0. May   2 0 0 5
A Fixed Income (Bond Investor’s) Perspective on the North American Steel Industry
David Common
S T R I C T L Y   P R I V A T E   A N D   C O N F I D E N T I A L

1. Bond investors have a different outlook vs. equity investors
We try to “outperform” Treasuries: 10-year Treasury currently ~ 4.25%
“High-grade” investors try to make basis points > Treasuries: %
“High-yield” investors try to make basis points > Treasuries: %
More caution given a different risk/reward ratio and different job description

2. Credit ratings are important…
Majority of the steel companies have high-yield ratings.
High
Grade
High
Yield
Source: Moody’s and S&P.

3. … but trading levels vary widely among like-rated bonds
Ratings Issue Price Yield
Ratings Issue Price Yield
BBB B
Baa2/BBB-
Thyssenkrupp Finance BV 5.000%
105.0
4.0%
B1/BB-
Texas Industries %
112.3
6.1%
Ba1/BBB+
Ispat Inland 9.750%
114.3
6.3%
B1/B+
AK Steel 7.750%
89.8
9.4%
Oregon Steel Mills %
107.3
7.5% BB
B2/B+
OAO Severstal 9.250%
103.0
8.7%
Ba2/BB
International Steel Group 6.500%
99.3
6.7%
B2/B
Earle M. Jorgensen 9.750%
106.0
8.3%
Ba2/BB-
California Steel Industries 6.125%
91.0
7.2%
Ryerson Tull 8.250%
85.0
10.6%
IPSCO 8.750%
111.0
5.9%
B3/B+
Allegheny Technologies Inc 8.375%
104.5
7.6%
Steel Dynamics 9.500%
107.0
B3/B-
Sheffield Steel %
102.0
11.8%
United States Steel 9.750%
110.0
6.9%
Corus Group 7.500%
101.8
Ba3/BB-
Gerdau Ameristeel %
109.0
7.8%
CCC
Russel Metals 6.375%
95.0
7.1%
Caa2/CCC
Schuff Steel %
10.8%
Source: Moody’s and S&P.

4. 2000 – 2005: A Truly Astonishing Cycle
Rating agencies say they try to “look across the cycle”
Investors do not; they try to time it. Degree of success? ….. Low!
Forecast ingredients: can anybody predict all this?
Steel Demand
Shipping Rates
Capacity Reductions/De-Bottlenecking
Currencies
Trade Flows
Raw Material Costs
Capacity Utilization
Sentiment
Inventory Stocking/De-Stocking

5. Fortunately, prices and costs are at least correlated
Source: JP Morgan and company reports.

6. 2004 unit profits were very high historically
2004 profits were 2~3x historical average
Source: JP Morgan and company reports.

7. Given the unpredictability, use debt with caution
Standard corporate finance:
Above-average business risk should be paired with below-average financial risk
But it’s not just the amount of debt. It’s the source and terms of the debt
Optimal capital structure:
Working capital supported by asset-based borrowings, backed by accounts receivable and inventories
P,P&E supported by long-term, “loan value” type debt, preferably “callable” (pre-payable, to some extent)
It’s better to ‘pay-up” for long-term and no/few financial covenants
Pay-up and live to fight another day

8. GM and Ford: A Major Investor Worry
Automakers with “legacy costs” face the same issues as similarly situated steel companies: uncompetitive cost structure
Something that can’t go on…probably won’t
“The market” expects management to go toe-to-toe with labor on legacy costs
Bankruptcy may be required to effect the magnitude of reductions thought necessary
Detroit vs. the transplants: as long as the cars get made/sold
Mix is obviously an issue
Longer term: Korea and China as a source of auto imports

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