Grin and bear it
The US steel industry is experiencing weakness of historic proportions, with
domestic production down more than 50% this year. With end markets showing
no sign of strength, we are initiating on the sector with an Underweight rating.
We see little chance of a strong bounce in 2010 given a lack of credit to support
demand and spare steel-production capacity ready to suppress any price
rebound. Near term, destocking will continue to depress pricing.
The steel industry in the late 1990s and early 2000s went through a complete
transition as bankruptcies proliferated. Industry consolidation and the onset
of growth in China brought the industry to spectacular heights from 2004 to
the first half of 2008. Then it all came tumbling down as demand plummeted.
Today, we view the US steel industry more as a domestic-demand story.
Significantly weaker domestic demand coupled with destocking has driven
utilization rates down so low that even the mini mills are operating at close to
breakeven (discounting high-priced inventories) while integrated mills are
experiencing operating losses.
The sector has worked its way through a lot of destocking. Demand is still
weak, but aggressive destocking at service centers and original equipment
manufacturers (OEMs) should lead to a demand improvement. There is still a
bleak picture for steel stocks as we believe 2010 will be another year of poor
demand. Our Asian counterparts also remain bearish as new supply is set to
hamper pricing rebounds. As destocking ends, we expect shipments to be
higher in 2010, but do not expect real demand to improve much. We forecast
a hot-rolled-coil price of US$475/ton in 2009 and US$525/ton in 2010.
We see three scenarios playing out: further deterioration; an L-shaped
recovery; and a V-shaped recovery. We believe investors are too
optimistically pricing in a V-shaped recovery. With such an outcome, inflation
is a serious risk leading to the possibility of a second downturn.
We initiate coverage on Gerdau Ameristeel and Steel Dynamics with BUY
calls, US Steel with a SELL, and AK Steel and Nucor with Underperform calls.
We believe that Gerdau Ameristeel and Steel Dynamics are undervalued at
current levels. We expect both companies to return to normalized earnings in
2011 due to their variable cost structure. The integrated mills AK Steel and
US Steel are overvalued with normalized earnings not achievable until 2012.

Contents
Executive summary ............................................................................ 3
Fundamentals fuel destocking............................................................ 4
Production discipline .......................................................................... 7
End markets show extreme weakness.............................................. 10
We prefer the flexibility of “mini mills” ............................................ 20
Company profiles
AK Steel..............................................................................................23
Gerdau Ameristeel................................................................................31
Nucor .................................................................................................37
Steel Dynamics ....................................................................................43
US Steel..............................................................................................49
Appendices
1: Price forecasts .................................................................................57
2: Company comparisons ......................................................................59