October 2008 - During the second quarter of 2008, strong global demand and a shortage of crude steel led to record-high carbon steel prices. Nonferrous metal prices were mixed, as aluminum and copper continued to show strength because of supply concerns, and nickel and zinc experienced a decline in pricing as a result of oversupply and slowing demand. During the quarter, the M&A market remained strong, led by continued consolidation in the scrap and recycling industry and several North American acquisitions by foreign companies such as OAO SeverStal.
Healthy supply and demand fundamentals continued globally, despite weakness in the U.S. economy. Lack of supply from Brazil, Russia, China and India, traditional exporting countries, was driven by strong demand because of infrastructure and urbanization efforts in those regions. This highlights what analysts see as a tightening global supply situation, which is a result of a long-term lack of investment in capacity together with steady growth in emerging economies. U.S. inventory levels remained at historically low levels because of a reduction in imports caused by limited global supply, low U.S. pricing relative to other countries and dollar weakness. At the end of the quarter, U.S. service center inventories were about 8 percent below their historical five-year average.
Reflecting the strength of the global carbon steel market, hot-rolled sheet pricing increased by $280 per ton, or 35 percent over the previous quarter's levels, rising from $800 per ton in the first quarter to $1,080 per ton in the second quarter. Hot-dipped galvanized also increased, climbing to $1,303 per ton, an increase of 29 percent from the prior quarter. Steel bar prices remained high on the back of strong demand from the nonresidential construction market overseas, increasing 32.4 percent from $695 per ton in the first quarter to $920 per ton in the second quarter. As a result of increasing rig activity and a renewed focus on sources of energy, demand for oil country tubular goods increased substantially and further depleted inventories. As a result, OCTG pricing increased 78.9 percent, increasing to $2,405 per ton from $1,344 per ton in the first quarter.
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 agreeing to an 80 percent price increase at the beginning of the quarter. 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. Scrap pricing, a key raw material for mini-mill steel producers, increased significantly, with No. 1 HMS climbing 112.2 percent from $205 per ton in the second quarter of 2007 to $435 per ton in the second quarter of 2008. Going forward, analysts expect input costs will act as a floor for steel prices.
Nonferrous pricing experienced a mixed second quarter, with aluminum and copper benefiting from supply concerns and nickel and zinc declining on high inventory levels and slower end market demand. Aluminum pricing increased 4.5 percent, from $1.33 per pound in the first quarter to $1.39 per pound in the second quarter, primarily driven by power-related production disruptions in China and South Africa. Copper prices increased 3.1 percent, from $3.86 per pound during the first quarter to $3.98 per pound during the second quarter as supply disruptions (in China, Chile and Peru), falling ore grades and low inventory levels supported prices. Subsequent to the end of the quarter, copper pricing fell by more than 15 percent partially because of the summer slowdown and fears of slowed economic activity in China. Nickel prices decreased 27.3 percent to $9.83 per pound during the second quarter of 2008 from $13.52 per pound during the previous first quarter. Poor demand for nickel from the stainless steel industry, which accounts for about 70 percent of nickel consumption, has driven prices down. Zinc prices declined 18.3 percent from the first quarter, decreasing from $1.04 per pound to $ 0.85 per pound during the second quarter. Zinc traded in a narrow range throughout the quarter as a result of increased production levels and slower demand.
Despite signs of softening demand in the U.S. market, analysts expect ferrous pricing to remain strong because of low imports, lean inventories, strong global pricing pressures and a weak dollar. U.S.-bound exports are expected to decline further, as 10 percent of Chinese capacity has been idled as a result of mill shutdowns (curtailed to clean the air prior to the Olympics and in response to higher export taxes).
M&A, financing market and analysis
M&A activity during the second quarter focused on scrap processors and recyclers, which benefited from increasing scrap prices and strong demand. Steel Dynamics/OmniSource acquired both Recycle South LLC and Sturgis Iron & Metal Co. in separate transactions. It acquired the remaining 75 percent of Recycle South LLC it didn't already own for approximately $515 million and acquired Sturgis Iron & Metal Co. out of bankruptcy for approximately $41 million. Metalico Inc. announced the purchase of The Snyder Group Inc. for $76.48 million, further adding to its scrap assets. SA Recycling also announced the acquisition of Pacific Coast Recycling LLC from Mitsui & Co. Ltd.
In addition to securing upstream assets, steel producers secured downstream assets, most notably pursuing rebar fabricators. In April, Pacific Coast Steel Inc., a subsidiary of Gerdau Ameristeel Corp., completed the acquisition of rebar fabricator Century Steel Inc. for $152 million. In June, Harris Steel Group Inc., a subsidiary of Nucor Corp., signed a purchase agreement to acquire Ambassador Steel Corp., a fabricator of concrete reinforcing steel, for approximately $321 million. Subsequent to the end of the quarter, Commercial Metals Co. announced the acquisition of Reinforcing Post-Tensioning Services Inc., adding approximately 150,000 tons of annual rebar fabrication.
After announcing the acquisition of Sparrows Point LLC, OAO SeverStal continued its North American expansion, announcing the acquisition of WCI Steel Inc. and Esmark Inc. OAO SeverStal's $1.2 billion bid for Esmark was superior to India's Essar Steel Ltd., who withdrew after SeverStal garnered the support of the United Steelworkers. OAO SeverStal acquired WCI Steel Inc., a producer of high-quality, custom flat-rolled steel, for $331 million. In addition to acquiring new assets, OAO SeverStal also increased its stake in SeverCorr LLC to 85 percent by acquiring its outstanding shares from the founding management team.
The second quarter witnessed 30 domestic transactions with total announced values of $5.2 billion, an increase over the 22 transactions announced during the same period last year. Internationally, 75 transactions were announced with an aggregate value of $2.1 billion compared with 63 transactions announced during the same period last year.
Equity market analysis
During the second quarter, the Houlihan Lokey Metals Index experienced a 16.3 percent increase. The specialty/nonferrous and aluminum segments experienced negative quarters, dropping 14.3 percent and 1.7 percent, respectively, from 2008 first-quarter levels. Experiencing positive quarters were the scrap processors (50.4 percent); integrated steel mills (42.4 percent); service centers (23.8 percent); tube and pipe (22.7 percent); mining, coal and iron ore (17.7 percent); mining, metals (11.8 percent); and mini-mills segments (11.6 percent).
The Dow Jones Industrial Average decreased 7.1 percent and the S&P 500 decreased 2.8 percent during the quarter, and the Russell 2000 increased 2.2 percent. The Houlihan Lokey International Producer and Metals Indices led all indices during the quarter with a gain of 20.4 percent and 16.3 percent, respectively.
At the end of the quarter, the scrap processors segment and the mining--coal and iron ore segment each posted a median multiple of 16.8x LTM EBITDA, the highest of the segments. The tube and pipe segment had a median multiple of 13.5x. The specialty/nonferrous segment had a median multiple of 5.8x, the lowest of all segments.
Quarterly sector equity returns for all segments over the LTM showed positive results except for the specialty/nonferrous and aluminum segments, which showed a negative 45.7 percent and 12 percent return, respectively. During the quarter, the specialty/nonferrous and aluminum segments again displayed negative equity returns of 14.3 percent and 1.7 percent, respectively. The tube and pipe segment posted the highest NFY EBITDA multiple of 11.5x, followed by the scrap segment at 10.3x. 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. Each year, it serves more than 1,000 clients ranging from closely held companies to Global 500 corporations. Houlihan Lokey's Basic Industrial Group was the No. 1 M&A adviser on all Industrial sector deals in 2007, with 39 announced transactions.
For more information, visit Houlihan Lokey's Web site at www.hl.com or contact William G. Peluchiwksi at 312/456-4714.
