Capacity utilization rate
The capacity utilization rate is a key indicator of the steel industry’s health. In simple terms, the capacity utilization rate refers to actual production as compared to the maximum production possible using existing plants.
Capacity utilization rate affects a company’s operating leverage. A company that has lower capacity utilization is more sensitive to changes in revenue and has a higher bankruptcy risk.
According to data released by the American Iron and Steel Institute, the US steel industry has operated at capacity utilization rates below 75% for the most part of 2015. AK Steel (AKS) operated its plants at ~78% capacity in 2Q15. AK Steel’s capacity utilization rates have fallen in recent quarters after its acquisition of the Dearborn plant.
U.S. Steel Corporation’s (X) capacity utilization rate in 2Q15 was much lower as compared to its peers due to lower tubular steel production. Nucor’s (NUE) capacity utilization rate was 78% in 2Q15, while Steel Dynamics (STLD) operated at a healthy rate of 87% in the quarter.
Steel Dynamics has historically enjoyed higher capacity utilization rates as compared to its peers. It currently forms 0.62% of the iShares S&P Mid-Cap 400 Value ETF (IJJ).
It’s important to note how changes in capacity utilization rates impact a company’s earnings. For example, we see a big jump in earnings when utilization rates improve from 80% to 85%. However, incremental benefits are lower when utilization rates increase from 90% to 95%.
AK Steel expects its utilization rates to “increase to the low 80%s and to the mid 80%s” in 2H15.
In the next article, we’ll look at the recent trend in steel companies’ upstream exposures.