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Quarterly Financial Report
Thursday | 07 August, 2008 | 3:41 am

First quarter 2008 in review

Written by By Houlihan Lokey

August 2008 - The first quarter of 2008 continued a period of strong market conditions for the ferrous and nonferrous metals industries. Record-low inventory levels combined with increasing raw material costs helped push ferrous pricing to record highs, while nonferrous pricing strengthened because of continued strong demand from emerging economies and tight market fundamentals. M&A market activity remained healthy, as well, driven primarily by continued scrap industry consolidation and steel mills' recent appetite for upstream integration.

Domestic ferrous prices experienced a sound quarter as depleted supply levels and higher raw material costs allowed steel mills to significantly increase prices. Additionally, inventory levels were driven to record lows, primarily as a result of weak U.S. imports on the heels of service center destocking in 2007, causing a supply shortfall and supporting elevated prices. Sharply lower imports were primarily the result of increased global pricing, driven by healthy demand from overseas coupled with lagging price increases in the United States, higher freight rates and a weak U.S. dollar. Strong demand from foreign countries, particularly in the Middle East, Eastern Europe, India and Russia, combined with higher shipping costs and the weak dollar created a lack of export supply from some of the world's traditional exporters, causing market tightness and, in turn, raising global prices to a level that made U.S. pricing unattractive to exporters.

Raw material price increases also helped push ferrous prices higher as key inputs from iron ore and coking coal to electricity rose across the board. Iron ore contract prices for 2008 increased 65 percent year-over-year, with Chinese mills recently agreeing to an 80 percent price increase. Pricing for iron ore, a key raw material input for integrated steel producers, has now increased for eight consecutive years and is up 474 percent over 2002 levels. According to analysts, coking coal prices are expected to surge 104 percent year-over-year in 2008, raising production costs for integrated mills by approximately $35 per ton. Impacting minimill producers, scrap prices also increased significantly, with No. 1 HMS rising 5.3 percent from $285 per ton in the first quarter of 2007 to $300 per ton in the first quarter of 2008. Subsequent to the end of the quarter, No. 1 HMS prices reached a high of $516 per ton. Higher scrap pricing has increased production costs for minimills, further contributing to higher ferrous pricing.

The price of hot-rolled sheet rose to $800 per ton in the first quarter of 2008, a 42.9 percent increase over prior-year levels. Subsequent to the end of the quarter, prices reached a high of $1,050 per ton, reflecting the sustainability of the strong steel cycle, as well as steel mills' ability to pass through raw material cost increases. Hot-dipped galvanized pricing increased 29.5 percent, from $780 per ton to $1,010 per ton during the first quarter of 2008. Cold-rolled sheet also experienced an increase in the first quarter of the year, increasing 33.3 percent, or $220 per ton, to $880 per ton from $660 per ton in the previous period. Nonresidential construction, albeit slowing marginally as of late, continued to drive long product prices higher, with steel bar prices increasing 5.9 percent from $656 per ton in the first quarter of 2007 to $695 per ton in the first quarter of 2008. Driven by the strong oil and gas market, oil country tubular goods (OCTG) pricing remained healthy during the quarter, increasing from $1,335 per ton during the first quarter of 2007 to $1,344 per ton during the first quarter of 2008, or 0.7 percent. Subsequent to the end of the quarter, oil reached above $140 per barrel, and OCTG pricing reached more than $1,500 per ton. According to analysts, ferrous pricing is expected to remain strong in 2008, as global supply trends are projected to remain tight, further exasperating the domestic import issue.

Tight market fundamentals also created a healthy nonferrous pricing environment, despite weaker demand caused by a deteriorating economic climate in the U.S. and other key metal-consuming economies. Aluminum prices increased 4.7 percent from $1.27 per pound in the first quarter of 2007 to $1.33 per pound in the first quarter of 2008 as a result of power-related production disruptions in China and South Africa combined with high energy prices and a weak dollar. Copper prices increased 22.5 percent year-over-year from $3.15 per pound to $3.86 per pound. The rise in pricing was primarily the result of tight market fundamentals and aggressive speculative and investor buying. Nickel prices continued their decline from previous years, decreasing 34.3 percent from $20.59 per pound to $13.52 per pound as a result of persistent high levels of LME stocks combined with weak physical demand. Subsequent to the end of the quarter, nickel prices dropped to as low as $10.77 per pound, a result of output cuts throughout the stainless industry and a lack of industrial demand. Zinc prices also experienced a decline on the back of a supply surplus, decreasing from $1.49 per pound in the first quarter of 2007 to $1.04 per pound in the first quarter of 2008.

M&A, financing market and analysis
During the quarter, M&A activity was led by the continued consolidation of the scrap industry and the emergence of a fundamental business model shift with minimill producers vertically integrating into scrap to secure raw material supply. A highlight of the quarter was Nucor Corp.'s acquisition of its long-term, exclusive scrap supplier, The David J. Joseph Co., for approximately $1.4 billion, representing 7.3x EBITDA. Nucor also acquired Metal Recycling Services Inc. toward the end of the quarter. According to analysts, the David J. Joseph acquisition will give Nucor greater control of scrap flows at a time of record raw material pricing. This transaction comes on the heels of Steel Dynamics Inc.'s acquisition of OmniSource Corp., one of its largest scrap suppliers, for approximately $1.1 billion, or approximately 6.2x EBITDA at the time the transaction was announced. This upstream vertical integration trend reverses steel mills' historical philosophy of moving downstream into processing. In addition, the highly fragmented scrap industry continued to consolidate. As ELG Haniel GmbH announced the acquisition of Consolidated Stainless Recycling Ltd., Alter Trading Corp. announced the purchase of Doggett Auto & Truck Salvage and SCI Recycling Service, and Scholz AG announced the acquisition of LNM Holdings. Subsequent to the end of the quarter, the industry continued its consolidation and integration trends with eight additional announced transactions, including Steel Dynamic's purchase of the remaining 75 percent of Recycle South LLC, Sturgis Iron & Metal Co. Inc. and Cohen & Green Salvage Co. Inc., and SA Recycling's announced acquisition of Pacific Coast Recycling LLC.

The tube and pipe and integrated steel mill sectors also witnessed significant M&A activity during the quarter. After declining to purchase Ipsco Inc. in 2007, Evraz Group announced the acquisition of certain Ipsco assets from SSAB Svenskt Stal AB for approximately $4.7 billion. Subsequently, Evraz agreed to sell Ipsco Tubulars Inc. and 51 percent of NS Group Inc. to OAO TMK for approximately $1.2 billion. Other notable transactions within the tube and pipe sector included Maruichi Steel Tube Ltd.'s announced acquisition of Leavitt Tube Co., Standish Capital LLC's announced purchase of the Small Tube Products Division of Wolverine Tube Inc. and Samuel Manu-Tech Inc.'s announced acquisition of Tubular Products Co. The Integrated Steel Mill sector also witnessed consolidation as OAO Severstal continued its expansion into North America with the announced purchase of ArcelorMittal's Sparrows Point mill for approximately $810 million. Subsequent to the end of the quarter, Severstal announced the acquisition of WCI Steel Inc. and was also involved in an attempted acquisition of Esmark Inc. Severstal's initial $685 million bid was rebuffed in favor of a deal with India's Essar Steel Holdings Ltd. in March. However, subsequent to the end of the quarter, Severstal increased its purchase price by 13 percent to $775 million, an offer Esmark accepted with union support.

During the first quarter of 2008, 22 domestic transactions were announced, compared with 30 transactions announced for the first quarter of 2007. Internationally, 39 deals were announced in Q1 2008, compared with 53 transactions in Q1 2007.

For 2008, analysts expect metals markets to remain healthy. Domestic ferrous pricing is expected to remain strong as high raw material prices are projected to persist and as global steel prices are projected to remain high as a result of healthy demand, making U.S. pricing too low to attract necessary imports. Strong nonferrous pricing is also expected as emerging economies continue to build their infrastructure, increasing demand for base metals, and as industry fundamentals remain tight. According to analysts, the M&A market should prove its sustainability as the scrap industry continues to consolidate, and ferrous and raw material pricing continues to rise, prompting vertical integration.

Equity market analysis
During the first quarter, the Houlihan Lokey Metals Index experienced a 1.1 percent decline. The specialty/nonferrous, tube and pipe, aluminum and mining--metals segments each experienced negative quarters, dropping 25.3 percent, 13.9 percent, 1.8 percent and 3.5 percent, respectively, from 2007 fourth quarter levels. In contrast, the minimill, integrated, scrap processors, service centers and mining--coal iron ore segments all experienced positive quarters, increasing 13.7 percent, 4 percent, 9.7 percent, 7.6 percent and 0.5 percent, respectively.

During the quarter, the Dow Jones Industrial Average decreased 4.6 percent, the S&P 500 decreased 8.6 percent and the Russell 2000 decreased 7.7 percent. The Houlihan Lokey International Producer Index led all indices during the quarter with a gain of 0.8 percent.

The mining--coal and iron ore segment posted the highest LTM EBITDA multiple of 10.8x, followed by the scrap segment, which had a multiple of 8.2x. Both the international and tube and pipe sectors had a 6.3x multiple, the lowest out of all segments.

Quarterly sector equity returns for all segments over the LTM showed positive results, except for the specialty/nonferrous segment, which showed a negative 39.1 percent return. During the quarter, both the specialty/nonferrous and tube and pipe segments displayed negative equity returns of 25.3 percent and 22.3 percent, respectively. The mining segment posted the highest NFY EBITDA multiple of 8.2x, followed by the scrap segment at 7.6x. MM

ABOUT HOULIHAN LOKEY
Houlihan Lokey, an international investment bank, provides a wide range of services, including mergers and acquisitions, financing, financial opinions and advisory services, and financial restructuring. Established in 1970, the firm has more than 800 employees in 14 offices in the United States, Europe and Asia. Houlihan Lokey's Basic Industrial Group provides metals industry clients with strategic and creative advice to help maximize shareholder value by offering investment banking, corporate finance and financial restructuring services to every segment of the industry.

For more information, visit Houlihan Lokey's Web site at www.hl.com or contact William G. Peluchiwksi at 312/456-4714.

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AIR FILTRATION

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NESTING SOFTWARE

SOFTWARE

Camfil APC - Equipment

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ATI Industrial Automation

4GL Solutions

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ALUMINUM

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InfoSight

PLATE

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Sandmeyer Steel Company

ANDRITZ Metals USA Inc.

LASER TECHNOLOGY

Trilogy Machinery Inc.

STEEL

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PRESS BRAKE TOOLING

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North American Steel Alliance

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PRESS BRAKES

TITANIUM

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MC Machinery Systems Inc.

Sandmeyer Steel Company

The Bradbury Group EMH Crane

PUNCHING

TUBE & PIPE

Fehr Warehouse Solutions Inc. Hougen Manufacturing BLM Group

COPPER & BRASS

Steel Storage Systems

SAWING

HGG Profiling Equipment Inc.
Concast Metal Products Co.
UFP IndustrialUFP Industrial Advanced Machine & Engineering  National Tube Supply

Copper and Brass Servicenter Association

Farmers Copper

Prudential Stainless & Alloys

MEASUREMENT & QUALITY CONTROL

Behringer Saws Inc.

WATERJET TECHNOLOGY

Advanced Gauging Technologies Cosen Saws Barton International

METAL FABRICATING MACHINERY

DoALL Sawing Products Jet Edge Waterjet Systems
Cincinnati Inc. HE&M Saw Omax Corp.
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ZINC

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