So much for my powers of prognostication.
Last week, in the hours preceding Canadian steel processor Novamerican Steel's (NASDAQ:TONS) third-quarter earnings report, I keyed in on management's recently announced authorization to repurchase as many as 450,000 shares of its common stock. Noting how those shares had only gotten cheaper since the buyback was first announced, I suggested it looked more than likely that when earnings came out, "we'll see that Novamerican has already begun to implement the buyback." My bad.
The earnings are, of course, now out -- they arrived Wednesday afternoon. But rather than seeing fewer shares reported as outstanding, we saw the share count rise a modest 2.9%. Whether that means the company bought back some shares to mitigate the rate of dilution, or hasn't begun to buy at all, was not made clear in the earnings release. But if Novamerican hasn't yet begun to buy, I think I see why: The news Novamerican had to share was not at all optimistic, at least in the short term, and management may see the potential to scoop up its shares at an even better price in the months to come.
According to Novamerican, the announcements of production cutbacks at Ford (NYSE:F), GM (NYSE:GM), and DaimlerChrysler (NYSE:DCX) are taking a toll on revenues, with management attributing its decline in "tons processed" specifically to "a larger than expected decrease in automotive demand." And the situation looks set to get worse before it gets better.
Novamerican opined that across the industry, both steel service centers (i.e., companies like Novamerican, which add value to the raw steel produced by manufacturers such as Nucor (NYSE:NUE), Mittal (NYSE:MT), or U.S. Steel (NYSE:X)) and the manufacturers themselves appear to be holding higher levels of inventory than demand would justify. In part, this owes to the depressed automotive industry; in part, it's due to more steel than expected being imported.
Now that the excess steel's here, though, there are really only two ways to work through the glut. Either the U.S. auto sector must undergo a spectacular rebirth, reviving the demand side of the equation, or else steelmakers and steel importers must bite the bullet and rein in production while the industry sells down its inventories. Either solution will take time to play out -- Novamerican says we can expect to see high inventories through the end of 2006. If that's true, sales will continue to slump. Profits may as well, if sellers grant price concessions in the interests of moving inventory. Both of those possibilities seem likely to depress prices of steel companies (and steel investors), giving Novamerican an even better price at which to implement its buyback.
Are three months too short a view for you? Want to know the long-term future of the steel industry? Check out what Novamerican president Scott Jones had to say on the subject in our recent Foolish Interview, "Building a Future From Steel."
For more Foolish reading:
- Foolish Forecast: TONS of Earnings Fun
- Foolish Forecast: Same Old Novamerican Steel?
- Nucor Coulda Stayed Home
- Trying to Tie the Knot With Steel
Mittal is a Motley Fool Inside Value recommendation. To learn about other companies that have great growth opportunities, try a free 30-day trial here.
Fool contributor Rich Smith does not own shares of any company named above. The Motley Fool has a disclosure policy as strong as steel.
