US Steel has announced at 49.9% stock acquisition, with an option to acquire the remaining 51.1% within the next four years, in smaller rival US flat products new entrant Big River Steel.
In its announcement, US Steel labelled this acquisition, alongside its investment in Mon Valley and Gary Works, as the third of its market-leading, differentiated and technologically advanced North American assets. They also noted they are looking for ways to extract incremental value from their iron ore pellet assets.
US Steel/Big River tie up makes strategic sense
Analysts agree that this deal makes strategic sense and we see this partnership as beneficial to US Steel, subject to some risks. One risk is financial; US Steel is increasing debt at a time when steelmaking capacity is increasing, and demand growth is limited. Ultimately, success will lie in Big River Steel’s ability to maintain its low fixed cost operating model, high productivity and high profitability under the new ownership structure. With new EAF-based flat rolled production being built in Arkansas, Kentucky, Ohio and Texas, we foresee a rush for talented operators. The team at Big River Steel - often recruited from other steelmakers - joined with a promise of being ‘rebels’ or market disrupters in a highly entrepreneurial enterprise. We expect the new owners will want to ensure the advantages of such a team and philosophy persist as part of the value they have bought into.
A time of structural change in the American steel industry
CRU has previously highlighted the need for integrated mills to change their operating practices and we have discussed this view with numerous clients over several months. This discussion comes as clients throughout the supply chain, including steelmaking raw materials suppliers, mills, distributors and manufacturers continue to think about the current investment cycle in steelmaking capacity. By 2024, the US is expected to see 7 million tonnes of new EAF-based sheet capacity while the Mexican market will see 6 million tonnes of new hot strip rolling capacity in 2021.
With this capacity coming online, we continue to forecast HR coil prices at below-average historical levels. Indeed, our October 2019 forecast of HR coil for 2022-2024 on average is $570 /s.ton, well below the $620 /s.ton average in 2004-2019. This view of low prices, given increased supply, suggests that margins at integrated mills will be challenged, and more so than those of EAF-based mills who will continue to benefit from their advantageous variable cost structure.
This strategic move by US Steel is the second bold step taken to prepare the company for a challenging new market environment. The first was a billion-dollar investment in the Mon Valley Works - an outlay in emissions control improvement but primarily, one in endless casting and rolling. When optimized, this mill is expected to lower their liquid steel to HR coil conversion cost.
Big River Steel will provide incremental benefits to US Steel
First, Big River Steel will be a vehicle for US Steel to smooth profits throughout the cycle. The upside of this is limited now as the company only has 1.5 Mt of capacity today, while US Steel has over 15 Mt of sheet capacity. But Big River Steel is in the process of adding another 1.5 Mt of capacity which we expect to be running by the end of 2020.
Second, US Steel will contribute their research and development experience as well as intellectual property via cross-licensing agreements. This is expected to allow Big River Steel to produce more advanced grades and perhaps including the highest grades of steel products ever produced at an EAF-based mill over the next few years.
Third, this transaction will eventually consolidate the market somewhat as it cuts out an independent competitor, though the near-term benefit to pricing power is limited given up to 7 Mt of new EAF supply coming online over the next few years.
US Steel average operating costs to be lowered by acquisition
CRU’s USA HRC cost curve shows that, on an operating cost basis (costs associated with raw materials, conversion and fixed costs), Big River Steel’s mill is lower cost than the nearby Granite City Works, but higher cost than US Steel’s other integrated mills.
Big River Steel does not disclose their financials publicly; however, analysis of other mini mill producers demonstrates that these producers realise higher EBITDA margins than integrated producers. Despite higher operating costs, Big River Steel and the mini mill sector in general benefit from lower capital intensity, lower resultant capital costs, and lower non- core costs – such as pension plans and other legacy costs. This cost structure at Big River Steel should allow US Steel to realise more consistent EBITDA through the cycle, especially once the capacity expansion project is finished and is operating at a high utilisation rate.
Big River Steel does not disclose their financials publicly; however, analysis of other mini mill producers demonstrates that these producers realise higher EBITDA margins than integrated producers. Despite higher operating costs, Big River Steel and the mini mill sector in general benefit from lower capital intensity, lower resultant capital costs, and lower non- core costs – such as pension plans and other legacy costs. This cost structure at Big River Steel should allow US Steel to realise more consistent EBITDA through the cycle, especially once the capacity expansion project is finished and is operating at a high utilisation rate.
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