLF data by YCharts.

There are opportunities in steel, but choose wisely

With the large-scale construction boom in North America starting to pick up, investors may want to consider getting into the steel sector. To be fair, there are headwinds here, particularly from an increasing flow of low-priced imports that depress prices. But this isn’t exactly a new phenomenon, so don’t let that put you off looking at the steel sector.

If you want to put some money into steel stocks, the best options for long-term investors are probably Nucor and Steel Dynamics. Their businesses are advantageous compared to peers and have a proven track record of rewarding investors throughout the entire steel cycle.

The best part? Both Nucor and Steel Dynamics are 20% to 30% below their recent highs. Now seems like an attractive time to consider these top steel producers for your portfolio.