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One Man's Broken Down Car is One Company's Treasure

By Reuben Gregg Brewer – Jan 21, 2014 at 11:19AM

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Controlling costs has been a key focus within the steel industry as a way to combat weak prices—overall results have been mixed, but here's one company that's still making solid headway.

Steel is a cyclical market that's stuck in a downswing. There's a fairly consistent pattern during the tough times and a big focus is always controlling costs. Industry heavyweights Nucor (NUE -1.58%) and AK Steel (AKS) have expanded their operations vertically to keep spending in check to mixed results. Schnitzer Steel Industries (SCHN -0.55%) has gone down a similar path, but appears to have found a growth niche along the way.

Key inputs
One of Nucor's key inputs is natural gas. It inked two deals with Canadian driller Encana (OVV 4.89%), providing funding for Encana's drilling efforts to lock in low prices for gas. The first of the two deals had been so successful that the second one seemed like a no brainer when it was announced in late 2012.

The only problem has been persistently low natural gas prices. The pair halted new drilling efforts about a year later. In the end, it will save Nucor about $400 million in capital spending in 2014. For Encana the halt isn't a big deal because Nucor is just one partner with which it works. AK Steel, meanwhile, has seen a similar stoppage, only in its company-owned coal mines.

Metallurgical coal is one of AK Steel's big costs, and to keep a handle on its spending it has been readying its own coal mines. While over the long-term that's a great idea, coal prices are relatively low right now. The company is still making progress on the opening of the first of three planned mines, but it's chosen to halt progress on the second and third mines.

AK Steel CEO James Wainscott points out that the "coal reserves aren't going to go anywhere" so it makes sense to stop. The same is true of the natural gas Nucor is trying to tap into. However, from an investor's point of view, it's not so positive to see these attempts at cost control floundering.

Still going strong
Schnitzer Steel appears to have selected a better niche for its cost control and expansion efforts—auto parts. That's not exactly the right way to look at the business, though, since what Shnitzer owns are really scrap yards. Old cars show up and are picked clean of usable parts, with customers doing most of the work. It's the same business that LKQ Corp (LKQ -0.57%) is trying to institutionalize.

During Schnitzer's fourth quarter conference call CEO Tamara Lundgren noted that the company added 12 new auto parts stores last year, increasing the size of the business by over 20%. Clearly the company isn't waiting for the steel market to improve to keep expanding this business. It is focusing on putting its auto parts stores near its scrap steel businesses. And that's the big benefit.

After making money by letting customers salvage auto parts off of junked cars, Schnitzer carts the empty husks off to its shredders so it can sell the rest of the metal in the car or use it in its own steel operations. Not only is that environmentally friendly, but it lets the company profit twice off of the same vehicle.

Interestingly, LKQ has been focused on rolling up just the scrap end of this business, since it is a largely fragmented industry. It's used acquisitions to build a portfolio of over 500 locations domestically and in Europe. The company's ability to build a profitable business in this space shows the potential of Schnitzer's foray—and the scale that could be achieved over time. It could also make LKQ an interesting acquisition target for a large scrap steel user.

While the diversification and cost control efforts at Nucor and AK Steel have stalled, Schnitzer's scrap yards haven't. The company doesn't have the size and scale of those two industry giants, but it might just have found a unique growth niche that will also help to give it a cost edge. Keep an eye on Schnitzer's auto parts business, it appears to be growing into a key asset.  

Giving your car to the scrap yards? Read this before buying a new one

Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends LKQ and Nucor. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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