CMC deal for Gerdau rebar mills seen boosting pricing power
Commercial Metals Company’s acquisition of four Gerdau reinforcing bar mills will give the steelmaker a dominant position in the US market, industry analysts said.
The $600-million deal is expected to result in the Irving, Texas-based steelmaker having US melting capacity of 6.2 million tons per year and rolling capacity of 5.8 million tons per year, president and chief executive officer Barbara Smith said during a conference call with analysts on Tuesday, January 2.
That’s up 77.1% from CMC’s pre-acquisition melt capacity of 3.5 million tons per year and up 75.8% from its pre-deal rolling capacity of 3.3 million tons per year. The additional capacity will allow CMC not only to increase its rebar output but also to “flex up” its merchant products capacity as necessary to meet market demand, Smith said.
The four mills - in Jacksonville, Florida; Knoxville, Tennessee; Rancho Cucamonga, California; and Sayreville, New Jersey - and 33 fabrication facilities CMC is buying from Gerdau will also allow the company to better serve strong non-residential construction demand in Texas, New York, California and Florida, she said.
Take the western United States, for example. CMC’s micro-mill in Mesa, Arizona, has been running near capacity primarily serving customers in California. That has forced the company to turn down business in other areas, she said.
With the acquisition, CMC will be able to shift some of that California business from Mesa to Gerdau’s mill in Rancho Cucamonga and free up mill time in Arizona to pursue opportunities in other states and at lower freight costs, Smith said.
The result of more attractive freight rates and having “captive customers” from the newly acquired fabrication facilities: CMC should be able to run Gerdau’s mills at a higher capacity than the approximately 70% they are running at now, Smith said.
And the timing of the deal should allow CMC to benefit from a fabrication market that has seen margins squeezed by imports but that has more recently stabilized and is expected to see higher margins in the coming months.
“Fab is really where the pressure has been … and that creates the opportunity to build some margin back into that backlog going forward,” Smith said.
CMC expects to spend approximately $200 million to $250 million in capital expenditures to upgrade the Gerdau facilities over the next five years. That works out to approximately $10 million per year for each of the mills the company has acquired, she noted.
The company plans to keep all four mills running and will consider adding new equipment - one analyst inquired about a spooler like the one being added at Mesa - to them once the deal closes. While the Gerdau mills are in good shape, they are “older” facilities and could use upgrades, Smith said.
CMC will have an approximately 50% share of the US rebar market once the deal closes, “likely further aiding pricing discipline in an already consolidated market,” Seth Rosenfeld, an analyst with Jefferies, wrote in a January 2 research note.
“Pricing discipline” is industry jargon for mills’ ability to enforce higher prices. On the call, Smith declined to discuss the deal’s potential impact on pricing.
The domestic rebar market is already highly consolidated because Nucor, CMC and Gerdau account for 85% of the domestic market, Rosenfeld noted.
Nucor and Steel Dynamics Inc. - another US mini-mill steelmaker whose products include rebar - will probably be “free-rider beneficiaries” of potentially higher prices. In addition, the deal should help to offset a “questionable rebar capacity build” by US mills, he wrote.
Nucor, Steel Dynamics and CMC are all adding rebar capacity.
Commissioning of CMC’s new rebar micro-mill in Durant, Oklahoma, is proceeding as planned, Smith said.
Speculation about the deal has been “rampant” since October, Philip Gibbs, a KeyBanc Capital Markets analyst, wrote in a January 2 research note. But just because the deal was expected doesn’t mean its closing is a foregone conclusion, especially given that Nucor and CMC will account for the vast majority of US rebar output following the deal.
“Concentration, therefore, could be a modest concern for regulatory authorities,” he wrote.
Smith said CMC would cooperate with antitrust reviews required under the Hart-Scott-Rodino Antitrust Improvements Act but declined to speculate about how long the review process might take.
A more immediate concern might be the 1.5 million tons of imported rebar that arrived in the US in 2017. That could leave US rebar mills running at lackluster capacity utilization rates of 75%. But CMC, like other US mills, stands to benefit from any import restrictions or infrastructure spending package enacted by the Trump administration, Gibbs wrote.
President Donald Trump has pledged to crack down on imports through a Section 232 investigation into foreign steel on national security grounds. A key report in that probe is due in mid-January. He has also pledged to spend $1 trillion to repair roads and bridges in the US, although details of the plan remain murky.
Wall Street cheered the deal, with CMC shares trading at $22.99 each in afternoon trading, up 7.83% from a previous close of $21.32 per share.
Reaction among steel industry participants wasn’t so frothy. “I totally expected it. We were waiting for months for it to actually happen,” one rebar market source said. The only thing that caught him by surprise was that CMC acquired Gerdau’s mill in Jacksonville. He said he had expected Nucor to buy it.
Expected or not, the deal will reshape the dynamics of the US rebar industry, a second market source said. “It gives CMC a level of strength to combat Nucor as well as imports in their market approach,” he said. “Consolidation leads to control - what that means is hard to tell this early on.”