How a Japanese Steel Firm is Trying to Dig a Moat

Bridget Freas: Hello. My name is Bridget Freas. I am an Equity Analyst with Morningstar on the basic materials team.

Joining me from Sumitomo Metals is Nobu Masuda with Investor Relations. Sumitomo Metals is a Japanese steel producer primarily serving the automotive, energy, and railway sectors in both the domestic market and globally. Nobu, thank you for being here.

Nobuaki Masuda: Thank you.

Freas: So just to start off, how would you describe your product offering relative to some of the other global steel companies?

Masuda: Okay, let me start with explaining this chart. We are basically 40 million tons steel producer, which is not as big as the biggest guy in the market such as Nippon Steel or ArcelorMittal. And we are different in terms of not only size, but also in products line.

The biggest difference is they are – Nippon Steel and ArcelorMittal are primarily in sheets, plates, long/shaped products, and their share of volume is 82% or 96% for ArcelorMittal. So they are in that area, but we are 55% for that product. The biggest difference is pipe and tubes, which consists 15% in volume and 30% in sales, and probably more than that in profit in a good year. That's how different we are from them.

Freas: Okay. Now you mentioned the pipe and tubes as being a much more profitable sector. How do you see demand in that product going forward and what is your strategy in that market?

Masuda: Let me explain first. The primary products in this area is – this is a chart of offshore drilling. This is called OCTG, and this is called Linepipe, and these are oil related business and this consists of 75% of our seamless pipe business. In that area, we have three categories.

This is our estimate of Global OCTG market, and 7 million tons is commodity, which could be manufactured by many, many manufacturers. 2.3 million tons is high-end products, and probably three to four companies can do that. For 0.7 million ton, we call it super high-end. This could be supplied by very small number of suppliers.

Our forecast is in those two categories. This might look very small to you. This is in volume, but because of the price difference for these three product, three categories, it looks like this in terms of value. This super high-end area is pretty big in value, and that's where we concentrate and that's where we are good at.

And our strengths over our competitors in those super high-end area. This vertical axis represents CO2 density within the well, and this horizontal axis represents H2S density in the well. And those two gases are very corrosive in a very high temperature, high pressure environment, and in those area, for example, you will need nickel alloy to develop a well. Using these doted lines our competitors can supply. But the whole thing Sumitomo is the only supplier who can do it, and that's the advantage we have over our competitors.

Freas:  And if we just take a step back and look at the global steel market, steel prices have declined dramatically, and profitability and shipping volumes have declined pretty much across the board for Sumitomo and other global steel producers. How are you preparing for the eventual upturn and what do you see the earnings recovery in the next several years?

Masuda: It's true that we incur the loss in '09 and our profitability forecast for 2010 is ¥80 billion, which is not very high. We have been planning to divest our production bases into emerging economies to counter – one, appreciation of the yen, and to take advantage of the growth market.

And that's what we are doing right now. So we have several projects overseas to make our service grow. So what we are doing right now is basically two fold. We are trying to introduce new products, new technology to differentiate ourselves, and that's what we have been doing for many years. And currently, what we are doing is to diversify our production base into the emerging economies and that's our growth strategy for the time being.

Freas: Okay. Nobu, thank you very much for being here today.

Masuda: Thank you very much.