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Meet the Street: Steel's Last-Minute Pardon

The battered U.S. steel industry got a much-needed reprieve from President Bush on Tuesday when he imposed tariffs ranging from 8% to 30% on steel imports over the next three years. The tariffs are designed to help save a domestic industry that has seen 28 bankruptcies in the past four years and competes with a glut of steel supply across the globe.

Clay Hoes
Senior Analyst,
American Express Financial Advisors
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Glen J. Buco

Clay Hoes, a senior analyst with American Express Financial Advisors, says these tariffs most likely will benefit smaller steel manufacturers, known as the mini-mills, as well as other steel companies that are struggling the most. And even though the U.S. steel industry has been through a great deal of turmoil in recent years, Hoes believes these tariffs will embolden it to raise prices.

These tariffs should allow U.S. steelmakers to raise prices, but their customers in the automotive and construction industries should take heart, Hoes is quick to add. That's because the tariffs and higher prices should guarantee that their steel suppliers will remain in business, at least in the near term, he says.

Read on for more of Hoes' take on the new tariffs.

TSC: Which U.S. steel manufacturers stand to benefit the most from these new steel import tariffs?

Hoes: Hard to say who wouldn't. They're all going to benefit. But the ones that are the marginal producers, which would include Bethlehem Steel (BS) and Wheeling-Pittsburgh Steel (WHX), are the ones that benefit the most because they are close to bankruptcy. Because this is a resuscitating event, they will participate on the upside much more than a U.S. Steel (X) would. U.S. Steel is a survivor, whereas these other two will either be acquired or shut down. So from a volatility perspective, there's a higher beta associated with the marginal producers.

But there's a flip side. The mini-mills, the low-cost producers, also benefit because the elimination of foreign competition will allow them to raise prices. They're all going to raise prices together. For the mini-mills, because they're the low-cost producers, their margins are probably going to be enhanced the greatest.

TSC: If U.S. steel manufacturers raise their prices as a result of these tariffs, what will this mean for their customers, namely the automotive and construction industries?

Hoes: Steel customers are certainly concerned. Caterpillar (CAT) already came out with their disapproval of the tariffs.

But, they can take solace in the fact that this pretty much ensures their suppliers will continue to be in business, which has been a concern of the steel industry's customers. Between these new tariffs, the increase in defense spending and the highway bill, it looks pretty certain that there will continue to be demand for steel over the next few years.

Steel consumers realize something had to be done, that this bill is a compromise and that at least it guarantees them a secured steel supply. It's like an insurance premium being paid, to ensure that their suppliers will continue to be in business.

TSC: While it may be true that having a guaranteed contract from a steel supplier is a concern for steel customers, there is a tremendous glut of steel. Boston Consulting Group estimates that around the world, only 72% of steel production is used. Why is there such a glut?

Hoes: Because we've allowed the industry to exist for a longer period of time than should have been the case. And I guess what I'm more surprised about is why the bankruptcies didn't occur sooner.

TSC: Why hasn't there simply been consolidation in the industry to correct this overabundance in supply? Is it because there are so many retired steelworkers receiving pensions, which are generally known as "legacy liabilities"?

Hoes: There simply hasn't been consolidation in the industry because of high-cost manufacturing and, yes, these legacy liabilities. As a consolidator, the last thing you want to be doing is increasing your ratio of retirees to active employees. For the industry as a whole, it's 5:1.

TSC: So which steel companies do you follow, and what is your general outlook for them overall?

Hoes: I follow the mini-mill steel companies, and we are favorably disposed to them. Nucor (NUE) is one that we like. They've been an acquirer in this period -- of assets without unions. They've steadfastly remained a nonunion shop.

TSC: In sum, how important would you say this tariff bill is for the U.S. steel industry?

Hoes: It will help the mini-mills and marginal companies improve their margins immediately in the short term, while sending a clear memorandum of understanding to the European Union and the rest of the world that we are concerned about the oversupply of steel. We are telling them that we are taking the reduction of steel seriously, we've already got foreclosures and bankruptcies, and we are not going to allow foreign steel to continue to come in. They've got to begin working on this in their own countries right now.

At the same time, Bush did not impose onerous quotas on countries that have helped us in Afghanistan. So, when you look at this whole thing, he's tread a lot of political fine lines very carefully, including sensitivities to the automotive and construction industries. And it should make a difference to the steel industry.

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