Steel Dynamics: Best in Class


NEW YORK ( TheStreet) -- Keith Busse, the CEO and one of the founders of Steel Dynamics ( STLD), owns the world's second largest collection of Corvettes. In fact, Busse set up his Corvette garage, which contains 60 of the classic Chevrolet sports cars, as a museum, and situated it directly across the street from Steel Dynamics HQ -- the better, perhaps, to jump into a Stingray and put it through its paces should the desire ever overtake him while sitting behind his desk.

As it happens, the former Nucor executive has another kind of hot rod in development, and, if it succeeds, Busse will once again have upended the steel industry and, investors and analysts say, very likely have added to the value of Steel Dynamics' stock.

It's called the Mesabi Nugget Project, it's a factory right smack in the middle of the Iron Range in northern Minnesota, and it makes a substitute for pig iron. If that doesn't sound like the sexiest thing in the world, maybe you need to think like a steeler.

Consider, first of all, that the manufacturing process used by Mesabi is an ultra-high-tech innovation developed with Japan's Kobe Steel and that the plant will be the first of its kind anywhere in the world. Consider, as well, that Steel Dynamics must now buy pig iron on the spot market, where the price for the raw material has become notoriously volatile, swinging as high as $1,400 a ton and as low as $400 within the last year and a half. Consider that the Mesabi project stands to make Steel Dynamics the only 100% vertically integrated steelmaker in the country other than that Big Steel blast-furnace icon U.S. Steel. (That is, if all goes according to plan, Steel Dynamics hopes it won't need to go to outside sources to buy any of its raw materials, thus controlling its costs). And, finally, consider that, by some estimates, the Mesabi project could end up adding more than $50 million to the company's annual bottom line.

That's a lot of dough -- and enough to cause investors to recalibrate the company's share value higher. "It's a differentiatable technology for them," Mark Parr, the metals analyst at KeyBanc Capital Markets in Cleveland, has said. "It has the potential to be differentiatable on valuation basis in the next few years. Steel Dynamics has been a pioneer."

Steel Dynamics -- based in Fort Wayne, Indiana, and founded after Busse and his mates defected from Nucor in 1993 -- can be considered the best in its class on a number of counts. Its management team, led by Busse (pronounced like "fussy") and his partners, Mark Millett and Richard Teets, who serve as presidents of the scrap metal and steelmaking arms of the company, respectively, is considered the most adept in the industry. They got their start, after all, building the first electric-arc mill in the world to fabricate sheet steel while at Nucor in the late 1980s, a process memorably chronicled by Richard Preston in The New Yorker and in the book American Steel.


Iron nuggets fresh from Steel Dynamics' Mesabi plant

Even outside the Mesabi Project (which sounds like it could be the title of an espionage thriller, starring Michael Caine), Steel Dynamics' technology is more leading edge and state of the art than its competitors. It's the lowest-cost steelmaker in the nation and likely the most efficient. The company can run its Butler, Indiana, mill -- the crown jewel of the company's plants -- at 25% capacity utilization and still turn a profit, which would be nearly unthinkable elsewhere. Thus, Steel Dynamics suffered only one quarter of losses during the recession, while its competitors spewed red across Wall Street like a group of zombies.

Partly that's because Steel Dynamics (learned from Nucor) has a workforce that's considered, once again, to be the best in the sector -- a nonunionized crew of young steelmakers who are paid basically on commission. That is, they get bonuses based on how many "heats" of steel they turn over in a day. "It's very different than the old legacy steel mills," says Rick de los Reyes, an analyst at T. Rowe Price in Baltimore. "The guys are very motivated, and they work hard."

T. Rowe doesn't own Steel Dynamics at the moment, as it turns out, having sold out its stake in order to take profits off the table. Reyes says the fund bought STLD stock when it was in the single digits back in early 2009 and rode it all the way to $18 early this year. Reyes points out that -- like all steel companies with mills that use scrap metal -- Steel Dynamics won't have the operating leverage of U.S. Steel, which produces its metal in the traditional way, with humongous blast furnaces that use iron ore as their chief feedstock. In an upcycle, U.S. Steel's profits get supercharged because its costs are largely fixed (the company owns its own iron ore mines).

Not so the mini-mill players, whose profits will be hemmed in by the rising price of scrap metal in a bull-running steel market. Thus, the stocks of Steel Dynamics and Nucor won't go as high as U.S. Steel's -- but nor will those companies bleed as much red ink in a downturn. Steel Dynamics, with its lowest-in-the land cost structure, is even more protected during bad times.

And that characteristic stands to improve once the Mesabi Project rolls into full-scale production. The company flipped the switch on the plant just in January after years of planning and construction alongside Kobe, which owns a 19% stake in the project.


The Mesabi Nugget plant, as it appeared while still under construction.

What comes out the other end of the factory is a pellet of super-concentrated iron, which the company will use as a feedstock in those electric-arc mills that produce flat-rolled sheet steel. Molten scrap metal -- old cars, mostly, and appliances, and the ruins of demolished skyscrapers, transmogrified into raw-steel lava by an enormous zap of electricity -- constitutes about 80% of mini-mill sheet steel. The other 20% is pig iron. Steel Dynamics' Mesabi nuggets will be a higher grade of iron than the pig iron available on the market. The nuggets melt faster, says Parr, "like putting a sugar cube in coffee, as opposed to an ice cube in a Coke." That melt rate means that Mesabi nuggets will reduce the energy needed to make steel by as much as 29%, the company estimates.

Mesabi will also free Steel Dynamics from the bonds of the pig iron market, a dicey business. After the collapse of Big Steel in the U.S., pig iron is now produced only in South America and the former Soviet Union.

To make its nuggets, Steel Dynamics needs iron ore, of course. That's why it acquired an old iron-ore mine, once owned by LTV, and built the Mesabi plant right next to it. The mine still has a half century of life in it (the company is in in the process of getting it permitted), and herein lies the rationale behind the whole thing. In the words of Fred Warner, Steel Dynamics IR man, "We wanted to assure ourselves of long-term supply at a reasonable cost."

The idea, too, of course, is to sharpen the company's competitive edge still more. According to some analysts' projections (Steel Dynamics hasn't given any numerical guidance on the matter), Mesabi could give the company $100 of cost advantage vs. its rivals for every ton of steel produced.

The plant is still ramping up, but the goal is to produce a half million tons of iron nuggets at the plant by next year. "We're making progress," Warner says. "But as with any new technology, you have your impediments." Indeed, most analysts expect some hiccups along the way. "A startup in the steel industry is a very difficult thing, and it's a long process," one analyst said. "But we think it'll work. It's just a question of when."

-- Reported by Scott Eden in New York

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