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By Bridget Freas, CFA | 11-10-2011 12:00 AM

Steel Dynamics: Impossible to Ignore China

China's steel producers are becoming more disciplined, but they still have a major impact on the raw-materials and finished-steel markets, says Steel Dynamics COO Dick Teets.

Bridget Freas: I'm Bridget Freas with Morningstar. Joining me from Steel Dynamics is Dick Teets; executive vice president and COO for steelmaking. He is also one of the founders of the company less than 20 years ago, making Steel Dynamics one of the relative newcomers to the U.S. steel industry and it's grown to be one of the larger steel companies and metals recyclers in the U.S.

Dick, thanks for being here.

Dick Teets: Good morning. Thank you.

Freas: I would like to start off talking about the selling price of steel, which has been very volatile in the last few years, particularly for flat-rolled. Now, some of that volatility can be explained by the high cost of raw materials, iron ore, and scrap, but I'm wondering do you think there is anything else that's driving the shortened price cycles, and what has Steel Dynamics been doing to maximize profitability when your selling prices change so quickly?

Teets: I think some of the other influencing factors in the changing steel prices, from a sales perspective, are inventory levels and bank credit availability of the customers that buy from us and would normally carry inventories. Also the, I call it, panic-buying mode sometimes happens when people are watching the cycles because they have such short inventory cycles. When their inventories become maybe distressingly low, they have to go out and quickly buy and hope that it is at the bottom of the cycle. And when the prices start to rise, then all of a sudden the orders flow in.

I think the things that we do a little bit differently are that, number one, we understand it and we don't react in a manner that some of our competitors do because with our variable cost structure, our low cost structure, we can weather the storm better when our backlogs are shorter and so forth than we'd like. But needless to say, some of our competitors with fixed costs and large requirements to feed blast furnaces and basic oxygen furnaces have to go out and react a little bit differently, and we can sort of ignore that panic at the time.

Freas: Yeah, and you mentioned the cost structure. I think one of the things that has really stood out during the recession is how much profitability depends on your raw-materials cost base given that steel prices and raw-materials prices no longer move so closely in tandem. Steel Dynamics has made a number of initiatives on this front, first with Iron Dynamics, then the purchase of OmniSource, and now more recently with Mesabi Nugget. How do you think these things have changed the competitive environment? Do you feel that they give the company a leg up, or do you think these types of initiatives are becoming a must-have for any steel company to effectively compete?

Teets: Well, I don't know that it's a must-have, though many of our competitors have also started ventures not in as many different areas as we have but on a limited basis. I think it gives you a very strategic benefit whereas we're now involved in the scrap business. The scrap company that we own is OmniSource, and it supplies about 45% of what we consume, and we only buy maybe 43% of what it produces. So, it gives us a great opportunity. We're still out there in the market.

We're paying market prices, but it has afforded us, just like those customers I referred to in the first answer with lower inventory levels, it has allowed us to take our inventories down ahead of the mills. So, therefore, we benefit from that involvement. Mesabi Nugget and Iron Dynamics are both great projects that take us out of the scrap markets from that equivalency standpoint. We continue to invest, and we'll continue to invest in that backward integration.

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