Why AK Steel is turning to vertical integration to add value


Sep. 11 2014, Updated 5:00 p.m. ET

Vertical integration at AK Steel

Vertical integration means owning the raw material and supply chains for the business. For a steel company, the major raw material is iron ore and coal. The supply chain includes a company’s own sales force and steel distributors.

As we have seen previously, the revenue share from distributors and converters has come down. Let’s now look at AK Steel’s (AKS) backward integration.

Mining assets acquisition

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To fulfill the raw material requirement for its steel plants, AK Steel has acquired interests in iron and coal mines. The chart above shows the company’s strategy of securing self-sufficiency for key raw materials. As you can see, AK Steel is almost self-sufficient in its coke and carbon slab requirements. AK steel is targeting 50% self-sufficiency in iron ore and coal.

Raw material security is a key driver for steel companies like AK Steel, ArcelorMittal (MT), United States Steel Corporation (X), and Steel Dynamics (STLD). An alternate way to access the steel industry is through the SPDR S&P Metals and Mining ETF (XME).

Will the vertical integration add value to AK Steel?

While raw material security is the prime importance for any company, the recent experience in the steel industry has been otherwise. The companies that own mining assets, like ArcelorMittal and United States Steel Corporation, have seen their valuations tumble.

This was due to the falling trend in iron ore prices. By owning mining assets, these steel companies have foregone the benefits of falling iron prices.

The current trend in iron prices is expected to continue in the near term due to the slowdown in China’s demand and the fresh supply of iron ore. Over the long time period, analysts expect the prices to stabilize and to see higher levels.

Horizontal integration is another aspect AK Steel’s recent strategy. We’ll look at it in our next part.


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