April 2009 - During 2008, steelmakers proved their ability to react to global economic conditions as they pursued strategies of backward integration during the first half of the year and production discipline during the second half. Production discipline, largely needed as a response to the global credit crisis, was also exercised across the base metals complex, albeit in a less timely and less effective manner than steelmakers. Long-term fundamentals, including urbanization and infrastructure build, are projected to drive demand for both ferrous and nonferrous metals beyond 2009.
Ferrous pricing increased to record highs throughout the first half of the year and later declined as the global economy turned. Through the first half of the year, ferrous pricing was driven higher by healthy supply and demand fundamentals, higher raw material costs, low service center inventories and low import levels. Hot-rolled sheet began the year at $563 per ton, eventually reaching a record high of $1,090 per ton at the end of May but ended the year at $560 per ton, a decline of 48.6 percent from its mid-year high. Despite the favorable market conditions throughout the first half of the year, steelmakers were able to quickly respond to evaporating demand. The fourth quarter largely consisted of extended maintenance outages and unprecedented production cuts. At the end of the quarter, analysts estimated that two-thirds of domestic blast furnaces were idled and 25 percent of global steel capacity was offline.
Despite aluminum and copper prices reaching record highs during the year, nonferrous price levels ended 2008 substantially lower than 2007, driven by deleveraging, the collapse in liquidity and downgrades to the global economic outlook. In July, aluminum and copper reached record highs of $1.49 per pound and $4.08 per pound, respectively. At the end of the year, aluminum, copper, nickel and zinc had declined 55.5 percent, 67.8 percent, 67.5 percent and 60.3 percent, respectively, from their 2008 highs. Generally, nonferrous metals were faced with rising stocks and a significant decline in demand during the second half of the year. Producers reacted by cutting supply and delaying capital expenditure plans.
China continued to affect both supply and demand in the metals sector. The slowing growth rate of China's economy contributed to the decline of metal prices throughout the second half of the year. China's economic slowdown was due to a number of factors, including slowing exports and weakness in the Chinese property sector. In November, China announced an economic stimulus package worth $586 billion in an effort to curb economic weakness. The package included a major infrastructure spending plan. The Chinese government has also rolled back export taxes on a number of goods, including metals, potentially creating a situation in which slowing domestic demand causes Chinese steel to flood the market and further decrease prices. Additionally, China's State Reserve Bureau announced it will purchase 290,000 tons and 300,000 tons of aluminum and zinc, respectively, from major domestic producers in 2009 to reduce the market surplus and support prices. Further, the China Nonferrous Metals Industry Association advised the government to purchase 1 million tons of aluminum, 400,000 tons of copper and 400,000 tons of zinc in 2009 to provide continued support.
Supported by strong global demand and low imports, domestic steel prices increased during the first two quarters of 2008 before deteriorating economic conditions and the credit crisis affected them. Hot-rolled sheet increased 91.8 percent during the first two quarters, from $563 per ton to $1,080 per ton, before declining to $560 per ton at the end of December, down 0.6 percent for the year. Cold-rolled sheet also experienced an increase in the first two quarters of the year, increasing 70.6 percent, or $480 per ton, to $1,160 per ton from $680 per ton at the end of 2007. Cold-rolled sheet ended the year down 4.4 percent, decreasing to $650 per ton in the fourth quarter. Long product prices increased throughout the first three quarters of the year, driven largely by strong commercial construction demand. Steel bar pricing rose 65.7 percent from $595 per ton at the end of 2007 to $986 per ton at the end of the third quarter of 2008, before declining to $676 per ton at the end of the year. OCTG prices increased 131.1 percent during the first three quarters of 2008, to $2,979 per ton from $1,289 per ton, before ending 2008 at $2,742 per ton, up 112.7 percent for the year. According to analysts, production discipline and lower imports, combined with an expected increase in demand in the second half of 2009, should serve to support ferrous prices somewhat.
Service center inventories declined throughout the year, from 10.3 million tons to 8.6 million tons, a decrease of 16.5 percent. Strong demand held inventories low during the first half of the year and low inventories during the second half of the year were a result of cautious purchasing, as service centers tried to avoid holding inventory in an environment of declining prices. At the end of 2008, service center inventories represented one of the lowest levels since September 1991 and a 22 percent decline from August 2008. Historically low net imports helped support prices throughout the year. Imports declined 4 percent to 31.9 million tons in 2008 from 33.2 million tons in 2007. Steel imports are expected to remain low because of weak demand and the lack of a U.S.-to-world price premium.
Raw material prices increased substantially in both 2007 and the first half of 2008, allowing steelmakers to increase prices and margins. Impacting mini-mill producers, scrap prices surged 96.9 percent from the end of 2007 through May 2008, as No. 1 HMS pricing increased from $234 per ton to $460 per ton. The second half of 2008 brought lower raw material prices as a result of the slowing global economy. Both iron ore and coke spot prices declined by approximately 50 percent since their mid-year highs. No. 1 HMS declined 68.5 percent from the end of May, decreasing to $145 per ton at the end of 2008. Going forward, analysts estimate a decrease of 30 percent and 60 percent in the 2009 annual contract negotiated prices for iron ore and coking coal, respectively.
Nonferrous metal prices declined during 2008, despite aluminum and copper reaching all-time highs. The fourth quarter witnessed substantial price declines as aluminum, copper, nickel and zinc declined 39.3 percent, 54.8 percent, 31.4 percent and 32 percent, respectively. Aluminum prices rose 30.8 percent during the first half of the year, from $1.07 per pound at the end of 2007 to $1.39 per pound at the end of the second quarter, and ended the year down 38.2 percent. Copper prices rose 31.4 percent during the first half of the year, from $3.03 per pound at the end of 2007 to $3.98 per pound at the end of the second quarter, and ended the year down 56.5 percent. Nickel prices also decreased throughout 2008, down 58.1 percent for the year, falling from $11.70 per pound to $4.90 per pound. Zinc also declined throughout the year, falling 51 percent from $1.04 per pound to $0.51 per pound.
Nonferrous price declines have brought aluminum, nickel and zinc prices in line with or below the marginal costs of production, and analysts estimate each is trading between the 50th and 75th percentile of cash costs. In response to current price levels, global producers have announced production cutbacks and delayed expansion projects. Analysts anticipate that decreased production levels will prevent significant price declines during 2009. Despite current economic weakness, long-term nonferrous fundamentals remain intact, supported by future demand from emerging market economies and structural supply-side constraints.
M&A and financing market and analysis
Strong M&A activity occurred throughout the year, highlighted by strategic buyers making both upstream and downstream acquisitions. Heavy consolidation occurred within the scrap industry, as steelmakers sought to secure raw material supply. The year witnessed more than 25 transactions within the scrap industry, including 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. Other scrap-related transactions included Nucor's acquisition of Metal Recycling Services Inc., Steel Dynamics Inc.'s purchase of the remaining 75 percent of Recycle South LLC for approximately $515 million and SA Recycling's acquisition of Pacific Coast Recycling LLC. Steelmakers, seeking increased raw material self-sufficiency, also purchased selected coke and coal assets. ArcelorMittal purchased a metallurgical coke plant from Koppers Holdings Inc. for $160 million and acquired the Concept Group, a manufacturer of coking coal. SeverStal acquired PBS Coals Corp. for approximately $1.2 billion.
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. Commercial Metals Co. announced the acquisition of Reinforcing Post-Tensioning Services Inc., adding approximately 150,000 tons of annual rebar fabrication.
Russian steelmakers made significant investments in North American assets during 2008. SeverStal continued its expansion into North America withseveral purchases, including ArcelorMittal's Sparrows Point mill for approximately $810 million. Shortly after, SeverStal acquired WCI Steel Inc.for approximately $402 million and Esmark Inc. in a brief battle with India's Essar Steel Holdings Ltd. SeverStal's initial $685 million bid for Esmark was rebuffed in favor of a deal with Essar, however, SeverStal increased its purchase price by 13 percent to $775 million ($1.2 billion including assumed liabilities), an offer Esmark accepted with union support. Novolipetsk Steel OJSC announced the acquisitions of both Beta Steel Corp. and John Maneely Co. NLMK acquired Beta Steel Corp. for $350 million in cash, a discount to the $400 million purchase price originally negotiated. The $3.5 billion acquisition of John Maneely Co. was eventually canceled.
The tube and pipe segment also witnessed consolidation as a result of strong demand for OCTG and increasing rig counts. 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 acquisition of Leavitt Tube Co., Standish Capital LLC's purchase of the Small Tube Products Division of Wolverine Tube Inc. and Samuel Manu-Tech Inc.'s acquisition of Tubular Products Co.
During the fourth quarter, several high-profile transactions were withdrawn. In late September, NLMK canceled its $3.5 billion acquisition of John Maneely Co. after allegedly seeking to renegotiate the terms of the deal. In November, the $9.3 billion merger of Cleveland-Cliffs Inc. (now Cliffs Natural Resources Inc.) and Alpha Natural Resources Inc. was canceled due to uncertain economic conditions. In November, BHP Billiton terminated its yearlong bid for Rio Tinto amid market uncertainty about the competitive effects of the transaction and the deteriorating economic environment.
During 2008, 77 domestic transactions with total values of $29.4 billion were announced, compared with 90 transactions with total announced values of $86.7 billion in 2007. The fourth quarter witnessed nine domestic transactions, with total announced values of $444 million, a decrease compared with the 18 transactions announced during the same period last year. Internationally, 45 transactions were announced in the fourth quarter with an aggregate value of $3.4 billion, compared with 63 transactions announced during the same period last year.
The later part of the year witnessed a decline in the strength of the credit markets, as both strategic and financial market participants encountered difficulty tapping lenders. Strategic buyers with well-built balance sheets were in a strong position to bid on assets, provided little or no financing was required, taking advantage of the current market to grow shares, secure long-term supply or, in the case of producers, secure downstream assets to drive future volume. Analysts believe current market conditions will cause further industry consolidation as companies with strong balance sheets can take advantage of distressed situations.
Equity market analysis
During the fourth quarter, the Houlihan Lokey Metals Index experienced a 39.5 percent decrease. Similarly, all segments of the metals index experienced negative returns, with the exception of the mini-mill steel producers segment, which posted an increase of 1.2 percent. The largest decrease, attributable to the precious metal mining segment, was 56.2 percent. Most metals-related equities experienced a sell-off during the quarter as a result of global economic weakness and the broad-based decline in commodities prices.
The Dow Jones Industrial Average decreased 19.1 percent and the S&P 500 decreased 22.5 percent during the fourth quarter, while the Russell 2000 decreased 26.5 percent. The Houlihan Lokey International Producer Index also dropped 43.7 percent during the quarter.
At the end of the fourth quarter, the tube and pipe producers segment posted a median multiple of 5.3x LTM EBITDA, the highest of the segments. The integrated steel producers segment had a median multiple of 1.6x, the lowest of all segments.
Quarterly sector equity returns for all segments over the LTM showed negative results. Over the past 12 months, the mini-mill steel producers dropped 35.8 percent. The aluminum producers segment posted the highest NFY EBITDA multiple, 7.8x, and the mining metals segment posted the lowest,3.6x.
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, valuations and financial restructuring. In 2008, the firm was ranked the No. 1 M&A adviser for U.S. transactions less than $2 billion by Thomson Reuters. In addition, the firm advised in eight of the 10 largest corporate bankruptcies and on more than 500 restructuring transactions valued in excess of $1.25 trillion in the past 10 years. 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.
For more information, visit Houlihan Lokey's Web site at www.hl.com.
Houlihan Lokey's Basic Industrial Group was the No. 1 M&A adviser on all industrial sector deals in 2008, with 39 announced transactions. The Metals 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.
