The Hindu Business Line : <I>Strategic rationale for consolidation </I>

For years, steel stocks have consistently reduced shareholder value, with companies generating returns on invested capital (ROIC) lower than the cost of capital (weighted average between equity and debt). This pushed the steel sector's price earnings multiple considerably lower than most industrial goods, such as, paper, chemicals, cement, and even mining.

Despite regional consolidation in Europe and the US, the steel markets have been highly fragmented, leaving them vulnerable to low industry growth and high cyclicality. For instance, even following the Arcelor-Mittal deal, the combination controls only a tenth of the global steel production and the top five steel producers — Arcelor-Mittal, Nippon Steel, Posco, JFE Steel and Baosteel — control just over a quarter of global steel production.

The industry finds itself sandwiched between customers and suppliers who have witnessed intense consolidation in the past decade. For instance, customers of steel in the automobile, construction and packaging segments have consolidated big time, enhancing their pricing power in the marketplace.

And on the supplier front, iron ore is now essentially the preserve of some key players, such as BHP Billiton, Rio Tinto and Brazil's CVRD, which have been calling the shots in the raw material market. Clearly, large-scale global consolidation is the only way the sector can regain pricing power with customers and bargaining power with suppliers.

Even the regional consolidation in Europe and the US between 2000 and 2003 helped substantially improve the capacity utilisation level of steel players in the past three years.

The developing world, led by China and India, will be the next big drivers of global demand for steel over the next few decades.

Fundamentally, China with its 350 million tonnes (or 25 per cent) of global capacity is feared as the wild card in the demand equation, largely because it can destabilise prices by exporting its production to the developed world if its economy starts slowing down, say beyond the 2008 Olympics.

However, the key steel players feel that these fears of pricing instability can be negated to a large extent through consolidation.

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