May 2009 - The entire U.S. economy is singing the blues--a song filled with recession, decline, slipping stocks and unemployment. From every news outlet, headlines are filled with negative language and images that are contributing to unease among consumers. Skyrocketing unemployment numbers are fueling the fire. According to the Bureau of Labor Statistics’ March Employment Situation, nonfarm payroll employment continued to decline and the unemployment rate rose to 8.5 percent.

"Since the recession began in December 2007, 5.1 million jobs have been lost, with almost two-thirds of the decrease occurring in the last five months," the BLS noted in the press release.

The Reuters/University of Michigan Surveys of Consumers reported, however, that consumer confidence levels remained largely unchanged in March, hovering near the same record low levels on file for last October. Richard Curtin, director, said in the press release, "The good news is that the free fall in confidence has ended. The bad news is that consumers expect their financial situation to remain dismal for the rest of 2009."

It’s the economy
As a result, consumers aren’t buying goods and services; instead they’re choosing to reserve funds for a rainier day. "The fewest consumers in the history of the survey reported that their finances had improved during the past year, with an all-time record number mentioning that their incomes had declined in the past year," Curtin noted.

"People have finally started talking about what we’ve been talking about in the manufacturing sector for the last eight years," says Dan DiMicco, chairman, president and CEO, Nucor Corp., Charlotte, N.C. He points out that the real unemployment numbers are higher than the current statistics. "Today, [unemployment is] not 8.5 percent; it’s more like 16 percent because they’re not counting all the people who have given up looking for work, and they’re not counting all the people who are underemployed."

The impact of these dramatic numbers is that "people stop spending," he says. "They save and just buy what they need."

As a result, "there’s a lot of money out there and a lot of people waiting to do business," says Dave Hannah, chairman and CEO, Reliance Steel & Aluminum Co., Los Angeles. "The real catalyst that needs to occur is confidence. People in this country need to gain some confidence in the economy and feel good about spending money, as opposed to feeling threatened that they’re going to lose their jobs or that money isn’t going to be available to them, and they can stop losing value in their homes and 401(k)s. All of that has destroyed confidence in our economy.

"We’ve been hearing only negative things for the better part of two years," he continues. "I think it was intensified because of the election year. The American people could only take so much. You can only hear all this negative stuff for so long before you start believing it. Then it becomes a self-fulfilling prophecy."

"We’re obviously in a recession, and we all understand that," says Rob Levey, general manager, commercial, Gallatin Steel, Ghent, Ky. "The way out of a recession is spending, but for most individuals, the last thing they want to do is spend any money because they’re afraid."

Big Three, big problem
The impending restructuring of the Detroit automotive industry could have a big impact on consumers’ confidence in the economy. Stimulus monies, layoffs and other cutbacks haven’t done the trick. The beleaguered automakers are struggling to keep their heads above water.

There’s no doubt that changes in Detroit would have a ripple effect on the metals supply chain, as well as on the entire U.S. economy.

"The automotive industry in the United States is obviously extremely important, given that one out of seven jobs in this country is in automotive or a related industry," says Scott Kelley, president and CEO, Service Center Metals, Prince George, Va.

"What we’re left with now is trying to find a suitable financial restructure for [the Big Three], recognizing the current environment and giving them an opportunity to shed their legacy costs," says Michael Hoffman, president and CEO, Macsteel Service Centers USA, Newport Beach, Calif. "I assume the management of these organizations will not be easily convinced to adopt a restructuring plan that doesn’t solve the problems with the unions. There’s no purpose for them to go from the frying pan into the fire."

"Rather than thinking of it as steel consumption, the survival of the Big Three could have a big impact on the economy," says Frank Kevane, president and CEO, ThyssenKrupp Materials NA, Copper & Brass Sales Division, Southfield, Mich. "There are so many Tier 1 and Tier 2 suppliers that would be impacted in a big way if there was a bankruptcy at General Motors. It’s a delicate situation."

"It’s important to the country, not just to steel," adds DiMicco. "Somebody’s going to build cars in this country. There should be the opportunity for the American car companies to be successful. It’s important for our economy, and it’s important for the nation not to lose that manufacturing strength, innovation, and research and development that goes along with it."

"If you look at the North American economy, it’s hard to imagine any kind of a robust economy without a robust automotive segment," adds Levey. "Whether it becomes more New-Domestic-type companies or renamed companies, time will tell. The traditional companies are going to have to change dramatically."

However, there’s no doubt the Detroit situation will have a big impact on the future of the industry. The survival of the Big Three is of "pretty good significance," says Hannah. "I don’t know that three will survive, but I think at least two will survive. It’s important to our industry because the automotive industry, in general, whether you’re talking the Big Three or the transplants, consumes a lot of metal. It’s probably more important to the mills than it is the service center industry, unless, of course, you’re a service center company that’s built your business on serving the automotive industry, which we have not."

However, he says there’s an indirect impact for those that aren’t so involved. The automotive industry "consumes a tremendous amount of metal and creates a tremendous amount of jobs, which gives people the ability to spend money on other things. If bankruptcy is the path that needs to be taken in order for their survival to happen, then so be it. The steel industry went through all the bankruptcies in 2001, 2002 and 2003 and survived stronger, leaner and more competitive."

Price concerns
The ripple effect of the economic downturn, the problems with the automakers and an extremely soft housing market has affected demand.

"We are a microcosm of what’s happening in the macro view," says Hoffman. "We’re seeing substantial decreases at our customer level in their level of sales, and naturally, the requirements from us have declined. ... We’re seeing numbers that reflect substantially lower levels of activity--much lower than we have come to accept as normal, in recent times.

"The question here is: Are these factors likely to exist in two or three or four months’ time?" says Hoffman. "Is this low level of activity going to sustain itself in the medium term, or do we expect some resurgence? It’s entirely dependent on one’s expectation on how the economy is going to evolve in the coming weeks and months. The vast majority of these industries have been affected by a substantial decline in consumer spending at different levels. The housing market is in the tank, as we all know, and it’s having an effect on washing machines, dryers, HVAC and a host of other supporting industries. The automotive industry is also going through a difficult time, and naturally, that’s having a domino effect. We need an economic recovery to herald a recovery in the manufacturing industrial sectors."

"The biggest issue that we’ve had is demand," says Kelley. "It’s just cratered since November. Prior to that, metal volatility in 2008 created problems for us. We had a situation where aluminum went from about $1.14 to $1.44 by midyear and then crashed to $0.71 by the end of the year. That created a lot of problems with pricing, inventories, customer order patterns, demand and uncertainty."

And domestic service centers also have to contend with the rapid drop-off in material prices.

"That’s a bigger issue than even the reduction in demand," says Hannah. "It’s different this time. Since 2004, the mills have had a great deal of discipline. Prices ran up as business improved in 2004, and then in 2005, prices reversed and went down for eight months of the year. Eventually, the mills drew a line in the sand and said, ‘This is as low as we’re going to go.’ Then, in 2006, prices went up, and in 2007, they came down. The mills drew a line in the sand once again, higher than the low that they set in the prior downturn. There’s still that discipline at the mill level, but they’re faced with new challenges. They’re running their mills at just a little over 40 percent of capacity. In 2005 and 2007, when they drew the line, they were running at much higher levels of capacity."

Those wild swings in price are making it tough to manage inventories. Kevane notes that hand in hand with the collapse on Wall Street came a "tremendous weakening in demand for our products. The single biggest issue is just the weakness of the market. The segments that we serve are down 15 percent to 50 percent."

And although the swings in copper pricing might not be as dramatic as the gyrations of the steel and aluminum markets, "copper prices have fluctuated like other metals," says Kevane. "But they’re now on the way back up. China is buying a lot of scrap, and that’s driving the price up. We always figure that the speculators are in this commodity, too. We don’t see the demand for copper being any higher than steel or aluminum or any other product."

As a result, Kevane says, "During a time like this, you’ve really got to manage your inventories. You really have to manage your assets. Our real investment is in inventory. It takes a lot of diligence."

Lonnie Terry, president and CEO of the North American Steel Alliance, Laguna Hills, Calif., says the members of the alliance are facing a "lack of consistency and predictability that has resulted in severe inventory devaluations. Every time they turn around, the price decreases."

He says the current lack of volume is also affecting them, with some members at 5 percent and some at 50 percent, depending on industry and geography. "It’s a Catch-22. Inventories are devaluing and it’s difficult to sell them at any price."

"All of us in the service center industry have taken a tremendous amount of value out of our inventories," Hannah notes. "We’ve reduced inventories to the lowest levels in quite some time. Shipments have also come down, so months on hand has not really improved. When you’re looking at that and the uncertainty in the prices maintaining current levels, then you only buy what you absolutely have to have--not one pound more. Because next week, you might be able to buy it for less."

"Inventory levels are extremely low," says Levey. "By the same token, economic activity and demand has fallen even more. My analogy is that it’s like a dog chasing a car. The steel mills caught the car, and we’ve got the flat noses to prove it. That happened last year. For the intermediaries and some of the manufacturers, every time they buy less to get to the inventory that matches their demand, their demand goes down. The car pulls away again, and they never catch it. The bright spot is, at some point in time, that has to change."

Stimulating demand--maybe
A short while ago, the American Recovery and Reinvestment Act of 2009 made its debut among much pomp and circumstance. Right off the bat, the sheer size of the $787 billion bill caused concern. "The legacy that this generation will leave for the next generation is a grave concern," says Levey. He does note, however, that stimulus spending will help the economy, eventually, but "it’s going to take a long time to work all the way through the system."

The bill does provide some much-needed funding to improve the United States’ crumbling infrastructure, but the need goes far beyond the currently budgeted amount.

"The much-ballyhooed stimulus package really provides miniscule support for infrastructure programs when compared to the need that the U.S. infrastructure requires," says DiMicco. "The U.S. civil engineering society said that there’s an immediate need for a $2 trillion spend over the next five to 10 years with respect to infrastructure needs. Roads, bridges, water systems, utility systems and the transmission grid are falling apart."

He points out that the current amount covers just the basics of infrastructure replacement and doesn’t touch on needs such as air traffic control. "So the $60 billion that we’re spending is disappointing."

Will the plan help stimulate demand? Hannah thinks so. "It’s got to help. Maybe it doesn’t help as much as we’d all like it to, but if confidence gets restored and the government starts spending money, maybe that gives people more confidence to start spending private money. The only thing is the timing. When is this really going to be felt? In the past, it’s always taken quite a long time to get spending started after bills have been approved. Hopefully, this time, it’ll be different."

"As most people today believe, it’ll be years or a decade before we get back to the same kind of economic consumption and GDP levels that we were at in 2006, 2007 and 2008," DiMicco says. "It’s going to be a long haul out, credit’s not going to be readily available and a lot of people who were consumers in the bubble will no longer be consumers in a credit-constrained world. Then you’re going to see the need for some potential massive restructuring in a number of industries, and steel may be one of them. Steel consumption could be strong if we get serious about rebuilding our infrastructure so we can provide a stronger future for our children and grandchildren."

A plan for survival
What goes up must come down and vice versa. The turnaround is coming, but board members are divided on when it will occur.

"The question I get asked most often is: When’s it going to turn around? The answer is: We don’t know. But we know that it eventually will," Levey says. "You need to plan for the worst and get some pleasant surprises rather than planning for the best and getting unpleasant surprises."

Kevane says, "I feel that we’re at the bottom. I don’t know if that’s just hoping, but the stock market hit bottom about six weeks ago, and the stock market usually bottoms before the economy. I’m not saying that the stock market has recovered, but it’s showing a little bit of lift."

"We’ve seen some more activity with quotes, inquiries and actual business over the last month," Kelley notes. "It’s been pretty moderate, and it’s too early to tell if it’s a trend. When we look at the end uses for our products, it’s certainly hard to tell what’s driving it because there aren’t any indicators that those particular industries have bounced back."

Terry says the members of the North American Steel Alliance say that anywhere from October to mid-next year could be a turning point. "Again, it’s geography and product mix. Some members who are servicing the energy sector, such as wind towers, are busy, while our members in Detroit working with the auto industry feel that they are in the midst of a depression at times."

"The longer the recovery takes to evidence itself, the more likely it is that the rebound will be substantial," says Hoffman. "Those are inversely proportionate to one another. I’ve heard a lot of political pundits talk about the fact that we may have seen the end of this recession, we might have bottomed, and we can see some gradual upcreep between now and the end of the year and a more substantial rebounding. I’m a little bit more conservative, and I don’t expect that we will see a rebound as quickly as some, but I do agree that the longer it takes to recover, the quicker the recovery will be."

One thing is for certain. It took the market years to get in its current state, so it’s not just going to bounce back overnight. And it’s an unfortunate reality that casualties will ensue.

"I don’t know that the mills will look too much different," says Hannah. "I do expect there will be changes at the service center level, and we at Reliance expect to be a continued part of that change. Even at our level now, we still only represent about 8 percent of the industry."

In addition, he points out that the service center industry is still primarily composed of privately held companies. "What we’ve seen in the past is a lot of business owners saying, ‘I don’t want to go through this again.’ All of us are five, six years older since 2003. Do you want to put the effort into building it back up? Even if you do, do you have the resources or the ability to finance continued growth? There will be some that don’t have those resources and some that just don’t want to do it."

"The impetus to consolidate will increase as a result of the current environment," Hoffman notes. "I’m not certain that it will be driven by bankruptcy because most of the players in the industry have sufficiently strong balance sheets to sustain any reasonable downturn. Smaller, privately held companies have built up a lot of equity over the years, and they’re unlikely to allow their businesses to disappear as a result of bankruptcy, but the impetus will be for them to seek a better resolution in the absence of a buoyant industry."

Levey adds, "One of the things that has allowed the industry to continue has been the consolidation among the North American mills. I think that the service center industry and the processing industry probably need to consolidate, as well. There’s overcapacity in product lines and services."

"Every time we go through a cycle or a tough recession like this, there are casualties," says Terry. "I believe that it’s a natural process that occurs in our economic system.' He notes, however, that small and midsized companies that have worked to develop a solid balance sheet and paid down debt during the good years are well-positioned for survival.

"The companies that have good marketing relationships and good supplier and customer relationships are going to be OK," he says. "Some of the niche-oriented companies will be OK. However, those without a plan or strategy could find themselves in serious trouble securing the capital necessary to work themselves out of this recession."

Regardless, Hannah says, "From our perspective, we’re going to make money. And we’ll be OK. I’ve been playing cheerleader to all of our people. You’re laying people off, business managers are feeling badly and business is down. It’s nasty. If you had to lay off 20 percent of your people, you’ve protected the jobs of 80 percent. It’s disheartening, but it’s something you have to do.

"Long-term, Reliance is going to be just fine," he says. "We’ll come out of this stronger because we’re going to be paying off so much debt. That will put us in a good position to grow the company for the future."

"The brutal drop in demand requires you to evaluate and fine-tune your business model," Kelley says. "For us, that means running smaller lot sizes, broadening our capabilities, getting out of our comfort zone and doing a lot more with a lot less.

"I know we’re going to be a better company, having gone through this period," he says. "It’s forced us into some areas that we haven’t been focused on in the past, and quite frankly, it’s forced us to do things that we weren’t even sure we were capable of."

DiMicco says, "We’re in a tough situation. It’s going to take people rolling up their sleeves, going back to basics and doing the right things with respect to how they spend and what drives their spending. We need to get back to making things in this country again." MM