BlueMountain's Feldstein on Three Steel Credit Trades

The second speaker at the Harbor Investment Conference is Andrew Feldstein, CEO of BlueMountain. Boaz Weinstein pitched the London Whale trade last year at the conference. Andrew bet against JPMorgan Chase & Co. (NYSE:JPM) and helped unwind the trade in the end. Ackman considers Weinstein and Feldestein as some of the smartest people in credit.

Feldstein gives quick background of the hedge fund, AUM is $12.5 billion. The hedge fund uses different strategies but key is asymmetric properties.

Andrew talks about the steel industry, and notes that China produces and consumes 46% of the world’s steel. Per capita consumption of steel is also supposed to beat the US shortly. We will have more in depth coverage on this topic soon.

However, the question is what if steel demand gets more volatilty as the past 100 years of data shows it to be extremely volatile asset. There are signs that Chinese steel demand is starting to crack. China only exports 7% of its steel, yet still the world’s largest exporter. On the other hand, Japan exports 67% of its steel but less in total exports.

If Japanese steel demand starts to decline due to demographics and decreasing Chinese demand this could hurt Japanese exporters.

The idea is related to CDS on JFE steel, the second largest domestic steel producer. The company is leveraged and 50% of sales is exported. The CDS are only trading at 146 basis points. 25% of debt is due in the next year. The five year CDS spread has gone down and is now near a low. There has been a big rally in credit due to actions by Abe.

On the other hand, United States Steel Corporation (NYSE:X) has 800 basis points, and AK Steel Holding Corporation (NYSE:AKS), which is in bigger trouble at 1200 basis points.

On a one year time horizon if you buy $100m CDS you can make a lot. Nucor Corporation (NYSE:NUE) steel trades at 70 basis points, it is had to believe JEF steel will go lower than Nucor Corporation (NYSE:NUE), so downside is low. Iron ore is biggest price component in steel, and Irone ore has been extremely volatile as well. Yet it is still going up in price.


Fortescue Metals Group Limited (ASX:FMG)  is not nor will be a low cost producer of Iron ore. Its the fourth largest steel producer. Fortescue Metals Group Limited (ASX:FMG) has 99% of its sales generated in China. In terms of enterprise valuation the company trades at $305 a ton and by 2015 will be closer to $170/ ton, the cost for new supply is $85 aa ton. If demand stays content the decline would be 84%. Short via equity options is an idea.

The US steel market also has problems. The US is the second largest integrated steel producer. The credit spreads show that historic credit spreads are extremely low on a historical basis. There is also a mispricing that there is risk on in credit although that is not the case in equity.

Long equity short credit is a trade idea for United States Steel Corporation (NYSE:X). If steel defaults and there is 40 cent recovery return on capital is 194%. The risk is that you lose the equity but credit rises so high you lose money on the CDS. To breakeven credit would have to recover to 72 cents. However, with the leverage and pension obligations this is highly unlikely.

The trade is especially attractive if the CDS returns to historic level of 300 basis points. In that case even if United States Steel Corporation (NYSE:X) recovers the return would b 88%.

Feldstein thinks that leveraged loans are pretty cheap currently. Mutual funds are buying 75% of new credit. They tend to buy liquid, unsecured bonds. Since mutual fund shares can be redeemed on a daily basis they will have to sell quickly, which could cause pricing pressure on those bonds. As interest rates rise, great rotation, defaults, are just three catalysts. Secured loans are unsurprisingly cheap on historic basis. The trade is long structured credit and long unsecured credit.