May 16, 2008 / 1:48 AM / 11 years ago

Steel costs starting to pinch U.S. companies

CHICAGO (Reuters) - U.S. manufacturers, which had shrugged off the domestic economic downturn and reported consistently strong profits thanks to overseas demand, are starting to look vulnerable as the price of key materials like steel continue to rise.

Global steel prices are up 40 percent since the beginning of the year and the pressure is showing up in a number of top U.S. companies’ results, including construction and mining equipment maker Caterpillar Inc (CAT.N) and motorcycle maker Harley-Davidson Inc (HOG.N).

Even oil and gas producers’ record-setting recent profits are feeling some of the heat as costs for drills and other equipment have spiked.

Then this week, farm equipment leader Deere & Co (DE.N), which had posted a string of record results, forecast disappointing full-year earnings, blaming raw material and freight costs.

Deere Chief Financial Officer Michael Mack, conceded steel prices were “racing ahead ... well beyond what we anticipated.” Investors took note and the company’s shares fell nearly 10 percent.

“Raw materials are now expected to hit them almost twice as hard,” said Matt Collins, an analyst at Edward Jones.

“Up until now, Deere had been able to avoid some of the margin pressures that most of its competitors had seen ... It looks like it caught up with them this quarter.”

Michael Locker, who runs a steel industry consulting firm, Locker Associates, in New York, said rising steel prices are unlikely to ease off much in the near term.

“Prices may peak soon, and then drop some. Currently, we are seeing $1,100-$1,150 (per ton) for hot-rolled steel and it may drop to $800 or $900. But, I don’t see prices going back to the $400 we had last year.

“Worldwide demand for steel has blown through the roof — not just China, but the Middle East, Russia, Latin America. Economic development demands steel,” said Locker.

SPREADING GLOOM

Deere, which said its 2008 material and freight costs would be $400 million to $500 million higher this year, double the inflation it had expected, is not the only manufacturer to warn that rising commodity prices are beginning to pinch.

On Wednesday, Toyota Motor Corp (7203.T), the world’s biggest automaker, agreed to begin paying 30 percent more for sheet steel, the Asahi Shimbun daily newspaper reported.

But given the slack demand for vehicles in the United States, it’s not at all clear that automakers — already facing stiff headwinds — will be able to recoup their costs by sticking U.S. buyers with higher prices.

Auto and truck parts supplier ArvinMeritor Inc ARM.N said on Tuesday it would begin charging a monthly surcharge in a bid to offset surging prices for steel and other commodities.

The announcement of the surcharge followed through on a pledge the Troy, Michigan-based company made last month when it announced its quarterly earnings and underscored the pressure on auto suppliers and automakers to raise prices even as demand weakens because of the slumping U.S. economy.

“As a result of the sudden and extraordinary surges in the price of steel, energy and other commodities, we are implementing a monthly review and adjustment process on all products,” Chip McClure, ArvinMeritor’s chief executive said in a statement.

While the auto industry has a great deal of exposure to steel costs, other industries will also face pressures.

Cambridge Energy Research Associates (CERA), a unit of information and consultancy IHS Inc IHS.N, said that costs to build new refineries and petrochemical plants rose 6 percent in the past six months — meaning it will be more expensive for the oil and gas companies to find and produce oil and gas.

“So long as oil prices remain high and demand for the end products remain high, I think we’re going to see continued high level of costs,” Candida Scott, senior director of cost and technology at CERA, said in an interview.

“We’d really have to see a slackening of demand and oil prices coming down to see any reduction in costs.”

BIG CAT’S COSTS

Caterpillar, too, has complained that its material costs will be more than originally predicted and recently announced price increases to try to recoup some of those costs.

Like Deere, Caterpillar protects customers who have already placed orders — even orders that are on backlog — so the benefits of the price increases will only start flowing through results much later this year, at the earliest.

In the meantime, steel remains costly and all the signs, including Toyota’s agreement this week and word that ArcelorMittal ISPA.AS, the world’s largest steelmaker, is upping prices by 20 percent in Europe, suggest the pressure will continue.

Collins at Edward Jones says many companies had long-term contracts with raw material suppliers that locked in prices and protected them through the first half of the year.

As those start to expire, he expects more pressure on companies that will show up on their balance sheets, especially if the U.S. economy continues to struggle.

“As we get deeper into this downturn in the U.S., it’s going to get harder to pass higher prices through and so if commodity prices stay where they are, you’re going to see it show up in a lot more places,” Collins said.

Additional reporting by Steve James and Mike Erman in New York; editing by Patrick Fitzgibbons and Tim Dobbyn

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