Although driven by a different cost base both vertically integrated Arcelor Mittal and mini mill Nucor are hurting in the current market. Popular wisdom goes that in times of low mill capacity utilization the mini mill model works better. Mini mills melt scrap in an electric arc furnace which can be operated at less than full capacity while still retaining moderate efficiency. Vertically integrated producers, however start with the reduction of iron ore in a blast furnace that has to be operated largely in an all or nothing manner. If demand drops dramatically for producers like Mittal, they have to produce blooms for which they do not have a current demand. The alternative is to close one or more blast furnaces. Mittal is carrying in excess of $26bn of debt which up until now they have not had any problem servicing. Last year, Mittal reported an EBITDA (earnings before interest, tax, depreciation and amortization) of $24.5bn. But Jeffrey Largey, an analyst at JPMorgan, as reported in the Financial Times said steel demand could drop by an additional 20% this year. Furthermore, he has predicted Mittal’s EBITDA could be between $6.1 and $8.5bn. Mittal has said they are working hard on a program to reduce debt by $4bn this year but the same article quotes bankers as saying the sale of one or more mills or a rights issue or both are being considered if the market does not improve soon.
Nucor, on the other hand, is faring even worse right now, it doesn’t have Arcelor Mittal’s mountain of debt but it just gave a profit warning for the first quarter as we reported yesterday down from a 34 cent profit last quarter and a $1.41 per share profit this time last year. Nucor operated at 48% of capacity in the fourth quarter but have slipped further to just 43% in the first quarter as sales have continued to decline. In addition and as we previously reported, the company is carrying high priced raw material, pig iron and scrap specifically, purchased back in 2008. At current rates, this high priced scrap will impact earnings through to the third quarter ” illustrating the size of the inventory problem.
But perhaps John Ferriola, Nucor’s COO, best explains it:
Nucor’s steel mill utilization rate for the fourth quarter of 2008 was 48%. That was down from a utilization rate exceeding 91% for the first nine months of 2008. And fourth quarter 2008 steel shipments of 3,400,000 tons decreased 37% from the third quarter and 40% from the year ago quarter. Another challenge faced by our team in the fourth quarter was the impact of such an abrupt decline in business activities on our scrap and scrap substitute costs. Extremely low steel mill utilization rates turned what would otherwise be normal scrap inventory levels into well above average inventories. The low mill production rates slowed the pace at which our mills consumed higher cost iron units purchased prior to the dramatic downturn. At our heat mills, this challenge was made more difficult by the fact that their pig iron buys are made with long lead times and are purchased by the vessel load.
Although our scrap and scrap substitute inventories remain higher than desired, we continue to enjoy substantial benefit from our highly variable cost structure. Our fourth quarter scrap and scrap substitute’s average usage cost was $430 per ton, decreased $103 per ton from the third quarter and the average cost of our fourth quarter scrap and scrap substitute purchases decreased $226 from the third quarter. I will also emphasize that other significant components of our cost structure are highly variable in nature. These include labor, energy, alloys and other raw materials.
Longer term, and while demand remains down, Nucor is likely better positioned to take advantage of its variable cost structure once they burn through inventory than the vertically integrated mills.