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RIO DE JANEIRO (Dow Jones) -- Merchant bank analysts downgraded various Latin American steelmakers Wednesday on prospects of falling steel prices in Brazil and deteriorating profitability amid weak first-half demand.
Now is the time for profit-taking in the Latin American steel sector after a recent stocks rally which is set to peter out, said analysts from Morgan Stanley and Citigroup, which both downgraded Brazil's Gerdau SA (GGBR4.BR), Usinas Siderurgicas de Minas Gerais SA (USIM5.BR, USZNY), or Usiminas, Companhia Siderurgica Nacional SA (CSNA3.BR, SID) or CSN, and Latin American steelmaker Ternium (TX).
Morgan Stanley's researcher Carlos de Alba said in a report he downgraded the four steelmakers because "steel prices are poised to fall" and there's little room for any further improvement in steel stocks prices, which have risen as much as 42% from recent lows. The analyst cut Gerdau and Ternium to equalweight from overweight and CSN and Usiminas to underweight from equalweight.
"Risk-reward profiles have deteriorated as the shares appear already to price in the improving Latam steel fundamentals we see in the coming years: higher volumes driven by demand growth and reduced raw material costs that will boost operating margins," de Alba said. "We think (steel) prices have peaked and will decline in coming weeks."
It's unclear how Ternium will generate an attractive return on its expensive acquisition of a controlling stake in Usiminas, where any turnaround by its new management will take at least two years, according to de Alba. In addition, Gerdau's stock is currently pricey and CSN continues to face problems expanding its iron ore shipments which has generated concerns over capital allocations, he said.
Citigroup analyst Alex Hacking cut Gerdau and Ternium to neutral from buy and Usiminas and CSN to sell from neutral. Target share prices were cut for all the steelmakers.
Hacking highlighted several near-term concerns for Latin American steelmakers in a report. Steel share prices have rallied without fundamental improvements, he said. First-half 2012 demand for steel in Brazil, the biggest Latin American producer and consumer, is looking weak and is overhung by high inventories, meaning there's little near-term prospect of higher prices for the region's steel mills.
"Global over-capacity has limited any sustainable pricing since 2008, and we do not anticipate any improvement in 2012," Hacking said.
While steelmakers' margins may rise in second-quarter 2012 due to lower raw materials costs, any advantages gained will fizzle out later in the year due to cost inflation, according to Citigroup's calculation.
In a report earlier this week, Morgan Stanley analyst Marcelo Aguiar said that a combination of lower risk aversion among equity investors and recent steel price hikes in the U.S. has brought investor attention back to the steel sector.
However, "we do not see earnings expanding for Brazilian companies, given a low probability of local steel price increases near term," Aguiar said.
The Morgan Stanley analyst notes there is "skepticism" on CSN's investment case and says that the stronger outlook for the U.S. economy seems to be already priced into the stock at Gerdau, which still needs to reap in any benefit from its current iron ore mining investments.
Appointment of a new CEO at Usiminas meanwhile "reduces the near-term visibility on Usiminas' strategy, which could act as an overhang," said Aguiar, who expects Usiminas to report weak earnings in fourth quarter 2011 and first-quarter 2012.
-By Diana Kinch, Dow Jones Newswires, Tel +55 21 2586 6086. firstname.lastname@example.org