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AUTO Wall Street sees plenty to worry about as sales stall

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Despite a few uncertainties, the automotive market appears to have momentum going forward.

"Long term, the automotive production and consumption markets look good," said David Martin, steel analyst at Deutsche Bank Securities Inc., New York. "Foreign owners of U.S. assets want to sell to that market, even though domestic car manufacturers continue to suffer at the hands of the transplants."

With most transplants opting to set up plants in the South, Martin expects more and more steel investments will be made where those plants are located, meaning less in the Northeast and more in the Southeast. Offshore producers of cheaper slab, mostly in Brazil, pose a threat to U.S. steel mills and might even invest in U.S. rolling facilities, he said.

While he doesn't expect any significant increase in interest rates that would impact consumer spending, Martin wonders how many Americans are financing their auto purchases through home equity loans at a time when the housing market is showing signs of weakening.

"Higher gas prices are also posing a threat to the SUV (sport utility vehicle) market, and auto manufacturers have cut production by between 10 and 20 percent to balance inventories, and that trend will continue," he said. "But the steel industry is well managed and well balanced, and it prefers to sell to the auto sector with its value-added products and a bit of a premium."

Randy Cousins, analyst at BMO Capital Markets, Toronto, sees the auto and housing sectors as the weak sisters of the steel industry. The good news is that the auto industry might have bottomed out while the transplants have taken up some of the slack, he said. And while auto production declined to 15.9 million vehicles last year from 16.3 million in 2005, it wasn't a major drop.

Cousins' favorite tool of the trade is the new orders category of the Institute for Supply Management's business index, along with statistics from the Iron and Steel Statistics Bureau in the United Kingdom and the Metals Service Center Institute. The new orders index is the best for steel pricing and demand, though, he said.

Last year, U.S. steel imports reached an all-time high of 40.4 million tonnes, up 42 percent from 2005. On the bright side, Cousins said import volumes are declining partly due to weaker pricing, resulting in less incentive to ship steel to North America vs. stronger markets around the world.

"The devaluation of the U.S. dollar vs. the euro is very positive for North American manufacturing. And although MSCI shipment figures are down from month to month, on a yearly basis they're showing signs of firming," he said.

The steel sector views the glass as half full rather than half empty in terms of auto production, said David Tyerman, analyst at Scotia Capital Inc., Toronto, who relies on monthly sales reports from the Big Three and Ward's Automotive Reports for his analysis. "Things are better than last fall for the flat-rolled guys, but it would be a mistake to say the sales side is better. We still have a negative second quarter (year over year), but it's still possible we'll have a positive second half," he said.

U.S. auto sales declined 3 percent through April, and the best explanation is the fallout from the slumping housing market, Tyerman said, noting that there is less cashing out of mortgage refinancing. "Will it get any worse or are we at the bottom of the cycle? Certainly, the tone of the Big Three is more cautious. And while the transplants are performing well, it's not enough to make up for the poor performance of the other guys. So if you're a steelmaker selling only to the Big Three, it's ugly," he said.

Research by UBS Securities LLC, New York, suggests things won't improve in the second half as original equipment manufacturers remain cautious about consumer demand as they look to reduce inventory.

Ford Motor Co., Dearborn, Mich., expects total auto sales to decline to 16.8 million vehicles this year from 17 million last year, while General Motors Corp., Detroit, expects overall sales to remain flat. As a result, UBS remains bearish toward the sector, noting a lack of "pent-up demand" to drive sales coupled with a weak housing market.


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