Tuesday, March 14, 2017

Steel Industry Finds Environmental Redemption

Smoke and blood is the mix of steel….

Steel barb-wire around The Works.
Steel guns in the holster of the guards at the gates of The Works.
Steel ore-boats bring the loads clawed from the earth by steel, lifted and
Lugged by arms of steel, sung on its way by the
clanking clam-shells.
The runners now, the handlers now, are steel; they dig and clutch and haul;
they hoist their automatic knuckles from job to job;
they are steel making steel.
Fire and dust and air fight in the furnaces;
The pour is timed, the billets wriggle; the clinkers are dumped.
Liners on the sea, skyscrapers on the land; diving steel in the sea,
climbing steel in the sky.

Smoke and Steel, Carl Sandberg

As Carl Sandberg described with such eloquence in the poem “Smoke and Steel,” production of steel is a highly consumptive affair, using vast amounts of energy, eating up raw materials and taking a toll on those who labor at the task.  The World Steel Association (WSA) indicates there were 1,621 million metric tons of steel produced in 2015.  As much as 40% of the cost of steel is related to energy.  The WSA estimates about half of the energy is sourced from coal, 35% from electricity and 5% each from natural gas and other gases.  Renewable energy sources have not made an appreciable entrance into the steel making industry.
To its credit, the industry has attempted to create efficiency in the steel making processes.  For example, by-product gases from the coke oven and blast furnace can be captured and re-used, reducing the need to buy additional fossil fuel.  Analysis of the German steel making industry suggests recovery of by-product gases saves as much as 300 million cubic meters of natural gas each year.
Now the steel industry is on the cusp of its first major technological innovation in decades.  This innovation also promises the dramatic energy efficiency, far outpacing the contributions of recycling gas by-products.

Image result for nucor castrip imageRecent improvements in materials science are making it possible to capitalize on a mass-production technique invented by Henry Bessemer over 150 years ago.  His idea was to cast strips of steel directly rather than as large ingots that are subsequently shaped into a final product by large rolling machines.  Bessemer wanted to pour molten steel between two counter-rotating rollers that would work much like a an old fashioned roller washing machine.  The water-cooled rollers would squeeze the metal into a sheet.  Unfortunately, the mechanics of the ‘twin rollers’ idea were an obstacle that has gone unresolved until recently.
Steel producer and recycler Nucor (NUE:  NYSE) has put Bessemer’s idea into action with its Castrip product.  The company touts the quality of Castrip steel as cast at or near its final required thickness.  This eliminates the need for additional hot or cold rolled reductions that add to cost and makes possible material properties that better meet customer needs.  Nucor is saving as much as 80% of the energy costs associated conventional steel making processes.  The company also claims the process requires a substantially smaller footprint, saving as much as 50% on land resources as well.  Nucor has begun licensing the Castrip process to other steel makers.
Investors with a mind to tap the source of energy efficiency and conservation could take a stake in Nucor.  The company posted a 11.2% return on equity in the year 2016 and converted 10.7% of its sales into operating cash flow.  Its shares are valued at 15 times times forward earnings and offer a dividend yield of 2.5%.   Analysts following Nucor expect significant earnings growth over the next couple of years, suggesting the ratio of price earnings to growth plus yield is at an attractive 0.70. 
 If a small-cap seems more appealing, Germany’s Salzgitter AG (SZG:  F or SZGPF:  OTC) is another steel maker adopting energy-saving processes.  Salzgitter is using a single belt caster, which casts liquid steel directly onto a single horizontally moving belt.  This process also allows for similar energy and resources conservation as Nucor’s twin-roller process.  The company has been widely recognized in Germany for energy efficiency.
Salzgitter delivers near 8.6 billion Euros in annual sales, earning an operating profit margin near 0.8%.  In the most recently reported twelve months the company reported a net loss, frustrating conventional valuation methods.   However, Salzgitter converts approximately 5.3% of sales to operating cash flow, providing internally generated resources for investment in new equipment and plant innovation.  Salzgitter is also consistent dividend payer.  The forward yield at the current price level is near 0.76%.
Salzgitter’s metrics may not be as attractive as Nucor.  However, Salzgitter’s environmental track record may be a bit shinier.  A position in SZG is thus a purer play on energy efficiency and environmental responsibility than NUE even as the fundamentals are not as attractive.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

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