For Subscribers

Get the complete article now!

TWST: Are there companies that should be allowed to fail?

Ms. Applebaum: Do you mean the trade barriers that exist between the United States and other countries, or trade barriers in the United States? The US steel makers are the lowest cost providers to the US market, and I don’t think that anyone debates that issue anymore. If there was free trade in steel throughout the globe, then overcapacity in other regions would be addressed quickly. In the US the imports issue becomes relevant one year in five; for the rest of the time, we need those imports to survive. But the problem is not that there are lower costs elsewhere; the problem actually is that everyone in the steel business uses exports as a supply relief valve when their own markets are declining. As everyone in our business knows, the marginal cost of production for an integrated steel mill is nearly free. So the issue is not that the US is higher cost — which is not true any longer — the issue is that everyone’s costs, at the margin, are virtually free, and everyone in the business tries to export their way out of their own demand problems before bringing operating rates down.

TWST: Michelle, why is investor sentiment so negative and is it equally negative to all segments of the industry?

Ms. Applebaum: I wouldn’t say that sentiment is unilaterally negative, but it’s pretty bad. There are two reasons for this, in my view, and the first is in terms of market capitalization. The industry has become so small that the returns on investment of time for investing human capital in the sector are difficult; even if you make money in the stocks, you cannot make a lot, given the size of the group. Second, because of this, the market tends to discount bad news before it happens and ignore good news. So I think when we were talking at the outset about the discrepancy between the commodity price performance and the equities’ performance, it’s partly because the good news simply isn’t believed. First quarter earnings, on average, for our recommended stocks came in 70% ahead of our forecast — and the stocks were virtually flat.

TWST: What will drive consolidation in the US steel industry, and what form should it take, in your view?

Ms. Applebaum: I would just ask Mike a question; I hear what he's saying about consolidation, and maybe that's the answer. However, I wonder why, when there has been consolidation like at LTV/Republic (NYSE:LTV) (I do not think you want to look at AK/Armco, because there's no carbon steel consolidation in that), you didn't see much benefit for the players. In the case of LTV, it was a disaster — they ended up in bankruptcy two years later and, from day one of the merger, you could see they lost market share. Therefore, I wonder if you have a fallacy of aggregation kind of problem with consolidation, where the individual companies that would effect the consolidation, like an LTV/Republic, were hurt. Maybe they did help the other companies by having fewer players in the marketplace; maybe it helped pricing overall. The problem is that the big customers do not like it. I think the reason that these managements are not acting is that anybody running a company today was in their formative years in 1984 when that happened. It was painful and protracted, and it certainly did not maximize shareholder value.