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Can Steel Companies Gain from a Higher Capacity Utilization Ratio?

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Capacity utilization ratio

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.

Running production plants at less-than-optimal capacities also increases the cost of production. The reasoning for this is intuitive. Fixed costs are distributed among fewer units, so the costs per unit go up. According to analysts, steel companies’ profitability is negatively impacted if plants operate at less than 80% utilization rates.

Utilization ratio fell in 2015

The US steel industry has operated at a capacity use ratio below 80% since November 2014. Last year, the capacity utilization use was ~77% in January. However, the ratio was on a downward trend in 2015, which was in line with the production slowdown. The US steel industry ended 2015 with a dismal capacity utilization ratio of ~60%. Overall, the average capacity utilization use in the US steel industry was ~70% in 2015.

In 4Q15, lower capacity utilization negatively impacted steelmakers like U.S. Steel (X), Nucor (NUE), and AK Steel (AKS).

Capacity utilization increases

As we discussed in the previous part, we have seen an uptick in steel production numbers. What’s better, the capacity utilization rate has also increased to 73.6%. Although it’s below the 80% mark that analysts see as a healthy sign for the industry, it’s still much better than what we have seen in the last couple of quarters.

The key to the steel industry’s real turnaround would be to sell more profitable tons. In the next part, we’ll explore how the spot steel pricing is playing out in March.

Investors who prefer not to pick individual stocks can also consider the SPDR S&P Metals and Mining ETF (XME). Currently, XME has invested more than half of its holdings in US-based steel companies. Allegheny Technology (ATI) currently forms 4.6% of XME’s portfolio.

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