April 2006
Business Topics
By the Staff of Metal Center News

Metals Demand to Stay Strong
in ‘Industrial Sector Decade’
The U.S. economy is in the midst of the “industrial sector decade,” which promises continued strong demand for metals suppliers.

The forecast for the remainder of the decade is positive, if not entirely predictable. “The next couple of years will be very good times for most of industrial America. The only thing you can guarantee about it is that it will not be linear,” says Eli Lustgarten, president of ESL Consultants LLC, who presented a market overview at the Metals Service Center Institute’s Specialty Metals Conference last month in Ponte Vedra, Fla.

Lustgarten says the industrial economy began its rebound in 2004 and has continued surging ever since. This year will see further growth, though perhaps not as rapid as in the previous two years.

“The difference between 2006 and 2004-2005 is that we are in a transition year, what we call a mid-cycle economy. The bottom line is that 2006 likely will be average or normal,” he says, but adds, “average is good.”

2006 is widely expected to be stronger in the first half than the second, though many are underestimating the full year’s potential, Lustgarten says, pointing to the Institute for Supply Management’s February Report on Business that shows economic activity in the manufacturing sector grew for the 33rd straight month.

Among the noteworthy findings of the report:

• The Purchasing Managers Index in February was 56.7 percent, up from 54.8 percent in January.
  
• The new order index was 61.9 percent in February, up from 58 percent in January, the 34th straight month of improvement.
  
• The product index was 57.4 percent in February, up from January’s 56.5 percent.
  
• Manufacturing employment improved for the ninth straight month.
  
• The backlog of orders grew as its index rose to 54.5 percent vs. 53.0 percent in January.
  
• The customer inventories index was at 48.5 percent in February vs. 46.0 percent in January. This was the 57th straight month that inventories were below 50 percent, suggesting inventories are too low at the customer level.
  

Current ISM data is consistent with GDP growth in the 4.0 to 4.5 percent range for the first quarter of 2006, Lustgarten says.

Additionally, capacity utilization in manufacturing moved up to 80.5 percent. This represents the first time since before the 2001 recession that the figure exceeded its 1972-2005 average of 79.8 percent.

Furthermore, the weaker dollar, the improving economic picture worldwide (particularly in Europe), and solid materials pricing all are positives for the North American industrial sector, Lustgarten says.

Still, he believes that 2006 will represent mid-cycle growth, where top-line growth falls from double digits to single digits. To realize the corporate business model of 8 to 10 percent top-line growth, and generate 12 to 15 percent bottom-line growth, companies must look to acquisitions, margin improvements from better pricing and lower input costs, new products and market-share gains. “All are possible in 2006,” he adds.

Buoying the hopes for steelmakers and service centers is the profile for capital spending in the coming years. Lustgarten says that most of the markers for an upswing in capital investment are in place. The net cash flow in the current cycle doubles the increases of the early 1990s and is larger than the significant gains of the early 1980s. The incremental growth in net cash flow totals $374 billion, three times the figure in the early 1990s upturn.

Other positive factors include the capacity utilization figure above 80 percent (78-82 percent capacity utilization historically triggers an increase in capital spending), faster depreciation incentives that have expired with minimal negative effects, and technological advancements.

The overall economy gives no cause for pessimism, he continues, pointing to consistent job recovery (low unemployment trending even lower, along with wage growth), lower unit labor costs and his belief that consumers can and will handle gasoline at prices of $2.50 per gallon. “Think about what consumers pay for water and soda,” he asked.

Lustgarten detailed the environment for the various end-use markets served by the specialty steel industry:

Heavy truck volatile
The introduction of increased emissions requirements in 2007 will be the key factor in the performance in this sector. Lustgarten projects continued strength for the remainder of 2006, as trucking companies pre-buy to beat the new standards. This will be followed by a volatile 2007, yet that volatility will not last long. Lustgarten projects a much better market in 2008 and 2009.

“The engines you hate in 2007 because of emissions you will love in 2008 and 2009, because what will scare everybody is 2010. The 2010 emissions are much worse,” he says.

Automotive has peaked
Lustgarten believes the automotive market has passed its peak, but isn’t projecting any kind of crash. He believes domestic auto production will soften from 15.8 million vehicles in 2005 to 15.4 million in 2006 before rebounding to 16.0 million in 2007.

Aerospace recovery continues
Though key worries (including airline bankruptcies, high oil prices and the remaining after-effects of the 2001 terrorist attacks) remain, the aerospace recovery continues. Lustgarten credits improving passenger miles and additional spending on new aircraft in the U.S. and overseas.

Construction remains strong
Residential construction remained strong in 2005, with housing starts unexpectedly improving to 2.07 million. That is forecast to fall back to 1.85 million in 2006, though any negative effect may be offset by the continuing increase in nonresidential spending. Lustgarten projects increases of 6 to 8 percent per year in nonresidential construction.

The construction equipment market has also been solid in the past two years, he says, and a flat or modest upswing is projected for 2006.

Power gen to grow slow
As it has for decades, electricity will grow more slowly than GDP, and perhaps even slower than in the past. Ten-year averages for growth were 2.7 percent, 2.9 percent and 2.3 percent in 1982, 1992 and 2002, though Lustgarten says the U.S. government will likely hold electricity growth between 1.2 and 1.9 percent through 2030. The country has required fewer gigawatts of capacity since the 1970s, and only 347 new gigawatts of generating capacity are projected through 2030.

Appliances yuppified
Yuppies are driving the market for appliances, Lustgarten says, as high-end sales continue to thrive. Front-load washers, three-door dishwashers, convection-style cooking and stainless steel products have been the trend in the last two years. High-end front-load washers are leading the way, as more than 4 out of 10 new machines are front-load types, up from 2 out of 10 just a year earlier.

The move toward more energy efficiency is part of the reason behind the growth of the premium machines, and also will likely be reflected in HVAC purchases.

Possible softening of new housing starts is the biggest threat to the appliance market, as new homes represent 20 percent of the market.
Railcars seeing revival

The past year represented the third year of a revival in tank car demand, a trend that should continue for at least another year. Since hitting the floor in 2002 at 5,500 cars, the market doubled to 11,000 in 2005 and is projected for a modest increase to 11,500 in 2006. From 2007 to 2010, demand is forecast in the 9,000 to 10,000 range.

Farm equipment lags
The one market that most concerns Lustgarten is the farm equipment sector. The reason is the bulging crop surplus, which has been building for 10 years and is now at 2.4 billion bushels. The past two years have produced record U.S. corn crops, reducing crop prices and corresponding farm income, leaving little room for investment. The forecast for 2006 is not good, and could possibly be lower than current levels.

The best hope for 2006, Lustgarten says, is if a weather-induced crop problem improves the short-term outlook.

The farm equipment sector notwithstanding, the industrial economy is primed for robust times through the remainder of the decade, he asserts, and companies should make every effort to take advantage of it.

“It will be a great decade for most of you,” Lustgarten told the specialty steel executives. “If you don’t restore your balance sheet and get your profitability where it should be, you’re missing your second chance in life.” n