2011 Not Half Bad
As the midway point of 2011 passes, service center executives polled by Metal Center News see generally healthy demand levels from most end markets, but worry that external forces could damage the economic recovery.
By Dan Markham, Senior Editor
As the metals distribution industry slides into the second half of 2011, service center executives are generally comfortable with the state of the market—but uncomfortable with matters outside it.
While concerns (some of which may be overblown) swirl around overcapacity, falling steel prices and chaos in Washington, little of that has directly affected the primary driver of service center business—demand from end-users. Most executives say they enjoyed good first-half demand and envision no serious downturn in the second half.
Metal Center News polled several distributors, large and small, about their views on the industry and the issues affecting it with half of the year in the books. Their comments reflect a clear consensus on the business climate, the state of inventory in the supply chain, fears of excess steel production and declining prices, and threats to the nation’s economic recovery.
Current business conditions
“I think they’re very strong through many industries,” says Steve Gottlieb, general manager and chief financial officer of Ratner Steel, Roseville, Minn. “There was a little seasonal adjustment in the month of July, which is typical, but all in all demand is very strong. May, June and July will all be up a minimum of 10 percent over last year, in tons, not dollars.”
That attitude was repeated by numerous service center executives.
“We had a very strong first half,” says Greg Gross, president of Northshore Metals, Deerfield, Ill. “We probably had an even better June than we originally anticipated.”
That assessment was mirrored by Ed Panek, senior executive vice president at All Metals Service and Warehousing, Spartanburg, S.C. “Current conditions are very favorable. We had a very strong first half of the year. June was especially strong for a variety of reasons, some of it market related and some of it situational. We are experiencing the typical July slowdown, but we’re seeing a heavy order book, so we’re hoping for a rebound in August.”
The demand strength is evident in most end markets, executives agree. Agriculture, heavy equipment, truck/trailer, energy and general fabrication were all cited as being solid throughout the first six months, with no signs of abating. “Our manufacturing customers are up really across the board,” says Holman Head, president and CEO of O’Neal Steel, Birmingham, Ala.
Two markets stand out at the moment, for vastly different reasons. Automotive has endured a bit of a slowdown in recent months, but most observers believe the dip is temporary and unrelated to demand. The devastating earthquake and tsunami in Japan in March has had a major impact on the supply chain both there and here. “It was more weather related than demand related,” Gottlieb says.
Even with the weather issues, which affected the parts supply to the domestic automotive chain, the auto industry enjoyed a solid first half. John Chirikas, CEO of Horizon Steel Corp., Shelby Township, Mich., cites strong management through the chain for making his job easier.
“As mainly an automotive supplier, it’s been relatively easy to gauge projected activity due to the great job the OEMs have done in keeping inventories in check. It’s been easy to project—if auto increases 10 percent, hypothetically, our order book should do the same. And overall, we had projected 10 percent growth, volume wise, for 2011. So far, we are pacing at about 13 percent growth for the year.”
On the other hand, there’s the construction market, which remains dismal. Some executives believe that at least the bottom has been reached, but the road back will still be arduous. By some estimates, it could be 2015 before construction spending begins to rebound. “I’m hopeful that’s not the case, but it certainly could be,” says Head at O’Neal.
Inventory on the mind
Since the Great Recession of 2008-09, no aspect of the service center business has undergone a more thorough re-evaluation than the attitude toward inventory. Even in an increasingly healthy demand environment, that attitude hasn’t changed.
“Historically, inventories averaged a three-month supply, but they’ve been redefined,” says Brian Robbins, CEO of Mid-West Materials, Perry, Ohio. “Now, they’re somewhere between 2.0 and 2.5 months supply. They ebb and flow and there’s differentiation depending on the size of the company, but the new benchmark is 2.3 months. That seems to be where people are, ourselves included.”
Both service center companies and their customers are adopting this new attitude toward securing material. “We changed our inventory practices dramatically as a result of the financial collapse. Like most service centers, we were caught with our pants down,” says Chirikas. “Once we bled the inventory off, we went solely to an order for order method of business. If we have a firm order in hand, we buy. Otherwise we don’t.”
For spot business, Chirikas adds, the company taps mill excess lists or buys from peers in the industry when the material is not available in its warehouse. “It has worked well, and I believe it may be a long-term program based upon the economic trends we see in place.”
Steel’s declining price through the second quarter reveals the wisdom behind the cautious approach to putting product on the floor, but the discipline is carrying over to times of rising prices, Robbins says. “On the upswings people used to go crazy,” he says. “Now, even with inflation, people are trying to buy more cautiously.”
Driving home that attitude is the volatility of recent price changes. In the past, shifts in pricing tended to occur slowly, in the range of $20 to $40 per ton. These days, prices can swing $100 per ton at a pace that turns heads and weaken hearts. “The market swings have become so dynamic and the frequency too quick,” Robbins says.
Gottlieb points out that the historically low levels of service center inventory are partly a function of the short lead times from the mills. “You don’t need a lot of inventory because you can get your steel so much faster than usual. And with falling prices, you don’t want extra steel on the floor.”
Ratner Steel is even below the industry average, carrying less than two months of inventory. “We’re probably as low as we can get. And I would say we’re indicative of what I’m hearing in the industry.
Fears over holding inventory in a declining price environment do provide some opportunities, particularly for larger service centers that supply other distributors. End-users and smaller service centers are more likely to buy in small quantities from a nearby distributor than place large orders with the mills during times of uncertainty.
“The new theme in our business is wait, wait, wait, and then overreact for a short period,” Gross says. “Everyone is waiting so long, it keeps the spot market relatively firm, even with a receding demand curve. I don’t see that new paradigm for our industry changing. We’ve learned there’s some scrambling involved, but we’re better off reacting to market conditions than anticipating them and becoming overinventoried.”
A question of capacity
Throughout 2011, steel analysts have wondered about the impact a move to full operation at ThyssenKrupp’s new Alabama mill and new capacity at Severstal’s Columbus, Miss. facility would have on the market. When RG Steel acquired Severstal’s operations at Sparrows Point, Wheeling-Pitt and Warren, Ohio, it only ratcheted up the concerns in some quarters. But thus far, executives say, the threat has not been realized.
“We’d be ignorant not to have concerns [about the potential for an oversupply to lower the price of steel], but right now the concerns are outweighing the reality,” Robbins says. “I often talk about demand as being real and apparent. The same is true of supply. Right now, the apparent supply is a bit higher than the real supply.”
That’s how Gottlieb sees it. He noted that the typical start-up issues both ThyssenKrupp and RG Steel are facing have so far prevented any overcapacity in the marketplace.
Metals USA President and CEO Lourenço Gonçalves, during his company’s quarterly conference call, observed that some of this so-called “new” capacity has already been accounted for by the marketplace. “RG is made up of a bunch of plants that have been in business for a long time in the United States. Calling this new capacity [because of its new ownership] makes no sense,” he said.
Still, since psychology has such a big effect on business, the constant capacity debate has taken a toll. “At this point, we have seen no indications that the market is glutted as a result of these mills flooding the market with cheap product, but that doesn’t mean there has been no effect,” Chirikas says, noting that the very possibility of an oversupply may have contributed to the recent price declines.
Moreover, if and when these mills begin to run at full strength, the market will feel it, he adds. “We are currently operating at 75 percent of mill utilization, exclusive of RG, Severstal and TK. Add six to nine million tons to the mix and, unless the mills work diligently as a group to keep capacity contained, we are going to be in deep water price-wise at some point.”
Gottlieb, however, has faith in the mills’ ability to adjust. He thinks North America’s producers will take some capacity offline before allowing prices to fall too sharply. “Once they approach the break-even point, the mills will do whatever they can to stem the tide.”
The rapid consolidation of the service center industry slowed to a crawl when the recession hit, but M&A activity has begun to pick up. Most notable of late were Olympic Steel’s purchase of Chicago Tube & Iron Company and the merger of Namasco and Macsteel Service Centers. Aggressive acquirers Reliance Steel and Aluminum, Metals USA and Ryerson all made strategic buys in the past year, as well.
Most executives believe this M&A trend will continue. “I think we’ll see additional mergers and acquisitions in the service center arena,” says Harvey Wrubel, executive vice president and director of Empire Resources, Fort Lee, N.J. “Especially service centers with limited financial resources or credit lines that will not be able to run their businesses efficiently and profitably and will need a larger entity to increase and safeguard their existing business.”
“The industry is filled with closely held companies, and there will be some looking for exit strategies,” Robbins says. “There are probably some people who limped through the last three years and are looking to sell, so there may be some opportunistic deals out there.”
On the buy side, the larger competitors in the service center market have all expressed interest in growing, particularly through acquisition. “As large companies continue to improve upon their economies of scale and seek to increase their market share, it’s inevitable they will look at acquiring some of the more advanced players,” Robbins says.
One doubter to the consolidation rebound is Northshore Metals’ Gross, who suspects there will be more sideline watching than activity in the next 12 months.
Factors outside our control
While most distributors feel confident that business conditions will remain stable or improve if left to function normally, factors outside their control cause them considerable consternation. And nothing earns their wrath like the political landscape. “My biggest concern is the pace and sustainability of the recovery and overall what goes on in Washington,” says Panek at All Metals.
The drawn out struggle to reach an accord on the federal debt ceiling, on top of the day-to-day political rancor, frustrates service center executives.
“We’re not going to go out of business as a country,” says Gross at Northshore Metals, “but a good push in the wrong direction and we become that much more paralyzed. The economy is so fragile, we can’t afford to go down that path, even if it’s just two days.”
“Both parties have created an environment so poisoned, it frankly turns my stomach,” adds Chirikas at Horizon Steel.
For most, it’s the uncertainty that is so troubling. They see the political maneuvering in Washington as one of the biggest threats to an otherwise decent economic recovery. “Until there is stability and certainty, it’s difficult to commit on anything,” says O’Neal’s Head. “Our business is growing, but as we have to make bigger decisions on hiring and capital investment, we’re a lot more reluctant. You can deal with good news and deal with bad news, but it’s very difficult to deal with uncertainty.”
“There are macro questions hanging over everybody,” agrees Ratner’s Gottlieb. “Do I really want to buy that new equipment right now? Do I want to hire new people?”
“When you account for the fact unemployment remains high and housing continues to be a drain on the consumer, you leave a certain portion of the population dead set against spending the cash they have,” Chirikas says.
On a hopeful note, Washington’s woes won’t last forever, says Wrubel. “I believe a lot of these issues will become clearer over the next several months, and that will assist us in shaping our business.”