August 2008- It won't be a year for the record books, but service center executives are surprisingly relaxed in the face of a weakening economy. That's due to the fact that, for the most part, balance sheets are still showing profits.
As for general business conditions, it wouldn't be the steel industry if there weren't pervasive concerns hovering behind the relaxed facade. Price is the biggest issue for service centers of all sizes, and rightfully so. The rapidly rising price of material is causing the leaders of service center organizations to scratch their heads and try to figure out the best way to communicate these increases to their customers.
It would be exceedingly difficult to have an exceptional year in 2008 because many major markets are still down. The Federal Reserve Board reported that industrial production declined by 0.5 percent in February, the first decline in four months, and noted that this reflects the housing and automotive sectors. The report also showed that the manufacturing sector, which makes up nearly 80 percent of industrial output, fell by 0.3 percent last month.
"The ongoing housing downturn continues to weigh heavily on a number of manufacturing industries," said David Huether, chief economist for the National Association of Manufacturers. "The drop in manufacturing output last month was led by 3 percent declines in both furniture and wood product production. At the same time, motor vehicle production dropped by 1 percent. This is the fifth decline in the past seven months and partly the result of higher energy costs as well as the negative wealth effects stemming from lower home prices."
Huether noted, however, that "at the same time, other manufacturing industries, such as computers and electronic products, machinery, medical equipment, and aerospace, have experienced gains in production in recent months, partly reflecting continued growth in exports. Thus, while the overall manufacturing sector is not in recession, it's clearly struggling. With the housing downturn expected to last throughout the year and the spill-over effects into consumer spending likely to intensify, the manufacturing sector will likely experience modest domestic demand in the first half of this year."
Participants in the steel market are optimistic, though. The American Iron and Steel Institute, Washington, D.C., reported that for January 2008, "U.S. steel mills shipped 9,246,000 net tons, a 7.3 percent increase from the 8,614,000 net tons shipped in January 2007 and an 8.8 percent increase from the 8,495,000 net tons shipped in the previous month, December 2007."
And many service center companies are preparing for relatively smooth waters ahead. This isn't a recessionary environment, says C. Lourenco Goncalves, chairman, president and CEO of Metals USA, Houston, one of the top 10 metals service center companies in North America with approximately $1.8 billion in sales per year. "Books are good."
Ron Whitley, president and COO of Ranger Steel, Houston, the largest independent steel plate distributor for North America, says, "We put our new facility in California, right in the middle of the so-called housing recession. We've been able to grow this facility much quicker than we anticipated, and we're not seeing the housing situation affecting the metals industry out there to any great degree."
Another indicator of the good conditions is that equipment manufacturers are seeing flat sales from their service center customers. Trumpf, a manufacturer of laser cutting equipment, has a long history with many major service centers throughout North America. Erin Chase, sales engineer, 2-D laser machines, says, "Trumpf's business with steel service centers has been consistent. We have more than 100 machines installed at various steel service centers. Many are processing work for the agriculture industry, and many are currently processing armor plating for military efforts."
The outlook isn't completely rosy, however. Roy Berlin, president and CEO of Berlin Metals, which stocks flat-rolled carbon and stainless steel products in slit coil form, says that "demand isn't strong. In general, few customers are busier than they were a year ago. Depending on what market they’re in, they may be as busy or less busy, but no one’s busier."
Prices push higher
One of the reasons there’s not a pervasive exuberance in the industry is a continuing rise in prices. Skyrocketing raw-material prices and ever-increasing energy and transportation costs are all contributing to the high steel prices that the current market is experiencing.
At first glance, higher prices equal higher profits. However, many service centers are facing the problem of passing along these increases to their customers.
Whitley says that one of the only things that could potentially put a damper on business is "the continued high price of steel. At the moment, the customers are reluctantly accepting them." However, he says, "We here at Ranger are fairly conservative in how we make predictions about the future, and I'm going to still go on record and say that I think Ranger can grow its 2008 business at least 15 percent to 18 percent in revenues and market shares, despite what's currently being reported in the media."
"The biggest problem we face right now is conveying to the steel consuming market what’s happening to prices," says Dave Deinzer, CEO of Denman and Davis, the largest independent general-line steel service center in the Northeast. "I don't think the price increases are going to disappear because they’re globally driven."
Relationships have always been an integral part of any service center's business and now, they're as important as ever. Partnerships with mills, suppliers and customers are paramount for large, mid-sized and small service centers as they work to get and give the best price possible for material.
Goncalves agrees that passing along cost increases in full is one of the biggest issues facing service centers. His strategy for passing along higher prices focuses on "telling customers the truth, not what they would like to hear."
"We did an e-mail blast to all our customers and explained where the prices were on Jan. 1 and what the increases announced through February were, plus what the announced increases into April were going to be," says Deinzer. "We're getting good comments from customers, saying that this is useful information because now they can go back to their customers and explain why prices are going up. It's back to good communication."
Deinzer says that some of his customers have a difficult time with the increases. "One customer really struggled with these increases because he had gone out and guaranteed prices to his customer for a year. We told him, 'don't ever do that, especially in this marketplace,' but he did it anyway. His customer had demanded that he do it because his competition was going to do it, and that's where some of these smaller machine shops get caught."
"There are some customers that buy a lot of steel and are familiar with the steel world," says Berlin. "They read the papers, study it and know what’s going on. They don’t like the price increasing, but they understand it. Then you have other customers who may not buy as much steel, may not be as much of a steel expert, don't like it and don’t understand it. So it's our job to help them understand it."
The Metals Service Center Institute’s Metals Activity Report noted that "steel inventories at metals service centers in the United States and Canada declined in February. U.S. steel shipments were flat with year-ago volume, while Canadian steel shipments rose 7.1 percent compared with those of February 2007." The report noted that "U.S. steel inventories at the end of February were 23.3 percent below year-earlier totals and represented, at current shipping rates, a 2.8-month supply. Canadian steel shipments rose 7.1 percent from February 2007 to 328,400 tons. Canadian steel inventories fell 7.6 percent to 1.14 million tons, equal to a 3.5-month supply at current shipping rates."
These depleted inventories mean that many service centers are faced with the problem of restocking at high prices or getting stuck with expensive material if they aren't careful about managing their inventory. "A big issue is managing the pricing because you have to make sure that you don’t have too much inventory," says Berlin. “When this market turns around, and there's never been a market where the prices have continued to climb forever, you don't want to get caught with $800 per ton hot-rolled coils that might cost you $700 per ton next month."
High prices may spur consolidation
The spike in material price may have an effect on industry consolidation, especially when it comes to smaller operations.
"The only impact I can see is if you're a smaller or more-independent service center that doesn’t have the means to access more capital to run your business," Deinzer says. "We're going to have the same inventory in tons, and it’s going to cost 20 percent to 25 percent more to carry. If you have a $10 million inventory, it’s going to cost you $12.5 million to carry the same amount in tons. If you don’t have the bank availability to get the credit or the internal profits in your business to come up with that kind of money, where are you going to get it? There could be a squeeze on those companies."
There are still a lot of small companies out there, says Berlin. "There are many family-owned businesses that do sell hot-rolled, cold-rolled and galvanized, and I would imagine with the combination of the Ryersons and the Reliances, the Feralloys and the Esmarks getting bigger and bigger, that’s putting a squeeze on those guys. In the Chicago area, you had Sun Steel and Century Steel, both family-owned companies that sold out in the last few years. Now they’re the core of Esmark."
There's always another side of the coin, however. "I deal in stainless steel strip," Berlin says. "Ryerson's a big dog there, so when they bought Integris a few years ago, there was some concern that they were going to own the market. They kind of do in terms of percent, but they’re such a big company that they can’t be watching all their customers. Some customers don’t like buying from such a big company. For me, I've got a customer that says, 'I need a favor. I need this order tomorrow and you have to help me.' Who are you going to call at Ryerson? The guy you called yesterday may not be there tomorrow. My people have been here 15 or 20 years."
Get the most from your M&A
With so many service centers still making large purchases, it's important to make sure that those companies will live up to expectations in the long run. According to Dan Schweller, partner and global steel M&A leader for Deloitte & Touche LLP, New York, "Delotte internal research has shown that as many as 70 percent of transactions across a variety of industries are not achieving their expected value. Companies that offer they haven't met their goals provide a variety of factors that can be broadly classified as errors in approach or errors in the execution of a transaction. Approach would include such items as transactions that don’t support the corporate strategy, poor diligence, misreading markets or other information about the target, even their own M&A capabilities. Execution miscues would encompass a multitude of integration lapses that cause the new entity to divert from capturing the true value of the deal—from poor synergy capture planning to lack of clear leadership, cultural differences and even moving too slowly."
But what many have realized, even as others struggle, is that firm decision-making makes all the difference. "M&A participants need to first have an overall M&A strategy," Schweller says. "This strategy should focus on value creation from cost synergies, revenue enhancements and innovation. Secondly, they need to make sure that any potential acquisition supports their strategy, that they set in place a process to properly evaluate M&A opportunities with a disciplined due diligence approach and integrate them quickly. Integration and value capture begin during the diligence process, not after the deal is closed. And, don't forget, some of the best deals for our clients have included those from which they walked away. Successful M&A players tend to capitalize on this strength. They have a strategy and a process to evaluate targets against their strategy and are disciplined buyers with a repeatable integration process. Players that don’t play the game often don’t have the enterprise knowledge for all these areas and will need to rely more heavily on assistance from others to grow their competency.
"After an unsuccessful transaction, companies are often internally focused on their own problems and not as focused on growing the business," Schweller says. "As always, the markets and stock prices tend to recognize those companies that are successful and punish those that aren't. In the long term, as consolidation continues in the steel industry, those that don’t have robust practices around acquisitions may become acquisitions themselves."
Whitley says that M&A activity affects his business in two ways: "The first deals with the supply side. Since the early 2000s, there's been a great dash for consolidation of the steel mills." He says that since this has been completed, "it has impacted how steel mills go to market to sell their product in a more positive way. It’s made the steel market more transparent and orderly.
"Now, from the customer side, in recent years, some of our customers have changed hands, either through merging or being outright sold," he says. "What we're seeing is probably more independent or family-owned companies that are going to bigger companies or equity companies. One of our large customers, a family-owned company, just sold to a larger company. Changes are always different and sometimes scary for people because the change makes a company wonder if it's going to continue. Some of these changes have been positive, and some of them haven’t been so positive. Unfortunately, we have no control over that, we just participate in it and try to carry on in a normal business fashion."
Stay light on your feet
The secret to staying nimble is the ability to adapt. "We evolve year to year," says Deinzer. "If you look at this company today, it’s a different company than it was 10 years ago, and 10 years ago, it was totally different than the company it was 10 years prior. You have to adapt and move in the markets. At one time we were very much focused on the original equipment manufacturers. That was probably 60 percent to 70 percent of our revenue. But as they’ve moved out of the Northeast during the last 10, 15 and 20 years, and gone to Mexico or China, we’ve had to change our strategy."
For now, Whitley points out that the current state of the market has been blown a little out of proportion. "Yes, the housing market is in a correction state, and the credit market is certainly experiencing some issues, but the United States is a wide economy based on a lot of different factors, and it's hard to keep everybody going at the same time. I think anybody in the metals industries right now is doing good business, with good prosperity, and I personally don't see any doom and gloom, unless customers just come to a halt in accepting further steel prices.
"For many years, prior to 2003, the steel business wasn’t exactly a glamorous place to be," Whitley notes. "I've had the pleasure of being in the steel industry for quite a long time and I’ve seen a lot of changes. There were a few years, though, where you were almost embarrassed to say that you were in the steel industry. Right now, the industry is in The Wall Street Journal every day, and you hear that the markets are up. There’s nothing but positive comments. It’s made a full circle to return back to popularity." MM