What's Next for the Global Steel Industry?

Apr. 4.07 | About: ArcelorMittal (MT)

One hundred years ago, steel was the IT industry of its day -- a cutting edge sector that was a symbol of a country's economic might. Andrew Carnegie, U.S. Steel, and Pittsburgh were what Bill Gates, Microsoft and Silicon Valley are today. The U.S., Britain and Germany made the bulk of the world's steel until the 1970s, when competition from Japan and South Korea sent these traditional Western steelmaker-behemoths reeling. By the late 1990s, the steel business had one foot in the grave. Two trends reversed this over the past five years. First, a series of recent mergers and takeovers among steel companies put the sector back on a more profitable and sustainable path. Second, a jump in demand for steel from China -- coupled with a tripling of steel prices -- brought the whole industry back from the brink of extinction.

Investing in Steel: The New Andrew Carnegie

Today's global steel industry has its own version of Andrew Carnegie. He's Lakshmi Mittal, a quietly spoken, London-based tycoon originally from India. The Mittal dynasty made its first investment in steel only in the 1970s, when its founder, Mohan Lal Mittal, bought a tiny steel firm in Indonesia. Since 2000, Lakshmi Mittal -- as chairman and main owner of the Netherlands-based Mittal Steel -- acquired Ohio-based International Steel Group, itself a recent agglomeration of famous names such as Bethlehem Steel and LTV. These and other acquisitions made his company into the world's biggest steelmaker. They also helped land him the #3 spot on the Forbes Billionaire List in 2005, right behind Bill Gates and Warren Buffett.

Another turning point came in 2006, when Mittal launched a takeover bid for the Luxembourg-based Arcelor -- the #2 steelmaker in the industry. Arcelor itself was formed only in 2001 through the combination of the top steelmakers in France, Spain and Luxembourg. Although Mittal's original offer for Arcelor was rebuffed, Arcelor's board finally agreed to sell the company to Mittal Steel for cash and stock valued at €25.6 billion ($32.2 billion). The merger created by far the world's largest steelmaker in terms of market value, revenue and output. Today, the combined Arcelor Mittal (NYSE:MT) group produces more than 120 million tons of steel a year.

Investing in Steel: A Wave of Global Consolidation

What's next for world steel? Expect yet more consolidation that will make the industry more efficient. Despite recent high-profile mergers, the global steel industry remains fragmented along national lines. And size has its advantages. Larger companies have more power to negotiate with suppliers. They can better manage production to keep prices and profitability high. They can exploit synergies in marketing, trading, and research and development that their smaller rivals can't.

U.S. Steel (18 million tons), now facing a giant in the form of Arcelor Mittal in its own backyard, last week bid for Lonestar Technologies. Germany's ThyssenKrupp (16 million tons), born of a 1999 merger, has long been looking for partners, both in Europe and America. NKK and Kawasaki, two large Japanese companies merged to form JFE. And, Korea's POSCO (29 million tons) aspires to become a 50 million ton producer.

Industry leaders such as Lakshmi Mittal ultimately expect that the steel industry will be dominated by a handful of companies that produce more than 100 million tons a year. Consulting group Accenture estimates that by 2010, the five top companies in steel will control 30% of the market -- each averaging 80 million tons a year. In 2000, the top five companies combined to control only 14% of the market.

Investing in Steel: Is China a Savior or a Threat?

The global steel industry has China to thank for its spectacular and unexpected recovery. Thanks to the Asian giant's explosive growth, global steel consumption has increased by an average of nearly 6% a year between 2000 and 2005 -- compared with an anemic 1.9% annual average growth between 1970 and 2000. Between now and 2015, global steel demand likely will grow by 3.5% a year.

Not surprisingly, increased demand has pushed prices higher. Hot-rolled coil, for instance, the sheet steel for cars and fridges, tripled from $200 a ton to more than $600 a ton. Steel companies also grew their operating margins to 30% and earned profits of up to $250 a ton. Some forecasts suggest that the prices for exported hot-rolled sheet could easily rise to about $700 a ton by the middle of the summer -- a harbinger of a further period of good profit growth for the steel industry.

But here's the downside. In 1994, China's steelmaking capacity was only 11% of the world total. Today, that capacity approaches one-third. With China investing at a rate of $35 billion a year, it plans for at least four huge new coastal steel plants. By 2010, China will produce 63 million tons of steel in excess of domestic demand. Over-capacity in the domestic market has already driven China's internal steel prices for the benchmark sheet steel down to $300 a ton -- well below international levels. Indeed, since the end of 2005, Chinese companies have started to sell steel in foreign markets. It's little wonder that the same Western steelmakers that have Chinese demand to thank for the revival of their industry are fearful that fleet loads of cheap Chinese steel will be sold in their markets.

Chinese dominance won't happen overnight. The Chinese produce a lot of poor-quality output that is unfit for many markets. And, the Chinese government is wary of angering more Western governments in a world awash with Chinese manufactured goods. But the rapid evolution of the steel industry in China shows how quickly the industry's savior can turn into its greatest threat.