MSCI Chairman Michael Petersen discusses the state of the industry, and the institute, on the eve of the trade group's annual meeting May 2-4 in San Francisco.

By Corinna C. Petry,
Managing Editor

Sidebars and Tables:

• China: Risks vs. Opportunities
• Apparent Steel Consumption

Where are we now and where are we headed?

That was the theme of London-based Steel Business Briefing’s “Steel Markets North America” conference, held Feb. 28-March 1 in Chicago, co-sponsored by the American Institute for International Steel, Washington, D.C.

While much has changed—bankruptcies, mega-mergers, plant closures, tariffs—much remains the same, experts agree: particularly the high level of competition that persists throughout the market cycle.

The steel industry has undergone a dramatic turnaround in both operating viability and profitability since 2000. Companies posted record profits and paid down debt last year, and are now able to access investment capital more readily.

There may be fewer steel producers and distributors these days, but the survivors in North America, though larger, won’t be allowed to dominate for too long in a highly competitive world market.

Looking at the producer sector, Jim Bouchard, chief executive officer of Chicago-based Esmark, described the mills this way: Between five and 15 years ago, 10 trains were running flat out on a collision course. Capturing market share was their driver, despite their weak balance sheets. Today, five trains are traveling full speed on independent tracks. Sustaining profits is their driver. In the future, as steelmaking’s cost structure continues to improve, he predicts, four trains will be operating, driven by excellent investment-grade balance sheets.

The North American steel distribution sector of a decade ago consisted of about 4,000 independent service centers. Many metal distributors have since been compelled to consolidate—rationalizing locations and headcount—in order to reduce inefficiencies.

Service centers are still at a very early stage of consolidation. In the future, Bouchard says, the market will be dominated by perhaps 25 super-sized multi-branch distributors, among about 2,000 companies. The survivors will be obliged to spend some investment dollars in order to improve their quality and customer service; they’ll be more inclined to hold less than three months of raw and finished inventory; and companies will operate with sustainable 18 percent gross margins.

Meanwhile, services centers continue to play the price squeeze game, caught between producer pricing and their own customers who are always looking to trim their material costs.

One idea that may help alleviate this problem, Bouchard suggests, is an early warning mechanism that triggers when the desired level of steel inventory has been exceeded, and then match that figure more closely to mill production planning. Such coordination would help in managing the entire supply chain.
“The [monitoring] technology is here today to slow these trains down before we have a wreck,” he says.

Japanese and European metals warehouses keep only one to two months’ supply on hand, compared with service centers in North America whose inventories often bloat to well over four months. And service center inventory figures do not include a lot of foreign steel sitting in U.S. ports. The domestic target here should be 2.7 months, Bouchard says.

“I believe there is 1.5 million tons of excess inventory in U.S. service centers alone,” he adds.

Inventory levels—especially of foreign-sourced steel—were also on the mind of Nicholas Tolerico, president of ThyssenKrupp Steel Services, Southfield, Mich., during the SBB/AISI conference.

In addition to forecasting a reduction in import buying by North Americans this year, he stressed that import statistics from the federal government are none too accurate, given both the erratic rate of reporting by companies receiving foreign steel and the snail’s pace of government agencies in tallying the numbers.

“There is a better way to track import trends,” Tolerico says, citing the American Institute for International Steel’s monthly import survey, which he calls “a pretty accurate portrayal of the future. When you realize that 30 percent of domestic steel supply is coming from imports, it’s a number you should probably be aware of.”

Michael Hoffman, president and CEO of Macsteel Service Centers USA, Newport Beach, Calif., also contends that measuring and managing “real” inventories continues to be difficult because they are typically underestimated.
Individually, service centers, importers and processors measure their own inventories pretty well, he says. “What we don’t measure, what we have never measured and what we have no idea of, is what is really in the pipeline. Nine times out of 10, the inventory pipeline is at least as large, if not bigger than, the inventory position” of these three groups combined.

As a result, he says, “I am not bullish as far as the second quarter is concerned. All parties will be working off much larger inventories than we anticipated.”

During the question and answer period, service center panelists were asked to forecast when the inventory excess would be worked off. Bouchard, Hoffman and Mike Taylor, vice president of Cargill Steel Service Centers, Edina, Minn., all predicted May.

Craving consolidation
The panelists also discussed the trickle-down effects—actual and anticipated—of producer consolidation.

“I think we will see much better pipeline management among service centers, processors and importers,” Hoffman says. “Inevitably, we will see further consolidation of service centers. The new discipline being thrust on the industry, in terms of a much higher steel cost, higher inventories and higher receivables, will force the smaller service centers to seek out alliances with some of the wealthier, larger organizations.”

Additional consolidation certainly will occur, Taylor says, among mills and service centers. Distributors stand to benefit from healthier mills that are more disciplined on pricing.

“Mills and service centers alike will be encouraged to make additional investments, align themselves more with others in the supply chain and create greater value. Mills will have a better return on capital, and may invest more in leading technologies.”

However, when three producers control 70 percent of the flat-roll market, it means fewer supply choices for distributors, Taylor says. “It requires service centers to be very cautious about who they partner with.”

Tolerico advises distributors that they “better have relationships with the Big Three steelmakers or with offshore producers,” and emphatically agrees on the vital importance of select partnering.

“We are talking with our customers and our suppliers about the need to choose partners. If you are a customer, you need to choose your service center partner and your mill very carefully.”

In the future, he continues, a service center needs to be “a total supply chain integrator. You need to be able to link any customer to any mill in the world. We are telling our customers that if their supplier cannot bring them the lowest total cost in material, they should be looking for a new supplier.”

Using this method of serving the market, he predicts that in the United States, ThyssenKrupp Materials NA Inc. “will move from the No. 3 company in the industry to No. 1 by 2010.”

Bouchard says Esmark is already realizing benefits from consolidating. “After our latest acquisition [U.S. Metals & Supply, St. Louis], we will have 4,400 active customers in the United States,” and less than 1 percent of them serve the automotive industry, which is notoriously fixated on cutting material costs. “So we have a very broad customer base. Our shipments across all industry segments are up; not one segment is lagging.”

Pricing prognosis
After examining variables affecting the procurement of raw materials and services, the panelists agree that steel prices are correcting, though some volatility is likely to persist.

“Raw materials will remain tight with prices easing off last year’s highs,” says Cargill’s Taylor. “Freight rates will remain at a higher level. We’ll see a steel price correction, but we don’t see a death spiral. We are in the midst of that correction, but we don’t see any crises on the horizon.

“We do expect to reach equilibrium between supply and demand,” he adds, but meanwhile, “we expect a volatile market environment.”

Esmark’s Bouchard is looking for the inventory train wreck at the service center level to clear up before he estimates price fluctuations. But he adds, “Steel consumption and shipments are excellent and increasing. The world is not falling apart.”

Macsteel’s Hoffman expects more modest price hikes in 2005. “The question always is, where is the bottom and where is the top? I think we have found out, there is no bottom and there is no top. The market decides.”