Cleveland-Cliffs/AK Steel Acquisition: How the Deal Hurts Steel Sector – Barrons

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Investors might be expected to cheer the latest deal in the embattled steel industry. Consolidation, after all, is usually a positive in commodity-producing industries.

Fewer producers, in theory, give an industry more control over supply and demand and, therefore, more control over pricing and profits. But the bane of commodity-producing industries is also at work today: more supply—and that has pushed the steel sector down Tuesday.

Steel stocks, excluding AK and Cliffs, are down about 2.4%.
United States Steel
(X) stock is off the most, down by about 4%. That’s far worse than the 0.7% decline of the
S&P 500
and the 1% drop in the
Dow Jones Industrial Average.
Cliffs shares are down about 10%, while AK—the company being acquired—is up 4%.

Trade news is largely to blame for the broad market’s decline. President Donald Trump said he might delay signing a U.S.-China trade pact until after the 2020 election. And steel is a more volatile sector than, say consumer-discretionary stocks, so tariffs and trade bulletins can push shares significantly. Monday’s trade news, however, has been positive for the sector. Trump announced tariffs on Brazil and Argentine steel.

Before the deal was announced, AK Steel was slated to close a blast furnace, taking pig iron—a precursor to steel—off the market. Now it won’t have to close the facility because of new access to low-cost iron ore from Cliffs. More supply is bad for everyone in a commodity business.

Yet the blast-furnace decision, outlined in the companies’ M&A presentation, belies the strategic intent of the deal. If the market didn’t need the blast-furnace capacity before the deal, it doesn’t need it afterward. Making the blast furnace “profitable” by cutting AK’s costs comes at the expense of Cleveland-Cliffs’ iron-ore profits. That isn’t a great way to justify any asset, economically speaking.

Both companies didn’t return a request for comment about deal synergies and ore pricing.

The news reverses a recent positive trend for the sector. Steel stocks were rallying before the announcement, pushing the sector into positive territory year to date.

Entering the green was significant for steel stocks. The sector had to dig out of a big hole created by falling steel prices. Benchmark prices fell from a 52-week high of almost $800 to a low of about $500 a ton. Prices have recovered to about $560 a ton. AK stock, for instance, is up 46% over the past three months.

Now the sector, excluding Cliffs and AK, is up about 3% year to date, worse than the 21% and 26% respective gains of the Dow and S&P over the same period.

It’s been an interesting year for steel, and 2020 is shaping up as another interesting year, with the Cliffs-AK deal slated to close in the first half.

Write to Al Root at allen.root@barrons.com

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