Last week, Brazil's Vale (NYSE: RIO ) announced it had resolved price negotiations with the world's major steelmakers, settling upon a 65% price increase. Shares of several steelmakers have continued to rise subsequently, on the expectation that they will successfully pass their cost increases on to customers by raising prices. But as investors wait to confirm whether these companies' margins will remain stable, we Fools can consult current earnings results to view how margins are behaving before this big price hike.
Let's look at steel manufacturer Ternium S.A. (NYSE: TX ) , a relative enigma among its peers. Though its corporate headquarters is in Luxembourg, and its parent company is in the Netherlands Antilles, all of its operations are in the Americas, with subsidiaries in Mexico, Venezuela, and Argentina. In its earnings report earlier this week, the company revealed that sales volume had grown 17% in 2007, while revenue from sales grew 25% on strong pricing. However, the company's operating margins contracted substantially from 32% to 26%, while operating income for the year end was down 3% on increased input, freight, labor, and interest costs.
Fellow Fool contributor Toby Shute correctly pointed out that South Korea's POSCO (NYSE: PKX ) and many other steelmakers project considerable resilience to cost increases because they have "ample room" to raise prices accordingly. But not all steelmakers are created equal, and whether a company enjoys sufficient demand to pass along its cost increases may be a question of geography as much as anything else.
While Asian steel companies such as Japan's Nippon Steel and POSCO may have convenient access to a more stable demand environment, particularly from China, companies like Ternium, Gerdau AmeriSteel (NYSE: GNA ) , and U.S. Steel (NYSE: X ) are far more likely to feel the pinch from softening demand in the United States, and perhaps also Europe. With freight costs also continuing to rise, these companies are constrained by the distances they can ship their products to market while maintaining profit margins and pricing power. Fortunately for Ternium, its relative proximity to CVRD's iron ore resources may be an offsetting factor, and solid demand from within Latin America has thus far absorbed much of the softness in U.S. demand.
As I've stated elsewhere, only time will tell which steel companies feel the pinch and when. Fools might be wise to consider the geography factor when deciding whether to forge an investment in steel.