Wednesday, March 29, 2006

WPSC Wheeling Pittsburgh Steel Corporation is very cheap and a good value.

Wheeling Pittsburgh Steel Corporation, the smallest of the US integrated steelmakers, is a tough little company. Its shares have been so hurt by bad news that it barely trades about book value. WPSC shares at $20 are very cheap, when its value in M&A transaction is closer to $30 or even $40 a share.

WPSC has achieved its goal of becoming a hybrid steel producer. It has both a blast furnace (and related facilities of coke ovens and a Basic Oxygen Furnace) which can convert iron ore into steel as well as brand new electric arc furnace (EAF). This gives the company enormous operational flexibility compared to many of its competitors.

EAF's are used to melt down and refine steel scrap. EAF operations have a variable cost structure because the cost of scrap steel varies along with the cost of finished steel. However scrap steel tends have contaminants, and so most EAF-only steelmakers cannot produce the very highest quality steel which can only be made with fresh iron. Right now EAF mini-mills such as Nucor and Steel Dynamics are the darlings of Wall Street. WPSC has the same equipment as they do, as well as access to fresh iron and extensive fabrication facilities that give WPSC the ability to make value-added steel products that mini-mills cannot do.

Making steel from fresh iron with a blast furnace has a huge fixed cost of keeping the furnace running at all times, as well as exposure to variable fuel and ore costs. Because WPSC has both types of facilities, it has flexibility to exploit differences in the price of making fresh steel vs. buying scrap steel on the open market. Because WPSC's EAF can use fresh iron as feedstock, WPSC can make much higher quality steel than its EAF only competitors.

The companies 2005 results were hurt by extraordinary events that affected operations as well as extraordinary capital expenditures.

In December of 2004, ductwork collapsed at WPSC's BOF facility. This led to costs associated with the repair of the ductwork and business interruption. WPSC is currently working with its insurers to recover in excess of $40 million worth of business interruption losses. Then WPSC's supplier of metallurgical coal claimed that they could not deliver coal under an existing fixed price contract. This forced WPSC to buy coking coal on the open market at much higher prices. WPSC discovered that its supplier was selling on the open market the very coking coal that it claimed it didn't have available under the fixed contract. Hilarity (and a lawsuit) ensued.

At the same time as these troubles were affecting the blast furnace operations, the company was making capital expenditures on hot steel roll changers that will increase its capacity at the Mingo Junction facility by 300,000 to 400,000 tons yearly. The company is also currently rebuilding its coke ovens in a joint venture with a Russian steel company.

Given the current consolidation in the steel industry, WPSC is a very attractive buy for a larger steelmaker. It has a state of the art EAF, a new blast furnace, and will shortly have brand new coking facilities that are collocated with Koppers Coal tar refining facilities.

In 2006, the extraordinary events of 2005 will not reoccur while the capital expenditures will begin to turn a profit. The EAF, which had been running at about 73% of capacity in 4Q2005, in January of 2006, was operating at 87% of capacity. Throughout 2006, the EAF ought to improve to be running at upwards of 90% of capacity. In 2006, company will probably resolve its disputes with insurers to recover a business interruption claim for an amount in excess of $40 million.

With shares currently, trading for slightly above the book value of $18.66 a share the stock market is assigning very little value to WPSC's going concern value. WPSC represents a fine company by itself, and would make an attractive acquisition target to others as well. By any measure, the company is very cheap at its current stock price, and is of interest to value and small cap investors.