aldo mazzaferro, cfagoldman, sachs & co. [email protected] steel manufacturers...

Aldo Mazzaferro, CFA Goldman, Sachs & Co. 212-902-9916 [email protected]

Steel Manufacturers Association Annual Board of Directors Meeting – Phoenix, Arizona

The Goldman Sachs Group, Inc.

February 16, 2007

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Outlook for 2007: A successful test of market discipline

Goldman Sachs Global Investment Research

2

Sustainability is keyDiscipline = Confidence = Higher valuations

• Investors fear volatility and surprises from rapid steel price change, supply swings, unpredictable earnings

• Investor’s express their comfort level by the multiple they pay for earnings or cash flow (i.e. P/E, or EV/EBITDA)

• Developing market recovery is building confidence and valuation multiples are rising.

• Continuing test for other key issues:

• Will discipline hold LT and will it be global?

• Will China’s production continue to exceed demand?

• Will too higher US prices trigger a large supply response?

• What about LT risks from greater capacity in other markets?


3

Steel’s virtual improvement cycleWe see higher valuation multiples ahead

• PE ratios should continue to widen as earnings recover by mid-year and HRC prices make another higher low.

• And balance sheet gains also help financial earnings and stock valuations

• Steel sector self-renewal process:

• Global consolidation leads to production discipline,

…which allows better fine tuning of supply and demand,

…which reduces cycle volatility further,

…which leads to more EPS stability and better valuations,

…which boosts management confidence further and drives more consolidation


4

Logical progression from sustainability to higher valuations

Investor confidence is difficult to define, discern and predict, but it is crucial to valuation.

Some factors that might increase investor confidence:

• Balance sheet improvement, lower net debt or higher net cash

• High free cash flow, which drives balance sheet gains

• Continuing supply/demand balance

Simple math:

Cash accumulation + constant EV/EBITDA ratio = higher PEs

Bonus:

Steady free cash flow + improving balance sheet should raise the EV/EBITDA ratio, which would raise the PE even further


5

Steel mill free cash flow yields Highest to lowest

Source: Goldman Sachs Research estimates.

18.4%

16.8%

12.0%11.5%

6.4% 6.1% 6.0% 5.9%

5.0% 4.8%4.2%

3.0% 2.9%2.4%

10.5%10.6%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

Fre

e c

ash

flo

w y

ield

20

07

*WOR, CHAP,STTX, CMC, SCHN, MM estimates are calendarized

Best: Ryerson, Worthington, and Reliance Steel


6

Steel mill price/earnings ratiosLowest to highest

Best: US Steel, Reliance steel, Gerdau Ameristeel

8.1X 8.2X 8.4X8.9X

9.8X 9.8X 9.9X 10.0X10.5X

11.3X11.7X

12.1X12.8X

13.6X14.3X

14.7X

0X

2X

4X

6X

8X

10X

12X

14X

16X

P/E

2007 (

X)

*WOR, CHAP,STTX, CMC, SCHN, MM estimates are calendarized

Source: Goldman Sachs Research estimates.


7

Current climate of supply, demand and pricing looks promising

Supply: Domestic production cuts and lower imports

• Americas – production, imports, inventories all declined

• Global – biggest source of supply ultimately is Chinese output

Demand: Auto production a concern, housing much less so

• Automotive – expect production schedule to stay soft

• Non-res Construction – expect demand to remain strong

• Capital Goods – continuing along with solid demand

Pricing: 4Q dip in pricing starting to reverse; higher by 2Q’07

• Bottom at higher lows, we guess HRC low is about $500/ton

• Where is normalized? Our latest $475 estimate might be low

Key risks: Chinese production growth and global demand

• Imports should decline, but China’s production is a concern

• Consumer sentiment softer, and auto weakness will hurt


8

Supply-side trends showing the best improvement

• Imports are sharply lower, and we expect further significant declines

• Domestic production was cut in 4Q, and should rebound as order books improve

• Key variable is that US pricing remains too low to attract import supply

• Imports should stay down and lead to sharper inventory decline on better seasonal demand


9

The decline in US imports has already been sharp, and we expect further declines

2,988

1,500

2,000

2,500

3,000

3,500

4,000

4,500

Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06

Mo

nth

ly S

teel

Imp

ort

s (

'000 t

on

s)

Average = 2,834K tons

Source: US Census Bureau.


10

Imports of Flat Rolled and Rebar are both down significantly in the past few months

Imports of Hot Rolled Coil Imports of Rebar

Source: American Iron & Steel Institute.

315,598

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

Feb-97 Feb-98 Feb-99 Feb-00 Feb-01 Feb-02 Feb-03 Feb-04 Feb-05 Feb-06

Mo

nth

ly im

po

rts

of

ho

t ro

lled

sh

ee

ts (

ton

s)

90,172

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

Feb-97 Feb-98 Feb-99 Feb-00 Feb-01 Feb-02 Feb-03 Feb-04 Feb-05 Feb-06

Mo

nth

ly im

po

rts

of

reb

ar

(to

ns

)


11

Service center inventory shows only slight decline so far due to seasonal factors, but much more to go on downside

Source: Metals Service Center Institute.

8,000

9,000

10,000

11,000

12,000

13,000

14,000

15,000

16,000

17,000

18,000

Jan-98 Jul-99 Jan-01 Jul-02 Jan-04 Jul-05

Mo

nth

ly i

nven

tori

es (

'000 t

on

s)

2.0

2.5

3.0

3.5

4.0

4.5

5.0

Mo

nth

s' su

pp

ly o

n h

an

d

Months' supply Inventory


12

Inventories of Flat Rolled are not down as much as inventories of Carbon Bar

Carbon bar

-1%

0%

-2%

1%

0%

-3%

0%

0%

-1%

-3%

2%

1%

-3%

1%

-1%

1%

1% 1%

-3%

0%

-1%

-3%

-4%

-1%

-5%

-4%

-3%

-2%

-1%

0%

1%

2%

3%

Mo

nth

-ove

r-m

on

th c

han

ge

(%)

1000

1200

1400

1600

1800

2000

2200

Mo

nth

ly in

ven

tori

es (

'000

to

ns)

Inventories MoM % change

Carbon flat rolled

0%

-2%-2%

0%

-3%

-5%-5%

-10%

-3%-2%

-3%

5%

4%

2% 2%

4%

3%3%

5%

6%6%

2%

-1%0%

-12%

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

Mo

nth

-ove

r-m

on

th c

han

ge

(%)

4,000

5,000

6,000

7,000

8,000

9,000

10,000

11,000

Mo

nth

ly in

ven

tori

es (

'000

to

ns)

Inventories MoM % change

Service center inventories of carbon flat rolled

Service center inventories of carbon bar

Source: Metals Service Center Institute


13

Discipline cut about 400K tons from weekly US production between September and the lows in December – rebounding now

1.919

82.1%

1.6

1.7

1.8

1.9

2.0

2.1

2.2

Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07

We

ekl

y P

rod

uct

ion

(m

n t

on

s)

60%

65%

70%

75%

80%

85%

90%

95%

100%

We

ekl

y C

ap

. U

tiliz

atio

n R

ate

Production Capability UtilizationSource: American Iron & Steel Institute.


14

Narrower US steel price premiums are the biggest reason to expect lower imports

US vs Europe $(62)

US vs China $31

Imports2,988

-$200

-$100

$0

$100

$200

$300

Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07

Pri

ce P

rem

ium

($

per

ho

t ro

lled

to

n)

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

Imp

ort

s (0

00's

to

ns)

US Premium to Europe US Premium to China Imports

Source: Purchasing Magazine, Metals Bulletin, Steel Business Briefing.


15

China’s steel production continues to grow while other major regions are more steady

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06

Mo

nth

ly P

rod

uct

ion

('0

00 m

etri

c to

ns)

China

EU

Japan

US

Source: International Iron & Steel Institute.


16

Global production would slow down a lot if China’s production growth matched demand

Source: International Iron & Steel Institute.

104,437

50,000

55,000

60,000

65,000

70,000

75,000

80,000

85,000

90,000

95,000

100,000

105,000

110,000


Mo

nth

ly G

lob

al P

rod

uc

tio

n (

'000

me

tric

to

ns

)


17

Encouraging: China growth rate of steel production has slowed somewhat to 21%

0

10,000

20,000

30,000

40,000

Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06

Ch

ines

e st

eel

pro

du

ctio

n (

'000

to

nn

es)

-20%

-10%

0%

10%

20%

30%

40%

Yea

r-o

ver-

year

ch

ang

e (%

)

Production y-o-y changeSource: International Iron & Steel Institute.


18

Not encouraging: China’s net exports show no signs of slowing yet

-6,000

-5,000

-4,000

-3,000

-2,000

-1,000

0

1,000

2,000

3,000

4,000

5,000

Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06

Ch

inese I

mp

ort

s a

nd

net

imp

ort

s

for

all

ste

el

pro

du

cts

('0

00 t

on

nes)

Net Imports Imports

Source: China Customs Statistics.


19

Demand-side trends a little softer, but not as important as supply

• Demand appears to be off 2%-3% since September, but that is much less than supply is down

• Non-residential construction markets have been very strong, capital goods are steady at high levels, but automotive has become very weak

• A weaker dollar would have two positive impacts: support steel pricing and stimulate domestic manufacturing


20

Non-residential construction has become very strong after bottoming in 2005

$300

$320

$340

$360

$380

$400

$420

Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06

Co

nst

ruct

ion

pu

t in

pla

ce (

$ b

n),

199

6 p

rice

lev

el

-15%

-10%

-5%

0%

5%

10%

15%

Yea

r-o

ver-

year

ch

ang

e (%

)

y-o-y % change Non-Residential ConstructionSource: Department of Commerce.


21

Non-defense capital goods has continued strong, although momentum has slowed

35

40

45

50

55

60

65

70


Ne

w O

rde

rs (

in b

illi

on

s)

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

y-o

-y %

ch

an

ge

Trailing 12-mo avg of non defense cap goods Trailing 12-mo avg (y-o-y % change)

Source: US Census Bureau.


22

Industrial production continues to indicate broad-based underlying demand strength

1.6%

107

60

70

80

90

100

110

120


Ind

ex

19

97

=1

00

-6%

-4%

-2%

0%

2%

4%

6%

8%

y-o

-y %

ch

an

ge

y-o-y % change Industrial ProductionSource: Federal Reserve Board.


23

Auto sales weakened in 2006, but the latest monthly comparisons are flat

Source: Automotive News.

2,000

2,500

3,000

3,500

4,000

4,500


U.S

. A

uto

sal

es -

No

rth

Am

eric

an m

ade

(to

tal

of

trai

lin

g 3

mo

nth

s, 0

00's

un

its)

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

y-o

-y %

ch

ang

e

y-o-y change U.S. sales (trailing 3 month)


24

Auto production is down sharply year to year, although comparisons should flatten

3,400

3,600

3,800

4,000

4,200

4,400

4,600

4,800

Jul-00 Jul-01 Jul-02 Jul-03 Jul-04 Jul-05 Jul-06

No

rth

Am

eric

an v

ehic

le p

rod

uct

ion

(t

ota

l o

f tr

aili

ng

3 m

on

ths,

000

's o

f u

nit

s)

-12%

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

y-o

-y %

ch

ang

e

y-o-y change

North American production (trailing 3 month)

Source: Automotive News.


25

Steel pricing trends – third successive higher low in pricing since 2002

Source: Purchasing Magazine, American Iron & Steel Institute, American Metal Market.

$0

$100

$200

$300

$400

$500

$600

$700

$800


US

Pri

ces

($

pe

r to

n)

80

90

100

110

120

130

140

US

De

ma

nd

(m

n t

on

s)

Demand

Scrap Prices

Hot Rolled Prices


26

Testing discipline: HRC metal spreads Lowest readings in February since 2004.Will they recover?

$100

$150

$200

$250

$300

$350

$400


HR

/Au

to B

un

dle

Sp

read

($

per

to

n)

Average $224

February estimate $216

Source: American Metal Market, Purchasing Magazine.


27

Long product spreads also testing the lows


February estimate $215

$100

$150

$200

$250

$300

$350

$400


Reb

ar/

Heavy M

elt

Sp

read

($ p

er

ton

)

Average $194


28

HRC pricing: We expect stability going forward after a 1Q 2007 bottom.

Source: Purchasing Magazine, Goldman Sachs Research estimates.

$200

$300

$400

$500

$600

$700

$800


HR

C P

ric

e (

$ p

er

ton

) $560 by 12/07


29

Plate pricing: Very resilient due to capacity tightness and strong demand

$200

$300

$400

$500

$600

$700

$800

$900


Pla

te p

rice

($

per

to

n)

$700 by 12/07

Source: Purchasing Magazine Goldman Sachs Research estimates.


30

Rebar pricing: We expect a quick recovery after an early 2007 dip


$200

$300

$400

$500

$600


Reb

ar P

rice

($

per

to

n)

$510 by 12/07


31

Beam price: We expect relative stability to prevail in beams due to tight supply


$200

$300

$400

$500

$600

$700


Str

uctu

ral

Pri

ce (

$ p

er

ton

)

$635 by 12/07


32

Price risk? Price versus 25-year average. Plate, scrap most extended, HRC least


$513

$739

$649

$492

$225

$359

$419

$382

$307

$112

$-

$100

$200

$300

$400

$500

$600

$700

$800

HRC PLATE BEAMS REBAR SCRAP

$ p

er t

on

Current 25-Year average


33

ISM Index: Showing signs of a slowdown

Source: Institute for Supply Management.

49.3%

25%

30%

35%

40%

45%

50%

55%

60%

65%

70%

75%


ISM

In

dex

(%

)

Expansion

Contraction


34

Currency trends – the dollar has risen vs. the Yen but has fallen against the Euro

Source: Bloomberg.

100

105

110

115

120

125

130

135


Jap

an

ese Y

en

to

US

Do

llar

$0.60

$0.70

$0.80

$0.90

$1.00

$1.10

$1.20

$1.30

$1.40

US

Do

llar

to E

uro

Yen per Dollar Dollars per Euro

Note: Chart is inverted

Yen: 120.8

Euro 1.297


35

Summary: Supply lower, demand slower. Pricing off now, but recovery expected.

• Supply: Production discipline and lower imports are positive

• Demand: Auto production should remain softer, while non-residential construction and capital goods should be offsetting positives

• US steel pricing: We expect the correction underway to last into late 1Q, but for the supply reductions to cause a sharp recovery in 2Q.

Key opportunity

Re-rating of the PE as cash flows remain strong, balance sheets improve and investors become more confident about sustainability.


36

Analyst Certification

I, Aldo Mazzaferro, hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or companies and its or their securities. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report.

DisclosuresFebruary 6, 2007


38

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Company-specific regulatory disclosures

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39

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Rating Distribution

Buy Hold Sell

26% 60% 14%

Investment Banking Relationships

Buy Hold Sell

47% 39% 36%Global

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40

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Definitions

Outperform (OP). We expect this stock to outperform the median total return for the analyst's coverage universe over the next 12 months. In-Line (IL). We expect this stock to perform in line with the median total return for the analyst's coverage universe over the next 12 months. Underperform (U). We expect this stock to underperform the median total return for the analyst's coverage universe over the next 12 months

Coverage views: Attractive (A). The investment outlook over the following 12 months is favorable relative to the coverage group's historical fundamentals and/or valuation. Neutral (N). The investment outlook over the following 12 months is neutral relative to the coverage group's historical fundamentals and/or valuation. Cautious (C). The investment outlook over the following 12 months is unfavorable relative to the coverage group's historical fundamentals and/or valuation.

Current Investment List (CIL). We expect stocks on this list to provide an absolute total return of approximately 15%-20% over the next 12 months. We only assign this designation to stocks rated Outperform. We require a 12-month price target for stocks with this designation. Each stock on the CIL will automatically come off the list after 90 days unless renewed by the covering analyst and the relevant Regional Investment Review Committee.


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Disclosures

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The Global Investment Research Division of Goldman Sachs produces and distributes research products for clients of Goldman Sachs, and pursuant to certain contractual arrangements, on a global basis. Analysts based in Goldman Sachs offices around the world produce equity research on industries and companies, and research on macroeconomics, currencies, commodities and portfolio strategy.

This research is disseminated in Australia by Goldman Sachs JBWere Pty Ltd (ABN 21 006 797 897) on behalf of Goldman Sachs; in Canada by Goldman Sachs Canada Inc. regarding Canadian equities and by Goldman Sachs & Co. (all other research); in Germany by Goldman Sachs & Co. oHG; in Hong Kong by Goldman Sachs (Asia) L.L.C.; in India by Goldman Sachs (India) Securities Private Ltd.; in Japan by Goldman Sachs Japan Co., Ltd; in the Republic of Korea by Goldman Sachs (Asia) L.L.C., Seoul Branch; in New Zealand by Goldman Sachs JBWere (NZ) Limited on behalf of Goldman Sachs; in Singapore by Goldman Sachs (Singapore) Pte. (Company Number: 198602165W); and in the United States of America by Goldman, Sachs & Co. Goldman Sachs International has approved this research in connection with its distribution in the United Kingdom and European Union.

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General disclosures in addition to specific disclosures required by certain jurisdictions

This research is for our clients only. Other than disclosures relating to Goldman Sachs, this research is based on current public information that we consider reliable, but we do not represent it is accurate or complete, and it should not be relied on as such. We seek to update our research as appropriate, but various regulations may prevent us from doing so. Other than some industry reports published on a periodic basis, the large majority of reports are published at irregular intervals as appropriate in the analyst’s judgment.

Goldman Sachs conducts a global full-service, integrated investment banking, investment management, and brokerage business. We have investment banking and other business relationships with a substantial percentage of the companies covered by our Global Investment Research Division.

Our salespeople, traders, and other professionals may provide oral or written market commentary or trading strategies to our clients and our proprietary trading desks that reflect opinions that are contrary to the opinions expressed in this research. Our asset management area, our proprietary trading desks and investing businesses may make investment decisions that are inconsistent with the recommendations or views expressed in this research.

We and our affiliates, officers, directors, and employees, excluding equity analysts, will from time to time have long or short positions in, act as principal in, and buy or sell, the securities or derivatives (including options and warrants) thereof of covered companies referred to in this research.

This research is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be illegal. It does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. Clients should consider whether any advice or recommendation in this research is suitable for their particular circumstances and, if appropriate, seek professional advice, including tax advice. The price and value of the investments referred to in this research and the income from them may fluctuate. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Certain transactions, including those involving futures, options, and other derivatives, give rise to substantial risk and are not suitable for all investors. Current options disclosure documents are available from Goldman Sachs sales representatives or at http://theocc.com/publications/risks/riskstoc.pdf. Fluctuations in exchange rates could have adverse effects on the value or price of, or income derived from, certain investments.

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Copyright 2007 The Goldman Sachs Group, Inc.

No part of this material may be (i) copied, photocopied or duplicated in any form by any means or (ii) redistributed without the prior written consent of The Goldman Sachs Group, Inc.

aldo mazzaferro, cfagoldman, sachs & co. [email protected] steel manufacturers...

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