Dey: Base Business on Fundamentals, Not Tomorrow's Price Forecast

By Dan Markham, Senior Editor

Tomorrow’s steel price is the most-discussed topic in any gathering of industry watchers. Publications and websites devote endless inches and bandwidth covering the subject. Entire companies are built around the task. Analysts, both inside and outside the industry, routinely project the cost of hot-rolled coil over any given period of time.

All of that is pretty pointless, said Saikat Dey, the former chairman of the now-departed Severstal North America. Dey, who now heads up Ockham Razor Ventures after overseeing the sale of Severstal’s North American production assets to AK Steel and Steel Dynamics, was among the lineup of speakers at last month’s American Metal Market Steel Success Strategies XXX Conference in New York.

Dey has compiled his insights on the steel industry in a book, “UnCommoditized: Uncommon Ideas for Commoditized Markets”. Among his observations is the importance of building a business strategy that is not dependent on price forecasting.

“I used to love it when my analysts came to me with forward-looking price projections. I got in the habit of tearing them up at my desk. You cannot build a strategy based on what the expectations of price are,” he said.

His rationale is based, in large part, on the poor track record of price forecasters. He pointed to a chart that showed the current market conditions, with forward pricing overlaid. Generally speaking, the consensus amounted to little more than current business sentiment pushed 12 months forward. It also has little connection with reality, he noted. Significant price spikes or price crashes—information that would truly assist a steel company or distributor in managing its business—were missed.

“The correlation between the market called 12 months out and what it turned out to be is insignificant,” said Dey, who described himself as a statistician at heart. Other methods of forward projecting are similarly flawed, he added. “We have to stop using strategy for building value in a commodity market based on where we believe the market is going. It has to come back to economic fundamentals.”

Dey said the current low price for hot-rolled steel was a result of three factors: declining oil prices, leading to a drop in OCTG demand; declining raw material costs; and the flood of low-cost imports. All of that pushed demand down against the cost curve, resulting in the steep drop. “It’s a pretty grim situation. We can do what we always do and just guess, or we can use the same framework to figure out how we’re going to counter what’s going on,” he said.

It starts with understanding how to maximize assets based on where they fall on the cost curve. “Every asset, based on its position on the cost curve, has a differential strategy,” he said. “With a high-cost asset, for example, a company would want to hedge against the downside risk. Therefore, a contract price is preferable to selling on the spot market.” The reverse works for a low-cost asset.

Dey pointed to successful companies in other industries as examples of what steel industry players could do. ExxonMobil, for one, has become a cash-generation behemoth in recent years through shrewd capital investment. The company doesn’t jump in and out of the market, but makes steady, smart investments regardless how the overall industry is performing, he said.

While much of the steel industry focuses on operations, Dey believes that’s actually the third most important factor in determining how a company performs. He pointed to one notable failure as evidence. His former company bought the Wheeling-Pitt, Sparrows Point and Warren steel mills several years back, then had to unload them 18 months later for a fraction of the cost. Those kinds of mistakes take decades to overcome through operational efficiencies, he said.

“You build your muscle by how you buy and sell your assets and how you buy and sell the products you produce. Third is how you operate your mills. That’s just your ticket into the game,” he said. “How you differentiate yourself is how you do commercially and how you do in M&A.”
 
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Monday, December 11, 2017