Second Half Remains a Big Question Mark
By Dan Markham, Senior Editor
In its annual mid-year poll of service center executives, MCN has learned that sales are still up, inventories are still down, but there is little consensus on what to expect for the rest of the year.
Photo Courtesy Steel Warehouse.
While results through the first six months of 2010 represented a substantial improvement from last year, service center executives remain wary of price volatility, an uncertain economic recovery and the overall health of U.S. manufacturing.
In numerous interviews with executives from service centers across North America, no question produced more divergent responses than the simple query: “Where does the market stand at the moment?”
Steve Gottlieb, vice president of Ratner Steel, Roseville, Minn., says “demand continues to be quite robust. It’s very nice here in the Midwest.”
More often, however, sources used contradictory descriptions such as “stable,” “uncertain,” “improving slowly” or “starting to slow” to describe current business conditions. The only clear consensus is on the state of nonresidential construction, which virtually all say is dismal with no signs of any turnaround.
“Many markets have strengthened, including government, energy, medical, material handling, agricultural and construction equipment,” says Craft O’Neal, chairman of O’Neal Steel, Birmingham, Ala. “Overall business is better, but in no way have conditions returned to the more robust years of the past.”
“I’d classify current conditions as steady, if unexciting,” says John Chirikas, CEO of Horizon Steel Corp., Shelby Township, Mich. About 70 percent of Horizon’s sales go to the auto industry, which has been a driving force in the recovery of steel usage in the past year, he adds.
Even those who are relatively optimistic remain deeply concerned about the economy. Don McNeeley, president and chief operating officer of Romeoville, Ill.-based Chicago Tube & Iron Company, was anticipating “a classic slow-growth exit from a recession” that would deliver as much as 60 percent of CTI’s business in the second half of the year. But with major red flags on the macroeconomic front, McNeeley has become less certain about the company’s prospects of meeting that forecast.
The failure of government stimulus money to kick start infrastructure projects and the persistently high unemployment numbers have McNeeley worried about another downturn. “There is a growing possibility of a double-dip recession,” says McNeeley, who has taught economics at both DePaul and Northwestern Universities when not running CTI. “We’ve got a $14 trillion GDP, and 70 percent of that is consumer spending. When one of every 10 consumers is out of work, that has to have some significant implications for the recovery.”
Nathan Kahn, president and CEO of Empire Resources, Fort Lee, N.J., says uncertainty over the economy changes the business environment almost weekly. “With any glimmer of positive economic news, the markets perk up. And the opposite is true as well.”
Despite the shifting sentiments regarding the second half, most companies were relatively pleased with their results from the first six months of the year. Many service center operators say their company’s performance met or exceeded their original projections for the first half.
“We, as well as most of the other service centers in Northeastern Ohio, have done a little better than we expected in the first half of the year,” says Mike Porter, a sales representative for Premium Metals in Cleveland. “It was going very slowly at the end of last year, but we turned the corner in November and December and began to pick up speed in January. We were so slow that it didn’t take much for us to seem to be going faster.”
The increase in sales has not necessarily translated into an increase in profitability, say many service center operators. “We’re a lot more ahead in sales than we budgeted, but the profits didn’t increase as much as they should,” says Norm Gottschalk, president of Butler, Pa.-based Marmon/Keystone Corp.
The situation is the same in the specialty metals segment of the market, says Jeff Wise, vice president of sales and marketing for Tolland, Conn.-based Titanium Industries. “We are exceeding our forecast in terms of shipped volume. However, the margin is under forecast, leaving us only slightly ahead of our total forecast.”
People and product
Throughout 2009, the primary objective of service center operators was to take costs out of the business. That meant reducing headcount and paring down inventories at most companies. Entering 2010, service centers have been slow to rehire personnel and even slower to bring inventories up to previous levels.
Though some service centers were able to get through the previous year without layoffs, others were forced to downsize as a result of the lower operating levels. “Unfortunately, we had to reduce staffing significantly beginning in late 2008 through 2009,” says O’Neal. “Permanent staffing has remained constant this year, with utilization of temps up considerably.”
Lapham-Hickey Steel in Chicago employed a variety of measures to keep its permanent workforce in place while still cutting back. In some cases vacant jobs were left unfilled, in others workers took extra unpaid days off. “We try very hard to keep our people because of the investment they have in us and we have in them,” says President Bill Hickey.
Even with business levels rebounding, companies have been slow to return to full employment without a little more visibility going forward. “We had some layoffs in 2009 and currently remain at the same levels as last year, with the exception of our new Wheeling, Ill., facility,” says Chirikas. “We continue to believe it is imperative to remain lean until a true economic recovery evolves.”
The same philosophy is governing inventories. “Our inventories are lean right now,” says Premium Metals’ Porter. “We’re waiting to find direction in the market and where it’s going. We’ll probably remain lean until we get to the fourth quarter and decide it’s safe to put some inventory on the floor without worrying about more depressed pricing.”
The recent downturn in metals pricing has reinforced buyers’ cautious attitude. “We stopped buying about a month ago as we saw the price declines happening and lead times shortening. We’ve gotten down to a manageable level and now we’ll wait for the next opportunity,” Gottlieb says.
“In the past, we carried a large inventory of stock items,” Chirikas says. “Due to mill price and customer volume volatility, we purchase now solely for actual customer usage and supplement our inventory if required through either spot purchases from mills or via our peers in the industry.”
If service centers are skittish about putting product on the floor, their customers are downright terrified. Manufacturers and fabricators throughout the supply chain are ordering only enough material to fill the job at hand.
“We have maintained a good supply on hand and we are reordering from the mills, but our customers have held back on maintaining inventory, and our customers’ customers have held back. That has affected us a little bit,” says Richard Farmer, president of Farmers Copper, Houston.
In some cases, the decision by customers to run lean is not entirely voluntary. Some don’t have the cash or creditworthiness to stock up.
“The availability of credit to our customers and credit insurance for our receivables remains a significant concern and challenge,” says Kahn at Empire Resources.
Wise, at Titanium Industries, says his company has not seen any easing from lenders. “We have not noticed any improvement in access to credit for our customers. In fact, quite the opposite. More customers are approaching their credit limits and in some cases trying to arbitrarily extend terms with their vendors.”
Eye on the competition
Service center operators all agree on one aspect of current business conditions—the competition is even fiercer than normal. “The business environment remains extremely competitive, even more so than usual,” says Kahn. “Each piece of business is bid as though it were the last.”
Customers often seek five or six bids rather than just two or three before making a buying decision, and there’s always somebody willing to buy the business by bidding down the price, McNeeley says. “Buying business has little long-term value for a company or an industry,” he adds.
Competitive pressures have not added to merger activity, at least not yet, say executives. Some of the larger companies have announced their intentions to resume growth through acquisition, but the market has remained relatively quiet.
Gottschalk expects the quiet to continue for a while. “What you’ve got is good companies that want to sell, but don’t feel they’ll get paid, and bad companies that want to sell, but nobody wants to buy them,” he says. “Until you have 12 months of a reasonable environment and people can show reasonable results, I don’t think you’ll see a lot of M&A.”
Others expect dealmaking to resume soon. “Frankly, I expected to see more of this over the past year than we have. If the economy remains muted long enough, asset consolidation is bound to happen as pressure on the small- and medium-sized organizations builds,” Chirikas says.
To McNeeley, the change will be dictated by psychology as much as sales. Service center owners have to realize that the changing business environment has lowered the value of their operations. “There are a number of small to midsize service centers that, in retrospect, wish they had pulled the trigger [and sold out] in 2008. Once incumbent owners come to the conclusion that their company is not worth what it once was, once they get to that emotional tipping point, you’ll see consolidation pick up,” he says.
Whenever this point arrives, the remaining players will welcome it. “Any consolidation, whether at the mill or service center level, would be looked at positively,” Gottlieb says. “It’s no secret more consolidation absolutely has to happen at the service center level. There are still a lot of service centers chasing 25 percent less demand than a couple years ago.”
Adding to the anxiety of service center executives are political concerns outside the typical supply-demand equation. Hickey, a vocal advocate for U.S. industry, testified in July before a congressional subcommittee on commerce and energy on the need for a national manufacturing strategy. The absence of a strong manufacturing policy by the current and previous administrations is causing immense harm to the economy, Hickey believes.
“For the last 10 years, there’s been a huge lack of common sense in Washington, D.C. The assumption that we can turn this into a service economy, where all we do is pass paper back and forth or do each other’s laundry, doesn’t work. I keep wondering when the people in Washington are going to wake up and realize that manufacturing jobs are the type of jobs we have to work hard to maintain,” Hickey says.
On top of that, some industry executives fear proposed policies will cause further deterioration of the business climate. “I’m most concerned about the direction our policy makers are taking us, and the economic vitality of our country longer term,” says O’Neal. “We need policies that restore confidence and reassure investors, risk takers and employers. What we’re getting is doing the opposite and the reason we are getting subpar growth and few new jobs.”
To Farmer, whose company operates near the Gulf of Mexico, the reaction to the oil spill there is one example. Postponing new drilling projects will have a damaging effect on the oil and gas industry throughout Louisiana, Texas and Oklahoma, he notes. “When an airplane crashes, they don’t stop flying. It’s a bad deal if the failure of that one piece of equipment shuts down everything. I can assure you the rest of the industry is not going to spill a drop of oil.”
Some worries go beyond our borders. Gottlieb points to the financial crisis in Europe and the threat that may pose to U.S. exports, as well as the troublesome trade imbalances with China.
While industry executives are starting to put some distance between themselves and the recession of 2008-09, some see lessons to be learned from the calamity. To many, the biggest takeaway from that time period is the need for tighter controls on inventories.
“Your success or failure to a great extent is determined by how you manage your inventory and your inventory costs,” McNeeley says. “With the industry turning down so quickly, so deeply and so protractedly, a lot of people got stuck with a lot of high-priced inventory in the channel.”
For others, the most significant lesson is how quickly conditions can change. “I believe the most important thing we’ve learned as an industry is to never, ever forget how quickly the world can collapse around us,” says Chirikas. “Watching material values plunge from over $1,200 per ton to under $400 per ton in a few short months converted all of us in the steel sector to a much more conservative breed of business people. I know from conversations with my peers in the industry that all of us remain deeply committed to cost control and lean practices.”
Remaining committed to those practices will be crucial for long-term success—and perhaps even harder than it was to implement them during the downturn, says McNeeley. “We’ve introduced levels of efficiency that heretofore were probably thought of as impossible. It will be my job, exiting the recession, to not surrender the efficiencies that were so hard-fought. It’s a bigger challenge. The recovery gets under way and everybody gets punch-drunk.”
Hickey suggests that the U.S. industrial economy may have undergone permanent structural changes. He points to the drop in steel production capacity from above 90 percent in 2008 to just 40 percent in mid-2009. Production is back up to the 75 percent level, and it appears the market has more steel than it can handle. “It looks like there’s plenty of supply for the existing demand with the steel industry at 75 percent capacity. That tells me there’s a lot of demand that’s not here anymore. What does that mean for the steel industry, for the service center industry and the customer base?” he says, asking the imponderable question.