Economy Takes Toll on Processors' Hope

Faced with a struggling automotive sector, the effects of mill consolidation and an iffy economy, toll processors are holding their breath as they head into 2008.

By Dan Markham,
Senior Editor

Faced with a struggling automotive sector, the effects of mill consolidation and an iffy economy, toll processors are holding their breath as they head into 2008.

Even before threats of a U.S. recession moved from idle speculation to front page news, toll processing executives were sounding cautious about their industry’s prospects for the new year.

Interviewed before worldwide financial markets tumbled in mid-January, toll processors expressed reservations about the outlook for the first half of 2008, hoping the second half of the year held more promise.

Though 2007 was generally good for toll processors, the year ended with a thud. The final quarter saw a downturn in business activity, a shift that may stretch through the first six months of this year.

“The first nine months of 2007 were pretty decent,” says Dave Detzel, director of outside sales for Voss-Taylor, Taylor, Mich. “We had good volumes and steel was moving well, with the lack of imports keeping the steel mills active. But in the fourth quarter, we saw a steady decrease in business activity. Everybody had a real good year for the first three quarters, but that last quarter saw a decrease in volumes.”

That synopsis was echoed by Ed Panek, senior executive vice president of All Metals, Spartansburg, S.C. “2007 overall was a fairly strong year. We didn’t see any real decreases start to come until the fourth quarter, when we saw a significant decrease.”

The decline coincided with a slowdown in orders from the automotive industry, the major end-use market for North America’s toll processors. As vehicle inventories started to climb above 100 days, automakers put the brakes on their builds, slowing production and extending holiday shutdowns. They’ve since resumed assembly operations, but at the slower November-December levels, executives say.

“The first half for sure is going to mirror the fourth quarter of 2007, with reductions in bookings of about 5 to 7 percent,” says Detzel. “In the second half, we expect to see it start coming back up.”

Auto industry analysts at CSM Worldwide, Lansing, Mich., predict U.S. light-vehicle sales will dip to a 10-year low of 15.8 million in 2008. CSM forecasts North American auto production will be even lower this year at 14.4 million units, a product of weaker market conditions, import trends and anticipated inventory corrections.

“The market will linger in a cyclical contraction phase,” says Joseph Barker, senior manager of North American Sales Forecasting for CSM Worldwide. “The downturn was triggered by diminished consumer purchasing power, depleted pent-up demand and structural changes at Detroit automakers.”

Companies such as Voss and others in the Detroit-area feel the pressure most acutely as their primary customers, the traditional Big Three automakers, are suffering the biggest losses. New Domestic automakers located primarily in the South—led by Toyota, which is in a virtual tie for market leadership with General Motors—continue to take market share from GM, Ford and Chrysler.

Voss Industries responded to this growing problem by shuttering one of its Detroit-area operations at the end of 2006. “We didn’t see the trend lines indicating we were going to be able to sustain two pickling operations in the Detroit area,” Detzel says.

“It’s pretty bleak here,” agrees Mike McIntosh, site general manager for SteelPro-Wayne Indus-tries, a warehousing and transportation specialist in Wayne, Mich. “We’re pretty nervous about the Big Three because if they’re not making cars, they don’t need steel.”

He sees no rebound on the horizon. “The state’s in bad shape now, as far as the automotive industry heading south,” McIntosh adds. “The automotive companies may come here and throw in a research and development facility, but with the unions being here, they’re building their plants in the South.”

There is hope for traditional car companies and the toll processors that service them, however. In late 2007, domestic automakers hammered out a new labor deal with the United Auto Workers, significantly reducing legacy costs and putting them on a more equal cost-footing with the New Domestics.

“That had to get done,” says McIntosh. “Hopefully that will give them some relief so they can concentrate on the product line they need to get out.”

Experts are giving GM high marks for new-product development, while Ford and Chrysler continue to play catch-up.

Tom McDonald, who recently retired as vice president of operations at Arlington Metals, Sawyer, Mich., but is still working as the company’s vice president of business development, says GM has introduced some interesting new models, “and it looks like they’re serious about energy-efficient cars.”

While conditions are cloudy in Michigan, the outlook is considerably brighter in the South, where several New Domestics have set up shop. Not surprisingly, the southern states are beginning to attract more processors.

“We’re seeing the migration,” says Bob McShane, president of Chicago-based First Precision LLC. “Most of the headquarters are staying here, but people are putting in adjunct facilities there.”

Voss Industries made that move in the 1990s, opening a second facility, Voss-Clark, in Jeffersonville, Ind. Given its substantial relationship with the New Domestics, Voss-Clark is in a better position than its Michigan counterpart.

The same is true for All Metals, which has facilities in Spartansburg and Cartersville, Ga. “We’re not seeing much falloff on the automotive side because the majority of the automotive we’re doing business with is the New Domestics,” says Panek. “But we’re definitely seeing the effects of the housing doldrums [on orders from other markets].”

Automotive’s southward shift is just one trend that has forced toll processors to adjust. Like service centers, processors also have been affected by a consolidating steel industry.

In the 1990s, processors worked with a few dozen steel producers to deliver cut or slit product to mill-direct customers. Today, through mergers, acquisitions and bankruptcies, that number has dwindled to a relative handful of major mills.

“When one of them barks, we all listen. They have a lot of leverage,” says McIntosh of the remaining steel leaders. “If we can’t do it for the price they want, they can impact our business immensely with the stroke of a pen or an e-mail. The next thing you know, there goes tons that will be awfully difficult to get back.”

“Being a toll processor, we’re kind of at the bottom of the food chain,” says Rick Snyder, general manager of Samuel Steel Pickling Co., Twinsburg, Ohio. “We have to live with what happens with consolidation and globalization. You just hope that when you wake up in the morning and learn that the mill that was LTV before is now ArcelorMittal, that you still know people you can contact.”

The leverage of the larger mills leaves little margin for error for the processors. “The mills are very cost-conscious, so you have to work harder. There’s very little forgiveness for misses—and they’re shouldn’t be,” says McDonald.

Getting price increases is difficult, even in the face of rising costs. “We use a lot of oil, because that’s the agent we use to protect the steel after we clean it. So if the price of oil goes up 30 percent, our cost is going to be 30 percent higher. But our customers, especially in the Detroit area, are reluctant to allow any kind of cost increase to go through,” Detzel says.

Compounding the issue in some markets is the problem of too much processing equipment. “There’s overcapacity in many processing markets,” says Samuel’s Snyder. “Not having the ability to increase your price because of this overcapacity, while the cost to processors continually increases, reflects on your margin. We’re dealing with $500 to $600 a ton hot-roll, and we’re only making a few dollars a ton margin. That’s the reality of the business and we have to deal with it. You can’t make a mistake.”

The same issue exists in another North American locale, Mexico.

“There are a lot of players now. I think there is an oversupply of processors,” says Carlos Rodriguez-Borjas, general director of Acero Prime, a Mexican joint venture between Feralloy, U.S. Steel and Mitsui Steel Holdings. In Mexico, processors and service centers have come from all over the globe, looking to take advantage of the country’s growth. Such globalization will be a focus of discussion at this month’s FMA Toll Processing ‘08 conference in Orlando, Fla.

“I don’t think any processor has a clear understanding of how the global steel industry is going to affect their business in the future. An obvious concern we all have is that the real economic supply and demand decisions are being made in countries like Russia and India. You’re sitting back as a processor and these decisions are being made across an ocean,” Snyder says.

The foreign influence on U.S. steel production increased significantly in the past year with the purchase of Oregon Steel and Claymont Steel by Russia’s Evraz, IPSCO’s acquisition by Sweden’s SSAB and the opening of the new SeverCorr mill in Mississippi, which is now being managed by Russian steelmaker Severstal. Looking forward, Germany’s ThyssenKrupp is constructing a carbon and stainless steel mill in Alabama to open in 2010.

For processors, the impact isn’t just the changing faces at some of the acquired facilities, but the changing attitude toward outside processing. In most other markets around the world, processing functions are performed at the mill.

“In Japan and Asia, all of it is done in-house under the jurisdiction of the mill. In Europe, it’s kind of a mix,” says McDonald, chairman of the FMA’s Toll Processing Council. “They all come with a different perspective.”

Though none have yet taken the step, McDonald expects foreign-owned mills to get into the processing business in the United States. “I will be surprised if a company like ArcelorMittal doesn’t look to purchase a large processing entity. If you’re a mill and processing is costing you some money, but you’re not getting money from it and somebody else is, you’ll take a look at it,” he says.

But globalization works both ways. North American companies are beginning to look at international markets to find a processing niche.

“You’ve got some footprint for that with companies going into Mexico and Canada,” says McDonald. “I don’t think it’s a big step to consider going across the ocean to Europe.”

In 2007, Worthington Industries Inc., Columbus, Ohio, entered a joint venture with The Magnetto Group to operate a steel processing facility in Kosice, Slovakia. The facility will perform slitting, blanking and cutting to length for customers throughout central Europe. The joint venture is Worthington’s first in Europe, though the company has announced its intentions to “expand its current geographic boundaries.”

McDonald says larger companies like Worthington and Platinum Equity—which added service center giant Ryerson to its roster of processors in 2007—will have the greatest opportunity to make a mark internationally.

But for most of North America’s processors, thoughts right now are not overseas, but on overseeing their businesses through the uncertain stretch ahead.

“Going into 2008, everyone is seeing a bit of a slowdown. I have my fingers crossed that there’s a pickup in the second half of 2008,” says Panek.

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