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Steel companies finally getting control of costs

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Nigel Treblin | Getty Images

I noted this morning that Schnizter Steel (SCHN) had raised its earnings guidance to $0.28-$0.32 versus Street estimates of $0.20 (excluding restructuring charges); after a horrible month for steel companies, SCHN is one of the outperformers today, up 5 percent.

Schnitzer has a steel mill in Oregon, but it is predominantly a scrap metal company. It produces reinforcing steel bars (REBAR) which are used as reinforcement in commercial buildings. The implication is that the nonresidential construction market is picking up in North America.

But the big trend is steel companies are finally getting their arms around the need to deleverage, consolidate and restructure. In 2007 and 2008, the previous peak, there was also a lot of consolidation, because balance sheets were flush. After that, the global financial crisis left many companies with high degrees of leverage and lower demand. Many companies became unprofitable.

The mantra for the past five years has been deleverage, cut costs and restore positive free cash flow.

It has taken a long time. The biggest problem is demand growth has been slow. The second problem is the high degree of operating leverage in steel. It's hard to maintain a positive free cash flow when capacity utilization rates are so low...right now it's in the high 70 percent range. A lot of steel companies can't generate a positive free cash flow when their plants are operating below 80 to 85 percent capacity, so this is a problem.

The answer: More consolidation. ArcelorMittal (MT) bought a new mill, AK Steel and Nucor and Steel Dynamics all bought mills recently.

Some are exiting the market: AK Steel and Steel Dynamics purchased Severstal's asets, a blast furnace in Dearborn, and a mini-mill in Mississippi. ArcelorMittal and Gerdau sold a mill they jointly operated in Kentucky to Nucor.

It's not all great news for steel companies. The strong dollar is a big headwind for steel companies exporting abroad.

But progress is being made. Look at US Steel (X). With a new CEO, Mario Longhi, who came in in October 2013, the company is finally starting to turn around. The stock jumped two weeks ago when it announced Q3 earnings would be higher than expected. It has been aggressively cutting costs; one trader told me that every 1 percent cut in costs translates into $1 in earnings. Last year, with $850 million in EBIDTA, the company found $400 million in cost savings; that's a 50 percent addition to EBIDTA. The current estimate is for US Steel to earn $1.15 in the third quarter.

At that rate, it could earn $6.00 next year. The Street is currently at $3.20.

  • Bob Pisani

    A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

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