The Fool's Rich Smith recently sat down with Scott Jones, president of steel processor NovamericanSteel (NASDAQ:TONS), for some insights into the steel industry -- including Jones' thoughts on MittalSteel (NYSE:MT), a major competitor and Motley Fool Inside Value recommendation.
Question: Can you give us a thumbnail sketch of your company?
Scott Jones: Novamerican is actually a group of 23 facilities, operating in three main business lines: steel tube manufacturing, steel processing, and general line distribution. We also operate a fabrication division that manufactures a variety of steel products, such as hardwood floor nails and heavy-equipment-loader buckets for the mining industry. Our business is about 60/40 Canadian and U.S., and we sell to everyone from the Big Three automakers -- Ford (NYSE:F), GM (NYSE:GM), and DaimlerChrysler (NYSE:DCX) -- down to your local town machine shop.
Q: We often hear that steel is a cyclical industry. The sharply higher steel prices we saw in 2004 and 2005 suggest that we're currently moving through an "up" cycle. Just how far along would you say we are on the latest upswing?
SJ: Well, I believe there are two types of cycles that are not necessarily related: the demand cycle and the supply cycle. Conventional wisdom suggests that cyclicality in our industry has always been defined by big fluctuations in demand -- which was true during the recessions of the early 1980s and early 1990s and of course during the upswing in 2004. However, since the end of the last recession, steel consumption has actually been steadily growing (give or take a few hiccups). Therefore, the extreme volatility in steel prices that has occurred over the past 13 years has been caused by fluctuations in supply.
Beginning in 2004, however, something changed. Our industry began experiencing the benefits of global growth, and specifically the tremendous demand for all commodities from China. In 2004, Chinese demand for steel and steel-related products (combined with healthy global growth almost everywhere else in the world) led to a rapid rise in hot-rolled steel prices from a low of $240 per ton to a high of $780 per ton. Today's price is approximately $640 per ton, which is much closer to the peak than to the trough.
The result of higher selling prices has been the financial improvement of individual steel mills worldwide, which has paved the way for the current ongoing consolidation of our industry. We now appear to be in a virtuous cycle that suggests the higher steel prices remain, the more profitable the steel mills become, and the more likely the consolidation continues -- which again will lead to more control over prices. The volatility will still exist, but it should be less extreme as the consolidation continues. I am hoping the floor for hot-rolled steel pricing will be in the $500 range.
Q: Ordinary Fools often don't have a lot of time to research stocks and are looking for just one or two metrics to watch to get a good feel for how well Novamerican is doing -- what would you suggest they watch?
SJ: Well, one of the questions we hear a lot from investors is why we carry so much cash on our balance sheet. It's a fair point, and we do need to put that cash to work. Investors should watch how we use that cash.
Our plan is to continue expanding our business as we have in the past, not through acquisitions but through greenfield projects. It can be really hard to compete with mom-and-pop steel service companies that aren't necessarily interested in making a profit, but just in generating income for their owners. So we need to focus on higher-margin business and use our considerable cash to move our business toward areas where both margins and barriers to entry are high. We'll be exiting lower-margin business and moving up the value chain -- that's how we can best use the cash to reward our shareholders.
Q: What is the most common misperception about the steel industry among investors?
SJ: Investors had it right until 2004. Overcapacity and underinvestment were the hallmarks of our industry. As my father always liked to say, steel companies wanted to make steel more than they wanted to make money. But now, times have changed, and the impact of the consolidation we're seeing is going to be very favorable. Consolidation should now allow the larger mills, specifically Mittal, to cut production at certain facilities in order to bring supply in line with demand. Mittal can make these cuts without having to worry about his financial viability.
Q: Hold on -- you're going to go out on a limb and utter the fateful words, "This time it's different"?
Is it different? Inside Value subscribers can read the complete interview with Novamerican president Scott Jones byclicking here. Not a subscriber yet? Take a free 30-day trial for full access to the service, including interviews, updates, discussion boards, and two new stock recommendations a month. Click here to get started.
Fool contributor Rich Smith does not own shares of any companies named above -- but if he did, he'd have to tell you. The Fool's disclosure rules are ironclad.
