Is the Steel Industry in a Boom or on a Bubble?
By CLAUDIA H. DEUTSCH
Published: January 18, 2005
ast year was a banner year for the steel industry. Steel companies consolidated and reorganized while demand soared, pushing up prices for steel - and for steel company stocks. Indeed, the Goldman Sachs index of steel companies was up 40 percent last year, with many of the stocks hitting record highs.
"No question, but price hike announcements sent steel stocks way up," said Mark Mousseau, a research analyst at Thomson Financial.
So why is the investment community so divided over steel's future? Why do only 6 of the 16 Wall Street analysts who follow the industry have buy ratings on steel stocks - and three of them have strong sells?
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As Merrill Lynch sees it, 2004 was a harbinger of good times to come. But CIBC World Markets, which downgraded the steel sector to underweight just last week, views the recent run-up in stock prices as the peak before the plunge.
Investors are understandably torn. "We're still bullish on the sector but we're already trying to identify when the game will be over," said Timothy M. Ghriskey, chief investment officer of Solaris Asset Management, which owns shares of US Steel.
Andrew G. Sharkey III, president of the American Iron and Steel Institute, said such uncertainty was typical. "Last year was extraordinary, but nobody has a crystal ball," he conceded. Everyone does have an opinion, though. And while nuances abound, the industry bulls and bears fall roughly into two schools of thought: the bulls say they believe that the domestic industry is in control of its own steel-making destiny, while the bears say that its fate is dependent on events that occur thousands of miles away.
"The health of the home industry is driven primarily by the U.S. market, and that means that steel prices are going to firm, even go up," said Aldo J. Mazzaferro, the bullish metals analyst at Goldman Sachs.
No way, counters Charles A. Bradford, his counterpart at Soleil Securities.
Mr. Bradford put a sell recommendation on several steel companies in October. In the United States, he said, "demand for steel was never as strong as everyone thought." As he sees it, neither the automobile nor the construction industries, which account for 50 percent of steel consumption, seem poised to soar.
"China was sucking up all the steel on the planet," he said, so "customers feared shortages, and they bought double, triple what they needed."
Steel users are loath to predict their coming costs. "The steel industry operates in a global marketplace, and with the volatility of the last few years, I would really hesitate to guess where prices will go," said Brian J. Lipke, chairman of Gibraltar Industries, which buys about 750,000 tons of steel a year.
Whatever happens, there's no imminent danger to most of the industry. Global steel production hit about 1.1 billion tons in 2004; American companies accounted for about 10 percent of that. Steel prices have dropped from their peak of $756 a ton in November, but they remain more than double the $300 a ton they commanded a year ago.
China remains the wild card. It is the world's largest importer of steel, but its own steel production is growing even faster than its usage: it could easily switch from customer to formidable competitor soon.
Indeed, for a few months last fall, China exported more steel than it imported. "China is a huge swing factor, and if it becomes a long-term net exporter, you are going to see a whole bunch of new steel bankruptcies again," said Wilbur L. Ross, who spent the last few years buying up bankrupt steel companies to create his International Steel Group.
Others worry that smaller nations like Brazil or Thailand will set up their own heavily subsidized steel companies, flooding the market with cheap steel. "When an industry goes through a strong year like 2004, inevitably some countries respond by building their own steel mills," said Mr. Sharkey of the steel institute.
The North American steel industry is in far better shape to weather even the worst-case situation than it was just a few years ago. In 1998, just before low-cost steel started flooding American markets again, there were 90 solvent steel producers in North America. By 2003, 28 of them were in bankruptcy, as they kept producing steel for customers whose needs were already sated.
"You can't run a steel mill at part speed," Mr. Ross said, "so if you don't have a way to cut out 5 percent of your production, you just keep producing."
Since then, some companies have disappeared, some have been acquired. Today, North America has 57 steel producers and only 3 are in bankruptcy.
"This has gone from a widely fragmented, poorly run industry to one that is consolidated and financially disciplined," said Daniel A. Roling, the metals analyst at Merrill Lynch.
For steel investors, Mr. Ross's decision to sell to Mittal Steel of London for about $4.5 billion - half in stock, half in cash - could be especially telling. When the smart money is selling, do you want to be buying?
But Mr. Ross had other reasons to make his move. Mittal has facilities in Eastern Europe, Mexico and other areas where International Steel Group is weak. Mr. Ross wanted badly to play in those markets - but he did not want to add new capacity.
"We were at a cost disadvantage competing with them, and we could never reproduce what they had," he said. Combining the two companies will yield the world's largest steel maker - a spot held until now by the French company Arcelor - with about $31.5 billion in annual revenues.
But that's not the only reason Mr. Ross chose to hedge his bets. "No one knows what will really happen to steel," he said, "because no one really knows what will happen to the global economy."
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