Nucor Not the Only One Holding High Priced Inventory

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Buy low sell high, a trader’s adage that everyone knows but companies only get right some of the time. Nucor announced it would post a loss of $0.55 – $0.65 per share for the first quarter due to poor demand. Shares fell 9.2% on the
news
. Of course none of us in the metals industry are surprised by these results. But there are a couple of points worth noting.

Besides poor demand, Nucor said it had been, working off high priced inventory, (which should have worked its way through already but due to poor demand, is still laying around). That issue raises an interesting question for purchasing managers. How much high priced inventory,  WIP, or finished inventory is on your books? Judging by our own recent client experience I think the answer is a lot. So much so that the high priced inventory everyone thought would be used up by the end of January is somehow still sitting around on March 19.

To get a sense of the high priced inventory that Nucor is working off I found this in their most recent 10-K filing: The average scrap and scrap substitute cost per ton used remained at historically high levels in 2007 and 2008, increasing 13% from $246 in 2006 to $278 in 2007 and increasing an additional 58% to $438 in 2008. During both years, Nucor used a raw material surcharge as a component of our product pricing to help offset the impact of volatile scrap prices. Okay, we all saw prices increase last year but many had said the price increases were not sustainable (including us very early last year during our annual predictions).

But according to Nucor, since pig iron and certain grades of scrap have lead times of four to six months, dramatically reduced sales volumes resulted in the accumulation of increased tons of inventories (primarily at our steel mills) ordered at peak market prices. Our margins will be reduced until we work through this high priced inventory. And herein lies the rub. Companies don’t taper their purchases as markets crest and therefore find themselves ‘holding the proverbial bag’.

This problem is by no means unique to Nucor. Yet playing a market timing game will only result in some wins some of the time and some losses some of the time. Southwest Airlines got caught on the wrong side of a hedge and because of mark-to-market accounting, had to write off its position and take the hit during one of its earnings announcements last year. But on the whole, Southwest has fared far better than its peers by placing bright minds on internal forecasting, hedging and sourcing strategies.

Hence the need for reliable forecasts, please see our earlier post. A company can play the market timing game for so long but as they say in Vegas, only the house wins.

–Lisa Reisman

Comments (4)

  1. LP says:

    “But on the whole, Southwest has fared far better than its peers by placing bright minds on internal forecasting, hedging and sourcing strategies.”

    After hundreds of years of open markets and secular/cyclical business cycles, you would think there would be a certain level of importance placed in this department. Yet humans come out with, “it’s different this time”.

    History has shown starting with the Japanese rice bubble and Dutch tulips, that it’s never ever different “this time”.

    While SouthWest took some losses on the hedge, it probably gained a few new customers when oil zoomed from 60 to 147. They probably made more sound business decisions as they were not pressured with the price of crude. Stuff like not surcharging their customers for fuel, pillows, water and air bought them a lot of good will.

    One of the things that most traders and business professionals take a long time to learn is market psychology. They always assume the highs will go higher and the lows lower. Fear begets more fear and greed begets more greed. But the real truth lies some where in between Fear and Greed. It takes a special person to have the courage and the intellect to buy near the lows and sell near the highs. We are often afraid of finding out the what if.

  2. admin says:

    Your comments are so insightful! Irrational exuberance? I’ve seen so many companies make that mistake. They are watching the data points and not the trends. And just as sure as I’m sitting here typing, purchasing professionals are looking at say aluminum, afraid to lock forward now for fear that…..volumes won’t be there? The price will go lower? Who knows. In the meantime, I continue to fly SW. They still give you a bag of peanuts for free!

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