Are Long-Term Profits Within the US Steel Industry’s Grasp?

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JamesMayheadshot_150Guest contributor James May is managing director of Steel-Insight.

Even though its price has dropped in the last month, US Steel stock is up over 20% so far in 2014, while the S&P 500 has eked out a gain closer to 5%. Why has its stock outperformed this year (albeit after underperforming the last two years)?

It’s down to the fundamentals of making and processing steel.

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We think of the steel industry value chain as 3 distinct buckets.

Bucket 1: Raw Materials

The first is raw materials. Steel mills buy iron ore, coal, power, natural gas or scrap in varying amounts depending on their steelmaking technology. These input costs vary if you are buying them on the market or are relatively fixed if you own them.

Bucket 2: Transformation Cost

Transformation costs vary from mill-to-mill depending on the efficiencies of the operation, internal logistics, the cost of labor, taxes and the fixed cost of the assets, but these costs tend to be stable.

Bucket 3: Mill Profitability

Finally, there is the spread over the production cost i.e. mill profitability. This is generally driven by the supply and demand for steel.

The chart below highlights why US Steel stock has risen on expectations of improved profitability. Raw material prices are sharply lower for iron ore and coal – the two key raw materials for US Steel – while its selling price has remained elevated.

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USsteelprices1

Index of US HR coil price vs integrated raw materials (December 2013 = 100). Source: Steel Insight

Steel is a cyclical business and steel mill profitability – the spread over raw materials – is usually closely related to utilization rates and the availability of steel.

When steel is in strong demand, but limited supply, the lead times for steel are driven higher and buyers are willing to pay more for it and also build up inventory to avoid being short of the material. Typically this is then followed by an increase in supply due to rising profitability. In North America, this can come in the form of higher output domestically or from an increase in imports drawn in.

Continued in “Can Consolidation Lead to Profitability for US Steel Companies?

Steel-Insight is a steel industry price-forecasting publishing company, based in Toronto. James May, the firm’s managing director, has been a steel industry analyst for 15 years and advises some of the major global steel trading companies, steel producers and steel consumers on the outlook for steel pricing and industry trends. For more information, visit www.steel-insight.com.

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