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Schnitzer Steel Industries (SCHN) recycles junk items such as old cars, old rail and home appliances and sells the resulting scrap metal to original equipment manufacturers and steel mills. SCHN also uses some of its scrap to make basic steel products such as steel girders, railings, and fence wire. SCHN additionally operates scrapyards which it uses to sell salvageable automobile parts to individuals and body shops before their source autobodies are shredded and refined. The parts are worth more when sold as automobile components than as shredded metal, so it is more profitable to sell them before automobiles are recycled.^[1]

Like most other companies in the United States steel industry, SCHN is sensitive to changes in the price of steel. When steel prices rise, the company benefits, because the "junk" that it recycles doesn't necessarily increase in price. On the other hand, falling steel prices can negatively affect the company's profitability because revenue drops while the cost of acquiring source materials remains constant. The 2008 subprime morgage crisis combined with the 2008 financial crisis have reduced steel demand by decreasing new construction, automobile production, and lowering consumer demand for home appliances. ^[2]

Contents 1 Company Overview 1.1 Business Financials 1.2 Business Segments 2 Key Trends and Forces 2.1 SCHN's business rises and falls with steel prices 2.2 International Sales Sensitive To Changes In The Value Of The US Dollar 2.3 Government Regulations Have Potential To Severely Harm Profitability 3 Competition 4 References

[edit] Company Overview

SCHN is at its heart a steel recycling business. Although it operates segments that sell auto parts and manufacture basic steel products, over 80% of company revenue in 2007 was produced by converting metal waste into recycled steel. The company buys waste metal from a myriad of sources ranging from railroad companies selling old rail, tow companies selling automobiles, to individuals recycling home appliances. In the case of vehicles, SCHN first sells usable parts to body shops and individuals before recycling the vehicles' remaining metal components. Once usable parts have been removed, SCHN shreds the automobiles along with other sources of waste metal into smaller pieces, often about the size of a fist, then sorts the pieces by composition. Most of the metal scrap is then sold to third party manufacturing companies, but the remainder is manufactured by SCHN into basic steel products, such as rebar and steel wire.^[3]

[edit] Business Financials

Although SCHN's processing facilities are located in the United States, the majority of the revenue produced by SCHN's Metal Recycling Business, approximately $750MM in 2007, is made by selling scrap metal to customers in Asia. By comparison, MRB's North American operations accounted for only $640MM.

[edit] Business Segments

Auto Parts Business (8.8% of Revenue, 9.8% of Operating Income) This segment purchases automobiles in poor condition and sells their parts. Schnitzer purchases vehicles from a variety of sources, including tow companies, charities, auto-auctions, and individuals.

Auto Parts Business (APB) operates both full service and self service parts stores which focus on sales to different markets. Full service operations pull parts from autobodies and inventory them, so that they can be purchased by remote body shops and service stations for reduced prices. APB tests and cleans the parts before they are shipped by truck to customers. Self service operations typically sell to individual customers who locate and remove parts from autobodies themselves. Although parts sold to both full and self service customers are priced significantly lower than their new counterparts, it is still more profitable for SCHN to sell use parts from automobiles before recycling them. In 2007, Schnizter operated 35 self service locations and 17 full service locations.^[5]

Metal Recycling Business (76.2% of Revenue, 75.0% of Operating Income)

This segment purchases highly processed manufactured products made with large amounts of metal and processes them so that the metal in them can be resold. The most common sources of recyclable metal include automobiles, home appliances, machinery, and railroad tracks. Virtually all of the raw materials consumed by the Steel Manufacturing Business segment are produced by MRB. The remainder of the scrap it produces is sold to OEMs and steel mills. In 2007, MRB's five largest customers were responsible for 25% of the revenue generated by the sale of ferrous metals to third party companies.^[6]

Steel Manufacturing Business (15.0% of Revenue, 15.2% of Operating Income)

This segment purchases recycled metal from MRB and uses it to manufacture basic steel products. These products include rebar, coiled rebar, wire rod, and merchant bar. Rebar is shipped in rod or coiled form and is used to reinforce concrete in construction projects. Wire rod has a much smaller diameter and is shipped in coiled form and is often used to produce nails, wire fencing, and stucco netting. Merchant bar is custom shaped steel bar, and can be used to manufacture products which include steel grating, farm equipment, and metal railings. In 2007, SMB produced over 1,400,000 tons of steel products.^[9]

[edit] Key Trends and Forces

[edit] SCHN's business rises and falls with steel prices

Because an increase in demand does not affect SCHN's operating expenses and raw materials prices proportionally, higher prices mean higher earnings for both Schnitzer and other domestic steel companies. SCHN often purchases scrap from individuals though a wide network of collection points, and if no competing collection point is nearby, it is not necessary for SCHN to pay more for scrap to remain competitive. Furthermore, with increased output of recycled metal, SCHN faces increasing returns to scale. Mega-shredders are more efficient than their smaller counterparts and are capable of processing thicker pieces of scrap.

Decreases in steel demand can however severely hurt earnings in August and September of 2008. During that period, stock prices were more than cut in half. One of SCHN's reactions to the low steel prices brought on by the US financial crisis was to slow or halt purchasing scrap metal in certain regions. The problem with steel demand is not unique to United States steel companies.

[edit] International Sales Sensitive To Changes In The Value Of The US Dollar

Because many of SCHN's customers are international, changes in the value of the US Dollar affect a large portion of SCHN's revenue. If the dollar is strong, SCHN products are more expensive when sold overseas, and are not competitive with international companies. Foreign customers will not purchase SCHN goods because SCHN prices have gone up relative to goods sold in their own currency. The opposite occurs when the dollar is weak. Customers can afford cheaper American steel and prefer to buy from companies in the United States. This translates into increased demand for SCHN steel and thus higher revenue.^[11] This trend helps to explain SCHN's good performance in the first half of 2008. High global steel prices, which alone boost profits, were coupled with a weak US Dollar and helped the domestic steel industry as a whole to achieve record performance in terms of revenue.^[12]

[edit] Government Regulations Have Potential To Severely Harm Profitability

In 2002, tariffs on imported steel intended to aid the ailing steel industry raised the price of steel within the United States to between 35% and 60% above pre-tariff prices. As a result, customers of steel companies struggled to stay in business and demand for steel dropped sharply. SCHN's sales of steel products fell approximately 18% between 2000 and 2002. By August 2002, approximately 30 domestic steel companies had filed for bankruptcy as a result of declining business. The tariff was repealed in December of 2003.^[13] In the following year, 2003-2004, after the tariff was repealed, SCHN's sales of fabricated steel products grew by over 41%.^[14]

Tariffs are not the only government imposed regulations that have the potential to directly impact the performance of steel companies. Environmental regulations hurt profitability in two ways. The government frequently requires companies to upgrade their manufacturing facilities with "greener" equipment. This forces companies to spend capital on new equipment as well as installation and training costs associated with their implementation. Green equipment is typically more expensive to operate than standard machinery; companies are required to "upgrade" to be more environmentally friendly because they would not choose spend capital on upgrades that do not improve earnings on their own. Thus, operating within environmental standards increases operating costs in the short term when equipment is purchased and in the long run if it does not function as efficiently as alternatives.

[edit] Competition

SCHN's competitors do not fit a general mold. All three of the company's business segments compete with a wide variety of firms, ranging from small private firms to multinational corporations. Competitors include OEM manufacturers of auto parts such as Ford Motor Company (F) and General Motors (GM), as well as family owned auto salvage companies. The stock prices of the below companies declined in a pattern matching the fall in stock of SCHN in the second half of 2008.

US Steel (X): is a large steel company with the capacity to produce 24.3 million tons of steel in the United States and additional capacity abroad. In addition to processing iron ore and selling steel products, US Steel also operates railroad and real estate business segments.^[15]

Nucor (NUE): is a steel company that produces hot and cold rolled steel in addition to steel products such as steel girders, fasteners, and mesh. However, only about 8% of the steel produced by Nucor's steel mills was sold internally to be manufactured, as most is sold to third party manufacturers. Nucor, like SCHN relies on ferrous scrap as a raw material for steel production.^[16]

Steel Dynamics (STLD): also produces basic rolled steel and fabricated steel products. In FY 2007, STLD's consolidated shipments totaled 6.2 million tons, excluding internal shipments. Steel Dynamics, like SCHN, operates a business segment to acquire ferrous and non ferrous scrap metal to be shredded and processed. Sources of the scrap similarly include autobodies, industrial machinery, telecommunications wire, and aluminum cans. The vast majority of STLD's processed steel is sold to third party manufacturers.^[17]

[edit] References

1. ↑ SCHN 10-K pg. 4-9  
2. ↑ SCHN 10-K pg. 13  
3. ↑ SCHN 10-K pg. 5-9  
4. ↑ SCHN 10-K pg. 16  
5. ↑ SCHN 10-K pg. 6  
6. ↑ SCHN 10-K pg. 2  
7. ↑ SCHN 10-K pg. 84  
8. ↑ SCHN 10-K pg. 9  
9. ↑ SCHN 10-K pg. 8  
10. ↑ "Google Finance Historical Data for DJUSST and SCHN"
11. ↑ SCHN 10-K pg. 14  
12. ↑ "Dissecting the Surge in Steel Prices, Seeking Alpha, April 2008"
13. ↑ "Steel Tariffs Put G.O.P. On the Spot In Campaigns, New York Times, 24 AUG 2002"
14. ↑ SCHN 10-K pg. 11  
15. ↑ "United States Steel Corp (New York Stock Exchange), Reuters"
16. ↑ "Nucor Steel Corp (New York Stock Exchange), Reuters"
17. ↑ "Steel Dynamics Inc (Nasdaq), Reuters"

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