Mittal Price Squeeze in $960 Billion Steelmaking Industry

Lakshmi Mittal
The U.K.’s richest person Lakshmi Mittal can’t stop his iron-ore suppliers from raising prices and can’t pass on higher costs to customers like Volkswagen AG, after the Luxembourg-based company’s market share fell to its lowest since 2009. Photographer: Peter Foley/Bloomberg

Lakshmi Mittal, whose $46 billion takeover in 2006 created ArcelorMittal as the world’s largest steelmaker, is getting pushed around.

The U.K.’s richest person can’t stop his iron-ore suppliers from raising prices and can’t pass on higher costs to customers share like Volkswagen AG, after the Luxembourg-based company’s market fell to its lowest since 2009. The company’s stock slid to a record today, and yields on debt issued this year are close to their highest relative to benchmark bonds.

Even after years of consolidation, today’s five biggest steelmakers including ArcelorMittal and South Korea’s Posco control no more than 19 percent of the $960 billion global market, too little to defend their prices. In contrast, BHP Billiton Ltd., Vale SA and Rio Tinto Group mine about 63 percent of the world’s iron ore exported as the main ingredient in steelmaking, while the five biggest automakers that buy ArcelorMittal’s steel make about 51 percent of the world’s cars.

“They really are between two behemoth industries,” said Tim Cahill, an analyst at J&E Davy Holdings Ltd. in Dublin. “They are just one cog in a chain between large suppliers and customers and they are just the middle man with no pricing power.”

ArcelorMittal reported an operating margin of 5.2 percent last year, compared with 49 percent at Vale, the world’s biggest iron-ore exporter. The steel company’s 500 million euros of 4.5 percent bonds due 2018 yield about 380 basis points more than benchmark German government debt. The gap was at a record 387 basis points yesterday, Bloomberg Bond Trader prices show.

European Pinch

ArcelorMittal today dropped 2.7 percent to 10.87 euros by the close in Amsterdam trading, the lowest since the 2006 merger. The Bloomberg Europe Steel Index declined to the lowest since August 2004, as Germany’s largest steelmaker ThyssenKrupp AG dropped 3.7 percent.

Spokesmen for ArcelorMittal, Rio and BHP declined to comment when contacted by Bloomberg News. Vale’s press office in Rio de Janeiro declined to comment.

The global pinch is sharpest in Europe. The Bloomberg Europe 500 Steel Index has dropped 80 percent in four years, the worst performance of the 37 industry groups tracked by Bloomberg.

ArcelorMittal is fighting to increase its market share from 6.2 percent last year as the industry faces a 1.8 percent earnings-growth forecast in the next 12 months. That compares with an average 6.7 percent among Europe’s largest 500 companies tracked by Bloomberg.

Mittal has seen his market share eroded by the financial crisis, slipping from 9.5 percent in 2006, when he created a steelmaker with $88.6 billion in annual sales, according to data compiled by Bloomberg. ThyssenKrupp said May 15 that earnings were being curbed by “intense competition” in the steel industry.

‘Party Hangover’

Global steel capacity use is about 80 percent, according to Macquarie Group Ltd., a level too low to give steelmakers pricing power.

World steel demand growth this year is forecast to slow to 3.6 percent from 5.6 percent last year and in Europe there may be a 1.2 percent contraction as the sovereign debt crisis saps purchases. Europe “remains a live concern,” ArcelorMittal’s Chief Financial Officer Aditya Mittal said last month.

“We are still suffering from the party hangover from the 2005 to 2008 years,” said Christian Georges, a London-based analyst at Olivetree Securities Ltd. “It was a once-in-a-lifetime situation where the steel suppliers had the upper hand on desperate buyers.”

CFO Aditya Mittal, Lakshmi Mittal’s son, said on a conference call last month that the industry has “room to do better” on supply discipline, while ThyssenKrupp said industry price discipline was “weak.”

Mittal Versus Chinese

ArcelorMittal “gives one the impression that there is a relatively high degree of consolidation,” Georges said. “The truth is that one big guy can’t change the logic of the industry. What does change it is when you have an oligopoly of three or four guys.”

Under Mittal, the 61-year-old chairman and chief executive who began his industrial career in his parents’ steel company, the company trimmed output about 20 percent from the 116 million metric tons produced in 2007, while Chinese mills have more than doubled volumes since 2004 to 684 million tons last year.

Global steel sales totaled about $960 billion in 2010, according to a report by Research & Markets, a Dublin-based research company.

Rio Tinto, Vale and BHP posted record operating profit last year, driven by earnings from their iron-ore units. Steelmakers have struggled to adapt to changes in raw-material pricing introduced two years ago as mining companies ended a decades-old system of annual contract talks in favor of quarterly accords or spot pricing.

‘Upper Hand’

That means steelmakers have lost the ability to negotiate the price of their biggest cost base, eroding margins as too much steelmaking capacity and competition for sales makes it difficult to pass on cost increases to their customers.

“There’s no doubt that having three guys controlling the world’s low-cost iron ore means that they have the upper hand,” said Georges. “They can accelerate or slow down their supplies and they will dictate the price level.”

To be sure, ArcelorMittal has focused on buying and building its own iron-ore and coal mines to reduce dependence on the biggest producers. The company plans to produce 100 million tons by 2015, up from 54 million tons last year, as it taps mining assets in countries including Canada, Brazil and Liberia.

Input Costs

“Steel production is essentially a conversion business now, and the days when raw materials made up only 30 percent to 35 percent of costs, compared to 75 percent to 80 percent now, are long gone,” Macquarie Group said in a May 14 report. Given weak demand and overcapacity, “the coming months and even years are set to see relatively tepid price action and thin steelmaker margins.”

ArcelorMittal’s average steel selling price at its Flat Carbon Europe unit, the company’s biggest business by sales, was $861 a ton in the first quarter, down from $928 a year earlier. The unit reported earnings before interest, tax, depreciation and amortization of $17 a ton in the first three months of 2012, down from $64 a year earlier.

European steelmakers have lost about three-quarters of their value from the industry’s pre-crisis peak in 2008. That compares with a 35 percent decline by the automakers from a 2007 high, and a 48 percent drop for mining companies from a 2008 peak, based on the Bloomberg World Auto Manufacturers and Bloomberg World Mining indexes.

“Unfortunately they are just the price taker in this, with customers who are very consolidated and suppliers who are probably the biggest oligopoly in the world,” said Cahill. “It’s hard to know what is going to change.”

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