This Japanese Steelmaker Is Red-Hot

Slashing costs has allowed JFE to become a global player again-and big price hikes are coming

Five years ago, production at the massive Ogishima steelworks slowed to a crawl, with supplies of steel exceeding sluggish demand as Japan's economy faltered. Monthly output was slashed by nearly a third, shifts were cut, and the plant's tin-plating operations were dismantled and shipped to China. But these days, the island in Tokyo Bay that's home to the mill is a hive of activity. Australian ocean freighters disgorge tons of iron ore onto conveyor belts leading to Ogishima's 105-meter-high blast furnace. A bit farther on, glowing one-ton ingots of steel thunder down rollers to be pressed into thin sheets. And at the far end, forklifts pile giant coils, sheets, and pipes onto trucks. "We're running flat-out for the first time in years," says Ryoji Tanaka, a plant official.

The surge of activity at Ogishima is yet another testament to soaring demand for steel stoked by China's manufacturing machine. But it also marks a turnaround in the fortunes of JFE Holdings Inc., which owns the plant. JFE -- short for the cheerful "Japan Future Enterprise" -- is the product of a 2002 merger of the struggling Kawasaki Steel and NKK steel companies. The combination is the world's No. 4 steel producer, and Japan's No. 2. Although many such mega-combos have foundered, JFE has consistently met -- or beaten -- its ambitious targets for earnings and production. "Our initial goal was reaching full capacity, but we've gone way beyond that," says JFE President Yoichi Shimogaichi, who had been CEO of NKK. "Some of our production lines are running at 120% of normal capacity."

HIGH-GRADE AT LOW PRICES

That efficiency has translated into earnings. Whereas Nippon Steel Corp. -- Japan's No. 1 producer -- once towered over the industry, JFE has emerged as a strong rival. For the year ending in March, JFE expects to earn $1.4 billion on sales of $27.4 billion, up from profits of $1.0 billion and sales of $23.9 billion last year. From just 6% in 2003, JFE's operating margins this year are expected to hit 15.8%, making it Japan's most profitable steelmaker, although JFE still lags behind Korea's Posco, which had margins of 25.5% last year. JFE's return on assets, meanwhile, is expected to reach 12% this year, up from 3.6% in 2003. Debt is projected to fall to $14.4 billion this year, down from $20 billion in 2003.

JFE's strength is the high-grade steel used to make cars, appliances, and the like. Although better grades generally command a premium, in Japan these days high-end steel is selling for about half the price of the lower-quality stuff used in construction. That's because commodity-grade steel is sold on the spot market, where prices have soared, while high-end steel is locked into longer-term contracts -- many dating back to when prices were much lower. Yet this year, JFE and other steelmakers will probably raise prices for higher grades as those old deals begin to expire, allowing them to largely cover rising costs for raw materials.

Even as profits have soared, JFE has kept an eye on costs. One of the first decisions by the combined company was to close two of its 11 blast furnaces in Japan. JFE has also shuttered a dozen inefficient lines for rolling and shaping steel -- about 15% of the company's capacity. In addition, it has cut the workforce by 9%, to about 47,000, and expects to trim that to 44,600 by 2006. All told, JFE has cut costs by about $1 billion since 2003. "The majority of JFE's earnings gains so far are coming not from price hikes but restructuring moves," says Atsushi Yamaguchi, an analyst at UBS Securities (UBS ) in Tokyo.

JFE has also used the best brains in each of the merged companies to revamp procedures and processes. The new leadership team transferred NKK managers to Kawasaki production lines and vice-versa in an effort to break down fiefdoms. While many groused about the reshuffling, the result was a redistribution of knowhow that spurred innovation. For example, NKK adopted a time-saving Kawasaki technique that uses ramps and trucks to get raw materials to the blast furnace instead of cranes. And Kawasaki-run plants now use an NKK-pioneered process to control the temperature of hot-rolled steel on its production lines. "The biggest synergies are coming from sharing technology," says Shimogaichi.

Kawasaki and NKK were reluctant partners. Once bitter rivals, they were effectively forced together as the unwinding of Japan's keiretsu -- networks of companies that typically favor other members of the group with steady sales at a hefty profit -- led to increased rivalry at home. Neither company could count on selling to its partners anymore, because Nippon Steel was aggressively courting the most profitable Japanese manufacturers. Nissan Motor Co. (NSANY ) Chief Executive Carlos Ghosn wrote recently that fellow keiretsu member NKK was livid when informed that the carmaker would no longer give it preferential treatment, prompting Shimogaichi to gripe: "How dare you? Toyota would never act in such a way."

STEEL SHORTAGES

That was a time when the price of steel was so low auto makers could shop around for the best deal. Now steelmakers have the upper hand as car manufacturers scramble to come up with enough steel. Nissan, for instance, was forced to cut output in Japan by 25,000 vehicles late last year because of steel shortages, and it expects to delay production of another 15,000 cars in March.

Their new leverage will probably allow JFE and other steelmakers to raise prices, but JFE still faces risks that could cap profits. Among these are slowing growth in Japan and the possibility of lower sales to China. Demand for cars there is cooling, even as Chinese steel producers ramp up production (although they mostly produce lower-grade steel). And while JFE benefits from a strong yen -- it makes the raw materials the company imports cheaper -- the currency's appreciation could hurt the sales of the big auto and electronics exporters that are its best customers.

Perhaps the biggest threat to JFE's new prosperity is overproduction. Unable to meet demand for top-quality steel, JFE is considering building a new plant in China near factories owned by Japan's big auto makers. "We can't focus on belt-tightening forever," says Shimogaichi. But its Japanese, Korean, and Chinese rivals are also looking to expand. If demand softens, as it inevitably will, so will everyone's bottom line. For now, though, JFE's merger of hesitant partners is paying off. So it may well be some time before the Ogishima steelworks goes quiet again.

By Chester Dawson in Kawasaki

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