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Is this a Fight that U.S. Steel Can't Win?

By Reuben Gregg Brewer – Feb 19, 2014 at 10:41AM

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U.S. steel makers are using trade cases to take on low-priced steel imports, do they risk losing the war even if they win a few battles?

Steel makers have been complaining that the U.S. market is the dumping ground for foreign steel makers. The typical route to deal with this is a trade case, which is the course the industry is taking. However, a changing world may finally be catching up to steel, and AK Steel (AKS) and Allegheny Technologies (ATI 2.32%) could turn out to be the canary in the coal mine.

Too much steel
Nucor (NUE -0.37%) CEO John Ferriola believes that the U.S. steel industry is, "among the lowest-cost producers of steel in the world." It should be hard to compete with efficient producers such as Nucor. That's why, during the company's third quarter conference call, he openly wondered how, "...imports of steel into the United States are on pace to again exceed 30 million tons this year or approximately double the 2009 level."

That's a problem because imports have kept U.S. steel makers at relatively low utilization levels. Owning and operating steel mills costs a lot of money. Running at 80% of capacity costs just about as much as running at 90% capacity. What changes is a steel maker's profit margin, meaning there's less cash hitting the bottom line for every ton produced. That's a double whammy, earning less per ton as a result of lower sales.

A chief culprit is China, which Nucor's Ferriola says has at least 300 million tons of, "excess steel capacity." AK Steel CEO James Wainscott was even more specific when he stated that, "we've seen America become the world's dumping ground for electrical steel." That's why AK Steel and fellow electrical steel maker Allegheny Technologies are working on trade cases that would put sanctions on those found to be dumping this specific type of steel.

A changed world
That's the typical approach in the steel industry, and many others, but is it an increasingly risky tactic in an increasingly global world? The U.S. electrical steel market is getting smaller, focusing around just a few major players. The list includes multinational companies such as ABB (ABB -0.16%) and General Electric (GE 0.22%), among others.

Therein lies the risk. ABB and GE can simply move production to other countries, specifically those with which the U.S. has free trade agreements, allowing them to continue buying foreign electric steel. There would be little impact on their businesses, but such shifts would materially reduce AK Steel and Allegheny's U.S. customer base.

But that's not the only problem. Smaller customers that can't move production will be forced to buy price-protected, and presumably more expensive, U.S. made electrical steel. That will put them at a competitive disadvantage compared to giants like GE and ABB. This dynamic could lead to even fewer customers if the smaller players are forced to exit the market.

Nothing to fear, yet
To be fair, there's likely no reason to be fearful just yet. The near-term impact of winning a trade case will probably be beneficial to the top and bottom lines at Allegheny and AK Steel. However, this is an issue to watch closely. Just ask tech industry giant, International Businesses Machines (IBM 0.21%), about the impact of globalization.

This one-time typewriter company has shifted its business model many times over the years. Most recently its been exiting the hardware market. For example, it sold its personal computer business to Lenovo a decade ago, furthering IBM's push into software and services. Now, the tech giant is looking to sell Lenovo its low-end server business, as well. These businesses once fueled IBM's growth, but foreign competition has reduced their profitability.

Can U.S. steel change with the times?
So, as U.S. steel companies use trade cases to take on foreign competition, it's worth considering if the industry is sowing the seeds of its own demise. And, while IBM has shown its resilience through time, can U.S. steel makers make the same dramatic shifts? If you're investing for tomorrow, don't worry about this issue; but if you're investing for the next decade you shouldn't ignore the risk.

It's not a game of darts...

Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends Nucor. The Motley Fool owns shares of General Electric Company and International Business Machines. 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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Stocks Mentioned

IBM Stock Quote
$146.49 (0.21%) $0.31
General Electric Stock Quote
General Electric
$85.66 (0.22%) $0.19
AK Steel Holding Stock Quote
AK Steel Holding
Nucor Stock Quote
$146.99 (-0.37%) $0.54
Allegheny Technologies Stock Quote
Allegheny Technologies
$28.63 (2.32%) $0.65
ABB Stock Quote
$30.87 (-0.16%) $0.05

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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