When Blazing Furnaces Go Stone-Cold

Striking deep into the heart of American industry, reverberations from the ongoing economic calamity continue to douse the flames of America's iconic steel and aluminum manufacturers. This directional shift from boom to bust is news to no one, but the deepening scope of the malaise commands the attention of every Fool.

With Chrysler on the ropes and General Motors (NYSE: GM  ) retiring the beloved Pontiac brand, we look to earnings results from steelmakers like Nucor (NYSE: NUE  ) and Steel Dynamics (Nasdaq: STLD  ) not with expectations of profit, but with hopes of mapping the confines of the downturn as it matures. Of course, automakers form an important component of domestic demand, but it requires a simultaneous hit to diverse client categories to slice an entire industry in half.

Steel is not looking so stainless
The domestic steel industry has been parted down the middle, with both Nucor and Steel Dynamics confirming last week that operations are running at about 45% of capacity in response to weak demand. This scale of demand deterioration, recently highlighted by coal miner Peabody Energy (NYSE: BTU  ) , has persisted for months now. Steel Dynamics sees "no clear sign" of demand recovery, while Nucor observed a pattern of deterioration during each succeeding month from September 2008 to March 2009.

As a result of reduced production volumes, both steelmakers incurred write-downs of iron inventories. Higher-cost scrap metal acquired before prices collapsed last year continues to gather dust. The capacity to make steel from scrap iron, which promised a competitive edge to these steelmakers when prices were soaring, is now biting at the bottom line at the other end of the price spectrum. Steel Dynamics incurred an $83 million inventory charge, while Nucor took a $60 million hit (offsetting much of the company's $105 million LIFO lifeline). Nucor swung from strong fourth-quarter profits to a first-quarter loss of $190 million, while Steel Dynamics turned in its second consecutive loss of more than $80 million. Operationally, these companies are painting with the same brush, but the parallel ends as we look to liquidity.

While Nucor is a model for moat-builders everywhere, Steel Dynamic's status is more … dynamic. Nucor boasts a $1.9 billion cash balance atop a $1.3 billion credit line, which in this Fool's opinion renders the company best-positioned to ride out even a protracted downturn to emerge as an iron-clad behemoth. Furthermore, I continue to encounter high praise of Nucor's management culture, whether from fellow CAPS members like blogger Dividends4Life or from enthusiastic Nucor employees themselves.

The impact of steel's cooling furnace, meanwhile, has impaired Steel Dynamics' liquidity position to a far greater degree, leading the company to warn that it might breach some loan covenants in the months ahead. Nonetheless, CEO Keith Busse conveyed confidence that debt waivers would be obtained as needed, which would mirror recent experiences from other debt-laden commodity plays like Teck Cominco and DryShips (Nasdaq: DRYS  ) . Intrepid investors are learning that covenant breaches don't necessarily lead directly to default.

Steel's softer cousin
Although aluminum production has not been curtailed as aggressively as steel, that marketplace is not looking much healthier. After striking out in the first quarter, Alcoa (NYSE: AA  ) is reportedly considering additional cuts beyond the 20% already executed, citing persistent weakness in automotive, commercial construction, and aerospace end-markets.

From within the rubble where a former aluminum sensation once stood, Century Aluminum (Nasdaq: CENX  ) continued a tragic comedy of errors last week with another earnings disappointment. The $115 million loss became even more difficult when CEO Logan Kruger indicated a willingness to expand existing production curtailments of 28% as market conditions warrant. If any other Fools are watching the indicators I'm tracking, you'll understand why I consider those added cuts a foregone conclusion.

Following the untimely removal of aluminum hedges, economic collapse in Iceland (where the company maintains operations), massive share dilution, class action lawsuits, and a jaw-dropping 96% retreat from the stock's 52-week high, the latest earnings miss writes one more horrid chapter in Century Aluminum's tasteless novel. With an estimated 1.4 million-tonne global aluminum surplus, and prices leaving little to no room for profit, I am concerned that similar tales have yet to be told.

The bigger picture
Without setting out to do so, my last several articles collectively have painted an undeniable portrait of an American industrial base being pressed further and further into the ground by the weight of this crisis. From decreasing freight volumes on the nation's railways, to worsening outlooks from leading coal miners, indications are mounting that the second quarter could be even uglier than the first. Corroborating observations from automakers, housing and commercial construction, oil and gas services, equipment manufacturing, and of course the makers of steel and aluminum have this Fool sounding the alert that a deeper wave of contraction awaits this beleaguered American economy.

Further Foolishness:

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Fool contributor Christopher Barker is the Nat King of Coal and the wild boar of iron ore. He can be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He owns shares of Peabody Energy and Teck Cominco. The Motley Fool's disclosure policy is busy learning Mandarin.


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  • Report this Comment On April 28, 2009, at 12:41 PM, Brettze wrote:

    As you might already be aware that manufacturers of computer printers are depending on the sales of highly profitable ink cartridges. Same can be said about heavy industry elsewhere that is highly dependable on fossil fuel sales. Many oil producing nations were willing to set up heavy manufacturing bases based on the premises that fossil fuel prices will continue to be high enough to subsidize the notorious money losing operations of their heavy industries. America which consumes one quarter of the world's fossil fuel production suddenly went cold turkey as the green movement roared on again. Ever new and novel green ideas mulitiply like Youtube clips you watch . Demand of fossil fuels "permanently" collapsed along with oil producing nations subsidization of heavy industry ( computer printer equivalent ) What I dont know is whether they will someday give up the idea of subsidizing the longer the fossil fuel prices stay low. Metal commodities is historically undervalued and abused toward the eyes of shareholders holding stock in those commodity producing companies like those you mention above. Automobiles are shedding weight like the "Big Losers" on TV. Owners of McMansions suddenly discovers that they dont really need to heat or cool the entire mansions let alone a few rooms and a hall or two. Utility bills are shrinking. Nobody is talking about drilling offshore anymore. Let me ask you which you would choose ... a pound of aluminium or a pound of chuck steak for valuation comparation... I would choose aluminium because of its durability, but at 60 cents a pound?? Why pay $3 lb for that cheap chucky steak after all? It should be reversed, right? Lets turn the table now!

  • Report this Comment On April 28, 2009, at 12:51 PM, Brettze wrote:

    The main reason metal prices remain low is because of metal thefts... People would suddenly rip metal wires, tubings you name it off unguarded installments everywhere.. Even bronze statutes would be ripped off.. Retail window framings may be the next craze! This is the trouble with high metal prices . I can understand that, but I ask you about the logic of investing in metal producing companies? There is no way anybody can continue to produce at 50cents -$1 a pound which is the same as 50 years ago. Everyone is still hoping that fossil fuel prices will rebound someday and that everything will return to normalcy as usual.. Dont count on it...I think more of us will choose higher metal prices over higher energy prices.. But what do we do with metal ciriminals?? Our governments show little interest in enforcing the scrap sales since they still believe that lower metal prices is benefical to economies. There is still lack of incentives ...

  • Report this Comment On April 28, 2009, at 12:57 PM, Brettze wrote:

    Automobiles could have been made with far more lightweight materials like composties , aluminium, etc. But fossil fuel proponents lack interest in reindustrializing automobile industries to facilitate changes in manufacturing and retooling plants for lightweight automobiles.. We are pretty content to depend on the same old steel and iron. Aluminium is making minor inroads but not much . The steel industry is well entrenched and not going to give an inch to the aluminium industry regardlessly of the inferior weight-performance comparisons.. They just dont care.. So we are still paralyzed in economies with full realization that fossil fuel prices will go up again once we start growing on the same old blueprints of the past... We are not transforming anything energy wise...

  • Report this Comment On April 28, 2009, at 2:34 PM, DiscoFinance wrote:

    Great point! This issue is exposed in a new movie (stockshockmovie.com). FYI: I used coupon code: FREESHIP for free shipping of the DVD.

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