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Schnitzer Sees Slowdown

By Rich Smith
January 7, 2005

Two stories emerged from Schnitzer Steel Industries' (Nasdaq: SCHN) fiscal first-quarter 2005 earnings report yesterday. The first was of a steel company whose profits continue to skyrocket -- up 250% over the year-ago quarter on a 55% increase in revenues. Boffo.

By unit, Schnitzer's steel manufacturing business led the way to this quarter's stellar results. The unit parlayed a 32% revenue increase into a reversal of last year's loss, generating $12.8 million in operating profits. Next up came the company's biggest unit, its scrap-recycling business, where revenues jumped 82% and yielded a 240% increase in operating profits. Bringing up the rear was Schnitzer's auto parts business, generating 32% more revenues this quarter than last but extracting just a 25% boost in profits from the extra business.

Investors should be pleased to hear that, year-on-year, dilution at this shareholder-friendly steelmaker was well under 1%, permitting its owners to share proportionately in their company's success. Per-share diluted earnings increased roughly in line with net profits, rising 250-odd percent from $0.39 to $1.38.

But Schnitzer's second story was the more interesting. With its habit of selling its products 90 days before it ships them, Schnitzer has proven itself a useful predictor of worldwide trends in the steel industry. So now let's look at where last year's trend toward record demand and record profits in this most cyclical of industries may be heading as we move into 2005.

On the one hand, Schnitzer said all the right words about strong steel demand continuing in the new year. In particular, the company downplayed concerns we've been hearing in recent weeks, that the Chinese economy and, with it, Chinese demand for steel, may be slowing. Schnitzer termed itself "bullish about Asian demand for scrap," as well as for finished steel products.

On the other hand, Schnitzer noted that the price it pays for steel scrap has declined a bit over the past 60 days, even as the price it charges for its products has leveled out. For the company, this suggests Schnitzer can retain its margins and continue making profits. For the industry, though, when combined with other comments the company made about the lessened difficulty in finding ships to transport its products, and an increase in steel inventories among its customers, this suggests that a steel slowdown may be in progress. Over time, such a trend could put the record profits still being racked up by steelmakers such as Nucor (Nasdaq: NUE), U.S. Steel (NYSE: X), AK Steel (NYSE: AKS), Reliance Steel (NYSE: RS), Steel Technologies (Nasdaq: STTX), and Mittal Steel (NYSE: MT) at risk.

If a slowdown's in the works, it probably won't be noticed right away, as seasonally slow winter activity will mask any slowdown next quarter. Nonetheless, this is something investors in this volatile sector should keep an eye on.

Steel yourself for the coming downturn by reading up on steel's recent rise and fall in:

Fool contributor Rich Smith holds no position in any of the companies mentioned in this article. The Fool has a disclosure policy.