August 2009- Overall economic weakness continued throughout the first quarter of 2009 as industrial activity remained low and the credit market remained tight. Domestic steelmakers' capability utilization rates hovered below 50 percent and carbon steel prices continued to slide as service centers refrained from meaningful buying and steelmakers' price discipline waned. Nonferrous metals prices ended the quarter mixed as copper and zinc prices increased as a result of several factors including large purchases by China's State Reserve Bureau (SRB). M&A activity was highlighted by transactions within the mining sector, at times spurred by cash-strapped sellers facing pending debt payments.
The domestic economy faced anemic demand across all sectors due to the financial crisis, credit turmoil and the global recession. Nonresidential construction, automotive production and white goods and heavy machinery OEMs faced strong headwinds as access to credit remained limited. Automotive industry analysts are forecasting North American auto builds to be 9 to 10 million vehicles in 2009, down from 12.6 million in 2008. This amounts to at least 2 million tons of steel that will not be needed. As a result of the current environment, carbon steel prices remained under pressure throughout the quarter.
Despite showing resolve throughout the fourth quarter of 2008, steelmakers' discipline waned over the course of the first quarter as they tried to use price reductions to encourage buying, generate cash and increase mill operating rates. These efforts were largely unsuccessful, as discounting made customers wary of buying in anticipation of further declines in pricing. Steel consumers and service centers continued to buy on an as-needed basis, and March marked the fifth consecutive month of U.S. steel mill average operating rates below 50 percent. Going forward, analysts expect mills to focus on increasing utilization rates before prices, preventing any significant pricing gains during 2009.
As a result of these market factors, hot-rolled coil (HRC) pricing decreased by $80 per ton, or 14.3 percent, from the previous quarter's levels, declining from $560 per ton at the end of the fourth quarter to $480 per ton at the end of the first quarter. Hot-dipped galvanized also decreased, falling to $620 per ton, a decrease of 15.1 percent from the prior quarter. Facing declining rig counts, OCTG prices decreased 28.0 percent to $1,974 per ton from $2,742 per ton at the end of the fourth quarter. Analysts expect ferrous prices to continue declining throughout the second quarter before the U.S. stimulus plan provides an increase in demand during the later part of the year.
Raw material prices decreased throughout the quarter, as steelmakers maintained limited raw material inventory and purchased on an as-needed basis. Consequently, No. 1 HMS scrap prices declined 20.7 percent from $145 per ton at the end of the fourth quarter to $115 per ton at the end of the first quarter. As a result of weak scrap prices, market activity remained subdued during the quarter and will likely remain quiet until a more stable environment returns. Analysts project scrap prices to reflect continued weakness throughout the second quarter of 2009. Integrated steel makers experienced limited benefit from reduced raw material costs, as prices for iron ore and coking coal declined throughout the quarter. Contract coking coal and iron ore prices are projected to be down approximately 60 percent and 40 percent, respectively, during the 2009/2010 contract year. As of the end of the quarter, benchmark iron ore prices had not yet been set for the year due to weak spot prices and a strained relationship between iron ore suppliers and steel mills. Analysts suspect that contract negotiations might last through midyear. Last year's contract, signed later than usual, was signed in June 2008.
Nonferrous metal prices ended the quarter mixed. Copper and zinc prices increased during the quarter, while aluminum, nickel and titanium declined. London Metal Exchange (LME) inventories grew during the quarter, as aluminum, copper, nickel and zinc stocks increased by over 35 percent each. Aluminum pricing decreased 6.1 percent from $0.66 per pound at the end of the fourth quarter to $0.62 per pound at the end of the first quarter, due to weaker end-market demand and growing inventories. Copper prices increased 38.9 percent from $1.32 per pound at the end of the fourth quarter to $1.83 per pound at the end of the first quarter. Copper prices were supported by optimism about the efforts of the Chinese and U.S. governments to stimulate economic growth and reports of ambitious stockpiling plans by the SRB. Nickel prices decreased 13 percent to $4.26 per pound at the end of the first quarter from $4.90 per pound at the end of the fourth quarter. Poor demand for nickel from the stainless steel industry, which accounts for about 70 percent of nickel consumption, continues to drive down prices. Zinc prices increased 16.1 percent from the fourth quarter, increasing from $0.51 per pound to $0.59 per pound at the end of the first quarter. Zinc prices were supported by massive supply cuts and stockpiling by the SRB.
During the first quarter, aluminum, nickel and zinc prices remained approximately in line with or below the marginal costs of production. In response to price levels, global producers announced production cutbacks and delayed expansion projects. Despite current economic weakness, long-term nonferrous fundamentals remain intact, supported by expected future demand from emerging market economies and structural supply side constraints, which will be increased by current underinvestment in exploration and development.
Succumbing to the current environment of oversupply and weak aluminum prices, both Aleris International and Indalex Inc. entered bankruptcy under Chapter 11 of the U.S. Bankruptcy Code. Aleris, formed in 2004 by merging Kentucky's Commonwealth Aluminum with Texas-based IMCO Recycling, went private in a 2006 transaction in which Texas Pacific Group (TPG) bought it for $3.3 billion, burdening Aleris with $2.5 billion of debt. Indalex, a portfolio company of Sun Capital Partners Inc., also entered Chapter 11, citing financial constraints caused by the global economic slowdown and resulting declines in demand, earnings and liquidity.
The first quarter continued to experience weakness in 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 that little or no financing was required, taking advantage of the current market to grow share or secure long-term supply. Analysts believe that current market conditions will cause further industry consolidation as companies with strong balance sheets can take advantage of distressed situations.
Although merger and acquisition activity remained subdued during the first quarter, several large transactions occurred in the mining sector. The first quarter witnessed 13 domestic transactions with total announced values of $2.6 billion, a decrease compared to the 22 transactions announced during the same period last year. Internationally, 39 transactions were also announced with an aggregate value of $8 billion compared to 41 transactions announced during the same period last year.
Merger and acquisition activity was led by debt-burdened miners turning to China for funding as traditional sources of credit remained on the sidelines. In an effort to reduce debt associated with the $38 billion acquisition of Alcan, the boards of Rio Tinto plc and Rio Tinto Limited (together, "Rio Tinto") agreed to a strategic partnership with Aluminium Corporation of China ("Chinalco") that will provide $19.5 billion in exchange for minority stakes in an assortment of mining assets and a new issue of convertible debt. On the heels of the Rio Tinto-Chinalco deal, China Minmetals Corp. offered to buy debt-laden Australian miner Oz Minerals for $1.7 billion. The proposal, supported by Oz Minerals' board, was rejected by Australia on national security concerns, as Oz Minerals' Prominent Hill copper-gold mine was too close to a missile testing site. Late in the quarter, China Minmetals revised its offer to acquire the bulk of the company, excluding Prominent Hill, for $1.2 billion. Subsequent to the end of the quarter, the Australian government conditionally approved the revised offer subject to other stipulations regarding mine and business operations.
In March, Asarco LLC announced an agreement to sell substantially all of its operating assets to Sterlite USA, Inc., a subsidiary of Sterlite Industries (India) Ltd. and Vedanta Resources plc, for $1.1 billion in cash and approximately $600 million in debt. The sale is part of Asarco's plan to reorganize under Chapter 11 of the U.S. bankruptcy code. Subsequent to the end of the quarter, Grupo Mexico announced a $1.3 billion all-cash bid to counter Sterlite's offer. A U.S. bankruptcy judge will have to determine which offer better serves Asarco's many creditors, including the United States and several other states, which are seeking money to clean up mining-related pollution.
Other mining transactions included Arch Coal's $761 million acquisition of Rio Tinto's Jacobs Ranch mine, Vale's $1.6 billion acquisition of iron ore and potash assets from Rio Tinto, OAO Mechel's acquisition of Bluestone Coal Corp. and Xstrata's $2.0 billion acquisition of the Prodeco coal mining business from Glencore.
Steelmakers and service centers largely refrained from participating in the M&A market during the first quarter as they instead focused on their own balance sheets and liquidity needs. Other notable transactions during the quarter included OAO TMKÕs acquisition of the remaining 49 percent interest in NS Group, Inc. from Evraz Group SA for $508 million and Samuel, Son & Company's acquisition of two service centers from Barzel Industries.
During the first quarter, the Houlihan Lokey Metals Index experienced a 0.4 percent increase. With the exception of tube and pipe producers and mining segments (both metals and coal & iron ore) all segments experienced negative returns for the quarter. The largest decrease, attributable to the integrated steel producers segment, was 39.4 percent. Most metals-related equities experienced negative returns amid general economic weakness and the tight credit market.
The Dow Jones Industrial Average decreased 13.3 percent and the S&P 500 decreased 11.7 percent during the quarter, while the Russell 2000 decreased 15.4 percent. The Houlihan Lokey International Producer Index also dropped 11.9 percent during the quarter.
At the end of the quarter, the tube and pipe producers segment posted a median multiple of 6.0x LTM EBITDA, the highest of the segments. The integrated steel producers segment had a median multiple of 1.2x, the lowest of all segments.
Quarterly sector NFY EBITDA multiples for all segments increased over prior quarter expectations with the exception of the scrap processors segment. The mini-mill steel producers segment posted the highest NFY EBITDA multiple of 9.3x and the international steel producers segment posted the lowest at 5.1x. 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, valuations and financial restructuring. In 2008, the firm was ranked the No. 1 M&A advisor for U.S. transactions under $2 billion by Thomson Reuters. In addition, the firm advised in eight of the ten 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 over 800 employees in 14 offices in the United States, Europe and Asia. Each year we serve 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 Industrial Group was the No. 1 M&A advisor 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.
