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Service Centers
Tuesday | 20 April, 2010 | 5:32 am

Navigating the challenges ahead

By Lauren Duensing

April 2010 - Many of the financial results of large service centers concisely tell the story of 2009: Net sales down 57 percent, tons sold down 15 percent, a net loss of almost $100 million. It was a disheartening downturn right on the heels of a banner year.

But with the dark days of 2009 solidly in the past, metal service centers are looking forward to better business conditions. Statistics compiled by the Metals Service Center Institute, Rolling Meadows, Ill., show that February shipments of steel from U.S. metals service centers rose 10.4 percent above 2009 numbers, "marking the first time since April 2008 that year-over-year shipments have been higher."

It looks like this trend will continue in the near future, with service center executives expressing optimism for the upcoming months.

"Our business has steadily climbed since August 2009," says James Barker, general manager of Sequoia Brass & Copper, Hayward, Calif., a privately held supplier of nonferrous plate, bar and sheet. "We have been very busy so far this year with an upbeat confidence from our customers."

Norman E. Gottschalk Jr., president of Marmon/Keystone LLC, Butler, Pa., a distributor of pipe, tubing and chrome-plated bar, also sees a gradual increase in business in 2010. "The second half should be stronger than the first half, although the first half is showing a slight increase," he says.

"Our outlook for 2010 suggests an increase in consumption of about 10 percent, compared to 2009 [tons]," says Johnny Hsieh, executive managing director, Ta Chen International Inc., Long Beach, Calif., a master distributor of stainless, aluminum and nickel alloy coils, sheets, plates, long products, tubes and PVFs.

"The majority of this increase (about 7 percent) will come by way of inventory replenishments with the 3 percent balance accounting for true increase in demand," he continues. "Service centers have purchased stock replenishments conservatively over the past year and a half. Because we have strategically widened our product mix, we hope to participate more broadly by providing greater synergies. We expect that key industries, such as construction, consumer goods and automotive, serviced by our distributor clientele will begin a turnaround and continue their recovery."

A minefield of challenges
Navigating an already-difficult marketplace is even more challenging when companies must withstand a barrage of uncertainty surrounding government policy. Gottschalk points out a few of the concerns, including health care, card check, and cap and trade. He says, though, "on an execution basis, the biggest challenge we’re facing is managing inventories because of mill lead times. Also, mill price increases that are driven by input costs are hard to pass through. It’s much easier to pass through price increases when they’re driven by demand."

Barker says that today’s service centers face a multitude of issues. "First is still international unfair fair trade practices. Next is the depleting domestic and North American mills that are fighting a losing battle with imports. But I still think a huge obstacle for service centers is trying to support customers that don’t or can’t forecast metal needs. Forecasting was replaced by JIT, but JIT failed during the 2002 recession. Now the only way to support customers is order future requirements based on historic numbers. I can’t see anybody buying high-priced metals and filling their warehouse in hopes of orders.

"We still support our domestic suppliers the best we can, but now we need foreign support due to the fact that their pricing drove many of our U.S. producers out of business," he continues. "As for forecasting, we use historic numbers, plus a safety allowance, and hope we purchase the correct items and quantity. The tough part is customers will do anything they can to purchase small quantities, want large order pricing and quick deliveries. Most of the time, they get what they want."

Inventory’s impact
Adjusting inventory management strategies will be a top priority for service center executives in 2010 and beyond. "We’re spending more time managing inventories than we have for years," Gottschalk says.

Hsieh points out that although managing inventories is always difficult, the solution for today’s service centers is "to try to do more with less, that is, to put an increasing dependence on master distributors and mill depots. Mill depot inventories are leaner than has previously been the case due to erratic price fluctuations, which have made mills more reluctant to carry a broad range of items that may be worth less the following month."

For Ta Chen, Hsieh says, "Our challenge is to stay ahead of the curve relative to price swings so that we can manage inventories and have availability at all times without creating overstock positions when prices slide and business slows. We find that the orders we receive have far greater urgency for immediate needs. One of our benefits is that we can typically fill such buyout orders as early as the same day or next day. We also find that in cases where mill shipments run later, which tends to happen more often in leaner times, we are often able to help our distributor customers fulfill their commitments."

Mike Petro, lead category manager, metals, for Ariba Inc., Sunnyvale, Calif., a provider of spend management and business commerce solutions, says that although service centers and raw metal distributors have always emphasized inventory control, the current environment makes it far more crucial because of the impact inventory levels will have on pricing.

"Figures recently released by the Metals Service Center Institute suggest conditions have improved of late, but inventory levels are sharply lower than in previous years," Petro says. "MSCI reported January steel shipments rose nearly 15 percent compared to the previous month, but inventories are sharply lower than a year ago, with current days on hand still hovering close to 2.5 months, which is down more than 26 percent year over year.

"Inventory management for service centers and distributors has shifted from an issue to be monitored into something that will be dictated by the highest levels of financial leadership," says Petro. "Tightening of inventory levels will have the largest impact on the differences in pricing for contract versus spot market metal buyers. While spot market inventories will be maintained, the delta in pricing for spot purchases will be substantial due to the increased liabilities of maintaining inventories that aren’t tied to a specific customer contract."

Everyone’s in the same boat
Across the country, both large and small service centers are dealing with similar conditions. However, tight credit can put smaller service centers at a disadvantage. Fritz Prine, CFO of Westfield Steel, an independent, family-owned, full-line steel service center. points out that he’s seeing mixed indicators but expects business to slowly improve. However, he says, "some of our customers are having cash-flow issues, so we become their de-facto bank."

He also notes, "All service centers still have too much inventory for the current economic conditions. Larger companies have buying power, so they should have an advantage in cost structure."

"Companies that are undercapitalized are having the biggest challenges," adds Gottschalk. "They used inventory drawdown money to cover losses and are now finding it hard to increase inventories and carry receivables as business picks up. A good credit line would help these companies, but credit is tight."

"Clearly, the smaller businesses are at a disadvantage and struggle more during times of decreased volumes," says Hsieh. "The fixed overheads of these companies do not allow them to realize satisfactory returns based on the lower volumes combined with lower prices. In this climate, we are monitoring credit line exposures and amounts outstanding with greater diligence."

The lower volumes and sluggish demand will eventually result in consolidation. "There will not be enough business to satisfy the existing service center capacity," says Prine. "Some service centers (independent or branches of larger corporations) will close. The remaining service centers will continue to fight over price.

"Service centers have all slashed inventory levels, slashed overhead and reduced debt," he continues. "Because most service centers are privately held (regardless of size), it’s difficult to know exactly what other initiatives have been taken. We’re familiar with peers who have closed their doors or sold out of necessity."

At the end of the day, good business all comes back to a familiar concept: customer service.

"Proactive raw metal suppliers should be prepared to compete on non-material cost factors that include incremental services, inventory management methods and varying payment terms," says Petro. "Metals buyers that do have attractive orders to place will be looking for suppliers that are willing to offer favorable non-material factors in exchange for the financial security offered by locked-in volumes over two or three years.

"Ariba is seeing increased interest in service centers and metal distributors pursuing new contracts with buyers looking to lock in longer-term contracts," he continues. "While fixed prices are still a thing of the past, metal suppliers and buyers alike are frequently looking for longer-term, adjustable-price deals to help smooth over the violent shifts in supply-and-demand pricing."

Focus on flexibility
The metal service center industry will move forward with a healthy amount of caution in 2010. No one wants to be caught on the wrong side of another market downturn with too much inventory and an overextended budget.

"We have reduced our cost structure and improved our balance sheet," Prine says. "We continue to focus on sales and marketing to find the next customer. We’re driving our company culture to be more flexible in order to take advantage of opportunities when they arise."

"The key word is conservative," says Barker. "We can’t afford to make too many costly decisions. We have to obtain knowledge and careful judgement in all that we do. From material purchasing to adding new equipment, the question is always, ‘Do we need it?’"

"There’s no question service centers and distributors have been forced to be nimble in order to adapt to and even survive the challenging market conditions over the past three years," says Petro. "Gone are the days of one-size-fits-all pricing and contract models. The metal suppliers that will emerge from the recession successfully are the ones that will be diligent with inventory controls and ones that will be able to avoid overreacting to the short-term rise and falls of demand."

"The risk-versus-reward ratios associated with maintaining larger inventories do not allow for the speculative purchasing of former times," Hsieh notes. "As a general rule, the thought process for service centers is to buy this month what they need this month. As for next month, they’ll cross that bridge when they get there. Smaller service centers have lived off this principle for years.

"In terms of investments or expansions, we see a lack of appetite or available funds at the present time. This will not change until there’s a clear indication recovery is moving forward at full steam. Even then, people will remember how easy it is to get burned. At this point, there appears to be a good amount of discipline in the marketplace. A modest, ongoing, steady growth is much preferred over bursts of enthusiasm followed by a cliff suddenly opening up in front of you." MM

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