With rising interest rates the subject of many financial headlines lately, there are many fears from investors, both justified and not. To change gears a bit, let’s explore one industry that actually stands to benefit considerably from rising rates. I’m talking about the steel industry and related materials companies, which have been some of the market’s worst performers of 2013. Interest rates have the potential to help these companies stop hemorrhaging money on their pension obligations, which have been a major contributor to the lack of profitability seen in these companies.
Underfunded pensions: some bad, some worse
While pension problems are plaguing most of the materials sector, let’s take a look at a few that stand to benefit tremendously should their pension obligations ease. First, United States Steel Corporation (NYSE:X) is one very good example, with a pension plan that is underfunded by an estimated $2.7 billion as of the end of the last fiscal year, as compared to just a $381 million deficit in 2004. Bear in mind that the entire market cap of U.S. Steel is $2.7 billion, the same as their underfunded obligations. While U.S. Steel has more problems than just this, such as oversupply problems in the industry and a big management change, the pension problem alone could provide tremendous relief, as we’ll see later on.
AK Steel Holding Corporation (NYSE:AKS) has an even more daunting task ahead of them when it comes to meeting its obligations. This smaller company, with a market cap of less than half a billion dollars, has to come out of pocket for its $180 million pension shortfall this year. If rates stay the same, the company is estimating $240 million in pension obligations for next year, but a drastic fall is anticipated afterwards, as the company stopped accepting new members into its program some time ago.
Just to put the numbers in perspective, not having to pay $180 million toward pension contributions this year would make the difference between a loss of $0.51 per share (as expected) and a profit of $0.81 per share, even if nothing else changed fundamentally for the company.
As a counterexample, Nucor Corporation (NYSE:NUE), the largest U.S.-based steel producer, is a shining example of what a difference not having these kinds of obligations can make. The first big difference is that none of Nucor’s plants are unionized, and the company has actually stated that unions are a destructive force in the industry. The company also has a performance-based compensation plan including profit sharing and a 401k (no pension at all!).
As a result of this philosophy, Nucor Corporation (NYSE:NUE) hasn’t laid off an employee for financial reasons in over 30 years. Nucor has remained a profitable company, even with all of the oversupply and other fundamental issues plaguing the industry. Take a look at the earnings of these three companies over recent years.