Morningstar‘s new report “Strike While the Iron is… Cold,” claims that iron ore’s new normal will mean lower steel prices and a flatter cost curve for the major steel producers.
Morningstar Research Analyst Andrew Lane wrote that, relative to other industries in the basic materials space, the steel industry exhibits a very flat cost curve. For the production of hot-rolled coil, 85% of the industry cost curve operates within $100 per metric ton of the marginal producer and 46% operates within $50 per metric ton.1 This is a tight range relative to prevailing US hot-rolled coil prices of $705 per metric ton ($640 per short ton).
“Steel’s flat cost curve means moats are rare,” Lane wrote. Of the 9 steel companies highlighted in the report, only three have an economic moat: Nucor, Steel Dynamics, and CSN. Due to their low costs in procuring or refining ready-to-melt iron units, these 3 companies are the only firms within our steel coverage universe that we expect to generate economic profit in a mid-cycle environment.”
The top quartile of the iron ore cost curve is lower than levels implied by consensus, according to Morningstar. The analyst also believes China’s steel demand is likely to disappoint the market’s moderated expectations.
As seaborne prices remain depressed, the cost advantage associated with the operation of low-cost mining assets will become less distinct, Morningstar says. For vertically integrated companies that historically provided ready-to-melt iron units to their steelmaking furnaces at a cost well below seaborne unit costs, Morningstar expects profitability to partially erode relative to profitability levels enjoyed by the marginal producer of steel. This is because marginal producers will be able to acquire seaborne iron ore at falling prices. Favorable conversion costs in refining iron ore into ready-to-melt iron units will become the more important advantage.
Morningstar Steel and Steelmaking Raw Material Price Forecasts ($/mt)
Morningstar has more on “Strike While the Iron (ore) is Cold.”