May 2010 - Thirty months have passed since the official beginning of the Great Recession. Although the metals industry has experienced boom, bust and everything in between, this downturn was particularly harsh. Last year, the outlook was bleak. Business was on hold, consumer confidence was at record low levels and the automotive industry was going through a major financial restructuring. In short, demand for metal products was almost nonexistent.

However, the start of a new decade usually brings some optimism, and manufacturing numbers are showing steady improvement. The March 2010 Manufacturing ISM Report on Business reported that economic activity in the manufacturing sector expanded in March for the 11th consecutive month.

Norbert J. Ore, CPSM, CPM, chair of the Institute for Supply Management Manufacturing Business Survey Committee, said in the report, "The rate of growth as indicated by the PMI is the fastest since July 2004. Both new orders and production rose above 60 percent this month, closing the first quarter with significant momentum going forward. Although the Employment Index decreased one percentage point to 55.1 percent from February’s reading of 56.1 percent, signs for employment in the sector continue to improve, as the index registered a 10 percent month-over-month improvement, indicating that manufacturers are continuing to fill vacancies. The Inventories Index provided a surprise, as it indicated growth for the first time following 46 months of liquidation--perhaps signaling manufacturers’ willingness to increase inventories based on expected levels of activity."

Although the upturn is welcome, according to Modern Metals’ editorial advisory board, there’s still a long way to go.

"I would suggest that all the metal markets will show growth this year compared to last year only because last year was such an abysmal performance from overall production and from the sales perspective. It’s hard not to beat one of the lowest record years in a long time," says William Peluchiwski, senior managing director, Houlihan Lokey, Chicago.

Michael Hoffman, president and CEO of Macsteel Service Centers USA, Newport Beach, Calif., sums up the state of the market in two words: "less bad." He points out, "It seems the market is off the bottom that was evidenced in the early part of 2009. There is no question that the low in steel consumption for the United States in 2009 will be improved upon in 2010. In my view, there is likely to be a steady but slow improvement, especially in industrial and manufacturing demand."

And markets across the board are starting to show signs of a pickup in demand.

"We’re seeing an improvement in lots of segments, particularly in the semiconductor market in the West Coast," says Frank Kevane, president and CEO, Thyssen-Krupp Materials NA, Copper & Brass Sales Division, Southfield, Mich. "Power distribution, which is all on the copper side for us, seems to be improving, but we see automotive releases and orders from automotive, so we’re actually seeing improvements in many of the segments we serve. It’s not up to the levels that it was, but it seems to be pretty much across-the-board improvement."

"Pricing has improved on all products as this year has progressed," says David Hannah, chairman and CEO, Reliance Steel & Aluminum Co., Los Angeles. "The increases are mostly being driven by mill cost increases and not demand, however.

Regarding demand, there has been improvement, albeit not huge, in most sectors, except for the nonresidential construction area, which is still getting slightly worse. The most improved areas compared to last year are in automotive; semiconductor and electronics; and energy, oil and gas."

Maximizing company capabilities
Emerging relatively unscathed on the other side of 2009 required making astute (and often tough) business decisions in a pressure-cooker environment.

Robert Levey, general manager, commercial, Gallatin Steel Co., Ghent, Ky., says the company is busy and running at capacity. He notes that throughout 2009, the company was very flexible on the operations side in order to serve its customer base and was able to make it through the worst of the downturn with no layoffs.

For Scott Kelley, president and CEO, Service Center Metals, Prince George, Va., his company’s relative youth worked in its favor. "Our people have a do-whatever-it-takes mentality," he points out.

"We have continued to operate with a start-up mentality on the cost-control side that we began seven years ago. We have focused on being the low-cost producer in the extrusion industry. We took more of an offensive approach and came up with creative ideas to support and serve our distributor customer base in new ways, which, quite frankly, turned us into a better, more efficient supplier. These programs were geared toward dramatically shortening lead times, which was very important over the last year in particular, reducing lot sizes, increasing turns and expanding our product offering."

And for service centers and distributors, the success of 2009 rested solely on the back of inventory management.

Kevane says a key strategy to getting through 2009 was "surgically managing our assets, which are primarily inventories. We also kept all our sales plans in place and all our sales force intact. We rightsized the company to current demand."

"We concentrated on maximizing cash flow and reducing debt," Hannah says. "In order to accomplish this, we had to reduce inventories and cut costs, all while trying to maintain profitability. Our most important (and most difficult) task was reducing our inventories as fast as prices plummeted and demand disappeared. We also concentrated on reducing expenses, which unfortunately meant we had to lay off a large number of our employees, which was emotionally very difficult."

Hoffman says Macsteel Service Centers USA improved its customer and product focus last year. "We had a better understanding of customer needs in difficult circumstances and attempted to accommodate those needs in a mutually agreeable manner. We had more improvement in asset management, especially inventory controls; continued and relentless focus on all categories of cost; and improvement in efficiency levels and employee morale."

Doing more with less
Managing inventories will continue to be a challenge for service centers and distributors because, at this point, all companies are running extremely lean.

Peluchiwski notes that service centers and distributors are still trying to gauge inventory levels. "They’re trying to manage having the right inventory. Some of the slow-moving goods are still slow moving. They just haven’t had the pickup because of some of the end-demand customers. Having an inventory imbalance in what you’re supposed to be stocking causes frustration. In good times, everything moves at a general rate, you get a sense of it, and today, you have to be more specifically right of what’s going to move and what will continue to have volume in it."

As a result of uncertain demand, service centers, distributors and OEMs are becoming more comfortable working with a lower level of inventory.

"We had a service center customer in here last week with a large OEM, and it was very clear in our conversation that the OEM didn’t want to carry inventory, [and] the service center wanted to carry a very minimal amount of inventory," Kelley says. "There seems to be a real change in thinking. In the past, service centers have carried more inventory. Now they’re relying on the mills to react quickly and get their product in a more efficient and timely manner."

Kelley also points out that on the aluminum extrusion side, there is a significantly reduced supply base. "Between 70 and 80 presses have been taken out of commission in the last two years. The vast amount of this capacity is older, and most of it is inefficient equipment that will not be restarted. On the demand side, the new normal is trying to minimize the impact of what most people see as ongoing, extreme metal volatility. It really puts a microscope on everything from inventories to your hedging programs to your forecast accuracy. If a material ships one month versus another month, it can make a difference of 10 cents a pound. And pricing policies have become outdated because of the volatility of metal in conjunction with very short lead times.

"Everybody in the second half of 2008 got burned on the metal because it was so dramatic," he continues. "Even with the run-up in metal over the last nine months, I think everybody is reluctant to stock more than they need because they’re still fearful of a significant dip. ... We see a lot of situations where people are caught short, and they need large orders in a very short period of time. We’ve had to increase our turns, decrease our lead times dramatically, reduce our lot sizes. We’ve really challenged the plant. Extraordinary times have required extraordinary execution, and our guys have stepped up and done a great job."

"At the end of 2008, you had declining prices and heavy inventories, so inventory levels became a huge focus," Levey says. "{At the end of 2009, you had significantly lower inventories but increasing prices. Most companies approached this situation very cautiously. They had to. My perspective is business in North America may have fallen 30 to 40 percent, but the steel mills were down 60 to 70 percent. The only explanation for that difference is inventory change. When we started seeing the need to begin increasing utilization, the big change was: ‘My inventory is at the level I think it needs to be; I need you to be responsive and have steel for me in seven days, six days, two days. Now I’m buying for what I’m consuming rather than to reduce my inventories.’ That was the light switch for a lot of us.

"No one’s comfortable speculating, and everyone’s trying to manage their businesses better. Slow and steady is better than very volatile, but I think we’ve created a world that’s going to be volatile, especially when we roll in quarterly iron ore pricing with spot, rather than annual, contracts. It’s going to get very interesting."

"No doubt, inventory management in particular and asset management in general will remain challenging and a focus of all," Hoffman says. "Mill lead times and end-user psychology will play a major role in understanding supply chain challenges."

"I believe that inventory management is the single most critical part of our business," Hannah says. "Almost all companies in our industry that have suffered repeatedly are those that make inventory mistakes over and over again. I also believe that volatility in pricing is here to stay, which makes turning your inventories even more important."

Kevane agrees that pricing volatility will continue to be a challenge. "As demand increases, we’ve seen an increase in price on several products. ... It’s so volatile that it wreaks some havoc with inventory decisions and pricing decisions. Pricing decisions have an impact on margins, so it’s really almost a new cost that we all have because it’s so volatile. It brings additional costs, and you have to manage your business accordingly with that in mind. Ever since I’ve been in this business, it’s been pretty steady state. This started maybe four or five years ago, and it’s really intensifying. It’s a new cost to doing business."

Risk of a double dip?
On the heels of an extremely tough year, it’s easy to latch on to any optimistic news--no matter how small. It’s also just as easy to be disillusioned by rumors of a dreaded double dip in the economy. Board members, however, say that’s not in the cards for the metals industry.

"The recovery is likely to be driven by slow and steady improvement with fluctuations in a narrow band of activity," Hoffman says.

"I don’t think it will be a horrible double dip," Levey says. "If you look at the change in pricing that occurred in 2008 and compare the slope of that line with the change in pricing that occurred in 2010, as concerned as consumers are that prices are going up too fast, they’re going up more slowly in 2010 than they did in 2008. If you turn around and look at the MSCI inventory levels, you’ll see that the inventory levels are lower in total and certainly lower in days. Let’s assume for a minute that we hit a brick wall again. It can’t last as long because there’s not the inventory decumulation that will be needed."

"I don’t know better than anyone else, but my feeling is that [the recovery will look] more like a hockey stick on its heel, with the severe drop already behind us and then a steady, but not steep, improvement over time," Hannah says.

"People have talked about the W, come back here and go back down," says Peluchiwski. "I think we’re on a slow upward slope. I don’t think we’re going to have a slip back down, albeit you’ll see some weaknesses. Once it gets going, you want to see that growth continue every month. When you see the growth and acceleration slow down, that doesn’t mean it’s going to go back down. It just isn’t going to go up as much. I think it’s going to be a long, slow road back to a steady-state level.

"What you saw in the last year was unsustainable. You couldn’t continue to produce as little as you did based on people eating, sleeping and spending nominal dollars. It was eventually going to have to pick back up, which is what you see today. That doesn’t mean that it’s going to get any better--it’s just not going to get any worse. I think you’ll see it get better only slightly. My prognosis is that it’s going to be upward, but it’s not going to be some big rebound."

Kelley, on the other hand, says, "Every economist that I’ve listened to, everybody seems to think it’s going to be a U. So, for that reason, we think it’s going to be a V. I think in the extrusion industry, with the capacity that’s being taken out and inventories still being really low throughout the entire supply chain, not just with service centers but also with OEMs--and then with human nature’s amazing capability to panic--we think it’s going to be a hard turn."

He points out that no matter what shape the recovery takes, companies need to have the ability to turn on a dime and adapt to marketplace demands at that time. "Whether they need everything in five days or lead times start to move out, programs need to be in place to protect lead times and your ability to satisfy your customers."

A new paradigm
Ultimately, the lessons learned during this downturn will create a more levelheaded and efficient industry. "I believe we will always remember what we lived through and what we learned," Hannah says. "I hope our peers will do the same. There will be a new normal, but I think it’s too early to know what it will be. We won’t change our basic operating model, as I believe that it was validated by our performance during the severe downturn. I do think that we learned to react more quickly to real and anticipated changes in the marketplace."

"I think there has to be a new reference point for expectations," Peluchiwski says. "Much of the demand from the 2006 to 2008 time frame was fueled by the credit bubble from a building perspective, from a housing and even from a commercial perspective. ... If you’re buying a house that you cannot afford, you end up buying appliances that you cannot afford, and so it ripples all the way through the entire supply chain."

"I think the new norm is actually going to be the old norm. Looking back on the spike in 2006, 2007 and 2008, maybe that was a little bit of a false norm," Kevane says. "That was a high peak. I think we’re going to return to a good level, and that would be the historical norms that we’ve always seen. Housing really fed things to a little bit of a false level. People had so much equity on their homes, they were able to buy second homes or additional cars or TVs or whatever. They had an ATM with the equity in their home. That wasn’t normal."

"The period of time that we’ve been through has taught everyone to run their businesses more effectively," Levey says. "You’re talking about conserving working capital, you’re talking about a focus on flexibility. Those are key values. The real lesson of a downturn is to remember the lessons as conditions improve. You just can’t go back to what you used to think normal was.

"There is a prudent way to be managing businesses, and the downturn really caused people to refocus and learn to do things differently," he continues. "What you will see is tighter supply chains with less inventory throughout, which is good for everybody, but it also means that any price movements move through it much more quickly.

"You can’t consume all your assets and then wonder what happened. You still have to spend money, still have to maintain facilities, still have to be reliable. Part of the new paradigm will be reliability, flexibility and efficiency." MM