2007 Scrap Metals Supplement -- Nimble Players

Whether they join the consolidation craze or focus on niche markets, many of the electric arc furnace operations in the United States are facing growing pressure from consolidators.

When Mittal Steel announced its plans to acquire Arcelor Steel, the well-worn perception of the industry changed forever. In the past, the prevailing thought regarding merger and acquisition activity was that a large steel company would seek to acquire a smaller steel company in an attempt to diversify its portfolio of products or to enhance its geographic footprint.

However, Mittal’s deal for Arcelor was a move to combine two of the largest steel companies in the world to create the largest steel company, sending the signal to the industry that every steel company in the world is a potential acquisition target, from the largest to small, privately owned operations, says Thomas Danjczek, president of the Steel Manufacturers Association, an association of North American steel mini-mills. "No one is safe from being acquired," he comments.

The prospect of an improved operating environment also comes in the midst of such mergers. The most recent potential merger is the bidding war that has been occurring over Corus Steel. In the fall, Tata Steel announced plans to acquire Corus. However, recently the Brazilian integrated steel producer Companhia Siderurgica Nacional (CSN) announced a counter offer for the company. A merger between Corus and either company would result in the fifth largest steel company in the world.

The battle over Corus, an Anglo-Dutch steel company, between an Indian and Brazilian company reflects the global merger binge that has moved the steel industry from a Wall Street pariah to a sector of great interest in the mergers and acquisition community.

Adding to this is the consensus from steel industry analysts that there will continue to be more large and small mergers and acquisitions. Recently, for example, a Russian steel company announced plans to acquire U.S.-based Oregon Steel.

For U.S. steelmakers, especially those in the electric arc furnace industry, being swept up in acquisitions is a real possibility. Even more daunting is that with larger companies competing, many will have to change their approaches to remain competitive.

For example, legacy costs were a heavy yoke for many traditional integrated steel mills. However, amid an improved environment for steel and with the sharp reduction in some legacy costs at many mills, this dynamic has changed.

Despite this change, it hasn’t necessarily swung the competition so that the EAF sector is at a major disadvantage. Danjczek says that despite legacy costs not being as key an issue now as they were several years ago, there are other cost advantages that EAFs continue to hold over most basic oxygen furnace (BOF) operations.

There are a handful of ways for EAFs to ride the merger wave taking place in the global steel industry, Danjczek says. One step would be to make acquisitions, such as Gerdau Ameristeel, CMC and Nucor have done. These companies also are seeking to strengthen their upstream and downstream businesses, to provide more of an integrated approach.

Wall Street appears to be supporting the flurry of merger moves. From a pariah industry only several years ago, today the steel and metal commodity business has been one of the most dynamic in the mergers and acquisitions markets. Danjczek says that the flurry of mergers will help to dampen some of the extreme volatility that has damaged the steel industry throughout the past several years.

Already there are signs that consolidation is allowing mills to keep better control of inventory levels, preventing sharply declining prices.

While finished steel inventory levels had grown by the end of 2006, there appears to be the sense that they should be reduced to much more manageable levels, perhaps as soon as the middle of the first quarter of 2007.

Jack Stutz, president and CEO of Tamco Steel, a smaller EAF minimill based in Rancho Cucamonga, Calif., acknowledges that small steel mills such as his have to ride the merger waves and try to be responsive to the marketplace.

One advantage Stutz says his company has is the niche it has carved out in California. "In 1970 there were 17 steel mills in California. Tamco now is the only one left," he says. Tamco also focuses on a small niche: the California construction market. "We look to maintain our market share," Stutz says.

While Tamco has been able to maneuver its way through the challenges confronting the consolidating steel industry, Stutz acknowledges that the biggest advantage that the company holds is the location of the mill in comparison to its market. Tamco is able to take advantage of much lower shipping costs as the majority of its end market is within several hundred miles of the steel mill.

However, Stutz says he doesn’t necessarily feel that proximity has created a total moat. The changing dynamics of the steel industry may afford a competitor the opportunity to ship material to this growing market, he says.

Stutz also points out that his company truly can’t offer any competitive advantage to the larger steel giants that are becoming more of a force in the marketplace. "We can do nothing better than Mittal (the largest steel company in the world), but we can be as good as the big companies," he notes.

Along with its niche, Stutz adds that because Tamco is a privately owned steel company, it is a rarity in the business. "As long as the company keeps its shareholders (Ameron International, Mitsui and Tokyo Steel, the three companies that jointly own Tamco) happy, we do okay."

One step Tamco has taken is to work to improve relationships with its supplier base. "We are in the market every month," Stutz says. This, he says, gives his company an advantage over ferrous scrap consumers who may jump in and out of the market.

Michael Locker, principal with Locker Associates, a steel-consulting firm located in New York City, says that for many independent steel companies the best way to remain independent is to focus on niche markets. Other steps include consolidating not only with other steel mills, but also with upstream and downstream operations. "Companies need to control both sides so they can add more value to their operations," Locker says.

Investing in new equipment also is a major advantage. "To remain strong companies need to invest in new equipment," he adds.

And, reflecting the significant advantage many of the EAFs have had throughout the past several years, Locker says companies need to have good labor/management relationships.

Danjczek adds that while it isn’t always the case, labor and related costs can be much lower at mini-mills than at traditional integrated steel mills.

The other advantages that EAFs hold, even with legacy costs being less of a factor, are that there can be far lower capital costs and maintenance costs at an EAF mill compared to an integrated steel mill.

With raw material making up such a significant portion of an EAF’s costs, companies are taking steps to better protect themselves from the whims of the market.

Scrap-consuming EAFs see the volatility in the scrap steel market as both an opportunity and a challenge.

Rich Brady, vice president of ferrous resources for Steel Dynamics Inc. (SDI), a mid-sized steel minimill headquartered in Fort Wayne, Ind., says that the business side of the global steel industry is becoming more complicated as global competition intensifies.

Brady says that while in the not-so-distant past, SDI might have had to compete regionally for ferrous scrap, nowadays companies have to watch not only regional competition, but also mills thousands of miles away.

Brady adds that the efficiency of the company’s workforce is a key to SDI remaining competitive. "We have the most productive workforce operating," he says.

Brady isn’t the only one extolling the virtues of Steel Dynamics. A recent article noted that while SDI is far smaller than many other steel companies, its size allows it to be more nimble. "They get more from the same equipment," analyst Charles Bradford with Bradford Research/Soleil, says in a recent article.

However, for EAFs an area of significant importance is the activity of the ferrous scrap market. Brady estimates that roughly 50 percent of the company’s costs are tied up in its raw material purchases, which includes scrap and scrap substitutes such as hot briquetted iron, direct reduced iron, pig iron and other materials.

Avenues taken range from Nucor opting to invest in some DRI capacity in Trinidad and Tobago to SDI opening up a new facility called Iron Dynamics to supply some of the raw material to its mills.

Concerned about the impact that iron ore suppliers wield in the steel industry, two of the largest steel companies—Japan-based Nippon Steel and Korea-based Posco—have agreed to jointly negotiate to buy iron ore, which could strengthen their buying power. Reportedly, iron ore producers will try to raise prices by 10 percent next year. This would be on top of a 20 percent increase seen in 2006.

Some industry analysts say mergers sweeping the steel industry are an attempt to get on an even footing with the iron ore suppliers.

SDI’s Brady points out that one big advantage his company has against integrated steel mills is that integrateds typically sign longer-term contracts for their raw materials. EAFs, however, have more flexibility throughout the year in procuring scrap. Therefore, SDI doesn’t have to lock into a price at the beginning of the year that may hurt the company later in the year.

Some EAFs, such as CMC, Schnitzer and Gerdau Ameristeel, have well-established networks of scrap yards to feed their mills.

Steel Dynamics, which, like Nucor, had focused feeding its mills using the open market, recently dipped its toe into the supply side when it obtained an auto shredding facility through its acquisition of Roanoke Electric Steel earlier this year.

EAFs also are investing time and money to develop alternate sources of raw material, whether that is hot briquetted iron, direct reduced iron or other scrap substitutes.

Finally, Danjczek notes that while much of the attention worldwide has been toward BOF steel companies, in the United States EAFs continue to grow as a component of the domestic steel industry. "The biggest trend right now is that 59 percent of U.S. (steel) production this year came from electric arc furnaces," he says. Danjczek says he feels this figure will continue to grow in the future. "We have been able to beat the integrateds because of the cost advantage," he adds.