Springboarding into Solid Second Half
By Dan Markham, Senior Editor
The first half of 2014 was surprisingly solid for North America's service center industry, coming off the brutal winter that crippled commerce and delayed deliveries across much of the country. Given that springboard, executives are uniformly optimistic about their prospects for the second half.
Metal Center News polled flat-rolled service center operators on a variety of topics for its annual mid-year report. Executives were unanimous in their positive outlook for the coming year and the need for regulatory reform, but of mixed sentiment on other topics affecting the metals distribution industry.
Asked to predict their second-half sales and shipments, most anticipate a small increase. "I think it's going to be a little better in the second half, probably up 3-5 percent. That would be counter to traditional shipments, but I attribute that to the polar vortex," says Jim Bouchard, chairman and CEO of Esmark Inc., Sewickley, Pa. "We're having a really good July, which sent a signal that we may have a decent second half."
Dave Lerman, CEO of Steel Warehouse, South Bend, Ind., is slightly less optimistic. He anticipates the second half will be relatively flat. He sees most transportation and energy markets performing well, while the agricultural market has slowed and there's not much movement in construction and appliance.
The most bullish forecast was offered by O'Neal Steel. Jeff Stephen, vice president of sales and marketing for the Birmingham, Ala.-based service center anticipates sales growth of 7-9 percent in the second half, for several reasons. "There's been a general lift to the economy, which we think will continue. And our success in opening new business and gaining market share with existing customers will add to that lift for us," Stephen says.
O'Neal is equally hopeful of a solid 2015. "Our expectation at this point would be that 2015 is 10 percent better than 2014," he says. "We think it has the potential to be the best year since 2008, at least for us."
Management at Kloeckner Metals, Roswell, Ga., is also excited about the outlook for next year. "We see further acceleration in demand. And there's going to be improved pricing power throughout the supply chain, which will give us the opportunity to improve financial performance in 2015," says John Ganem, executive vice president of corporate purchasing. "I think some of the potential trade action is setting up the market nicely, surely on the flat-rolled side of the business."
Mike Kruse, vice president of marketing for Toledo, Ohio-based Heidtman Steel, says his company's investments demonstrate its belief in the market's strength next year and the years to come. The flat-rolled specialist has opened a new operation in East Chicago, Ind., while it ramps up activity at its venture in Mexico.
Lerman, however, believes the ultimate strength of the market is contingent on an outside force that hasn't been terribly helpful in the past--the government. "I think 2015 depends on the political situation. Pipelines that are being held up could make for a big positive, and some positive indications on highway construction could give us a nice bump in the economy."
But even if Washington continues its dysfunctional ways, growth should be the expectation in 2015. "The country keeps growing a little bit, and the employment numbers keep going up, so folks have a little more money to do something," he says.
Also promising is the prospect of more manufacturers relocating facilities to the United States. Operators have seen some evidence of that migration, though it's more of a continental, rather than a national, phenomenon.
"Mexico is booming. We're seeing U.S. companies move to Mexico, and we're seeing business that moved offshore coming back there," says Kruse.
Ganem agrees that nearshoring to Mexico is exceeding reshoring to the U.S., as the country to the south offers a low cost of manufacturing while maintaining the logistics and other advantages that have prompted companies to rethink their overseas locations.
The U.S. does have an edge in energy, but "some of the regulatory issues are offsetting the benefit of the low energy costs," Ganem says.
Also working against it, Lehman says, is the price of steel, which remains higher in the U.S. than in China. "That price difference has grown to the point where it covers some of those issues that make it more favorable to move back."
Canada has suffered some of the same job losses to the Far East and other foreign destinations as the U.S., but its prospects for recovery may not be as strong. "We've lost a lot of businesses to low-cost countries, and it's going to take a long time for people to reopen those businesses here," says Bill Chisholm, president and CEO of Samuel Son & Co., Ltd., Mississauga, Ontario.
One of the most surprising aspects of the first half was how long the price disparity between hot-rolled coil in North America and China held up. Ordinarily, a spread of $150-$200 per ton wouldn't last long, with the inevitable increase in imports pulling the price back closer to historical norms.
"The gravitational pull from the rest of the world is dramatic," says Lerman. "A $200 per ton spread would not let anyone in our business buy domestic steel in the old days."
But the domestic mills, through a combination of aggressive pursuit of trade cases, planned and unplanned supply outages and some special deals with customers have managed to maintain the healthy gap against foreign competitors. Solid domestic demand has helped to keep prices aloft.
Where does it go from here? Generally speaking, most executives anticipate some price softening in the second half, though the first-half resiliency has them believing the decline won't be dramatic. Moreover, the potential for strong action on the trade cases, a more curtailed and disciplined supply situation with the recent Severstal sale, and uncertainty over Essar Algoma's financial picture may lend support the current pricing, says Mike Welch, vice president of operations for Magic Steel Sales, Grand Rapids, Mich.
Views on the supply chain Opinions range widely on the efficiency of the current steel supply chain. Some operators are pleased with the state of the industry, while others bemoan the structural weaknesses they see with no easy fix.
The strength of the supply chain, some executives say, is the growing competence of the service centers. As an industry, service centers have invested hundreds of millions in new equipment and technology that allows them to offer many more services, and more precise processing, along with stronger inventory management. At the head of the chain is a mill industry that's producing better products customized to meet users' needs.
"I think the greatest strength of the supply chain is the efficiency of how metals and processed metal products can get from the manufacturers to the end users," says Richard Robinson, president of Norfolk Iron & Metal, Norfolk, Neb.
But others see too much fragmentation for the chain to operate at peak efficiency. "The mills are selling to a lot of different people who aren't necessarily certified or qualified to add a lot of value. We feel the chain needs a little more structure," Kruse says.
That structure could be defined as simply having fewer players. Kloeckner's Ganem says until the top service centers can claim nearly 20 percent of the market, the efficiencies simply won't be realized.
"The mills are going to have to start picking winners and losers, deciding who their partners are and creating a more segmented marketplace," he says. "If you look at efficient supply chains, you tend to have master distributor type structures, and that would be the goal for steel. But we're so far from that it's hard to see it getting there."
Several of the executives say they support further consolidation of the industry.
"A 25 percent reduction in the number of players is necessary, at a minimum," says Welch. "The barriers to entry are not great enough to deter marginal participants, however. The mills may need to weigh in more and develop stronger relationships with service centers that enhance value."
In fact, Chisholm says his company sees more small start-ups entering the market than the current M&A activity is able to absorb.
Moreover, many of the service center acquisitions thus far have not had the desired effect for the market as a whole. "We've had a lot of consolidation, but at the end of the day what we really need is rationalization," Ganem says. "We need consolidation that also takes out redundancy."
On the mill side, the biggest question is not at home, but abroad. Overproduction around the world, particularly in China, puts a squeeze on the U.S. market. "Some parts of the world are doing better than others. Steel flows heavier into the areas that are doing well, bringing oversupply and all the issues that come with it," Robinson says.
That oversupply may be curtailed by the ongoing trade cases, most notably the oil country tubular goods case recently given a boost by the Commerce Department. A favorable ruling for domestic steelmakers could result in the OCTG market eating up a lot of North America's steel production capacity, among other benefits to the region's producers.
One service center operator believes North America's capacity is far more robust than it is often given credit. Esmark's Bouchard says winter made it clear the U.S. market had no trouble supplying all of its needs. "When the polar vortex was going on and you saw this huge disruption in iron ore shipments and steel production shipments across the board, usually the demand side would have outstripped the supply very quickly. But there was so much capacity out there the mills were able to meet any domestic increase in consumption."
The costs and challenges of doing business change regularly, and 2014 was no exception. The biggest hurdle for service center companies in the recent past, and near future, is getting a handle on the Affordable Care Act. Opinions are mixed on the effects thus far, though most believe the end result will be damaging for business.
Bouchard says his company has already felt a dramatic effect on costs, with more expected in 2015. Others haven't seen much impact yet, but are bracing for more upon complete implementation.
Norfolk's Robinson says his company, and its employees, have gotten the worst of both worlds. "As a company, we've always offered our people very affordable, great healthcare. Now, we're almost forced to dumb down our insurance, and it costs more," he says.
One alternative businesses are taking to reducing coverage is even less helpful to workers. "It's affecting employment," says Welch, saying that companies are simply making do with less rather than take on the obligations.
Those service centers that aren't discouraged from hiring still face obstacles. Whether it's finding qualified and insurable truckers, floor workers with the requisite skills to operate today's complex machinery or executive personnel willing to forego Wall Street for a career in the industrial business sector, distributors are regularly challenged on the personnel front.
"We have struggled [to find talent] even in high-unemployment markets," says Lerman.
Bouchard says hiring for office positions is further hampered by location. Mills, and most service centers, are located outside urban centers, often far removed from where today's college graduate wants to live. "They don't mind driving out to get training, but they want to live in Chicago," he says. "We can afford to bring them in; they just don't want to come where we are."
One possible solution, he says, is to let them work where they live, setting up offices closer to their city homes rather than forcing them into remote locations. "We have to figure out a way to bridge that gap."
The situation becomes more significant given the aging nature of the service center workforce. "Our median age is starting to get up there," says Samuel's Chisholm, who just completed his first year heading up the Canadian service center giant. "We're starting to see more retirements, and we need to attract the younger generation into our industry."
Finally, MCN asked service center executives one last question: If the Obama administration and Congress could accomplish just one thing, what would be most beneficial to the industrial economy? Most called for less burdensome regulation. Others pointed to the need for a comprehensive energy plan, improving the corporate tax structure and enforcement of trade laws.
One executive suggested another, perhaps more practical possibility: accelerated depreciation. Tax savings from accelerated depreciation would drive businesses to spend more money on equipment, improving their competitiveness and, ultimately, leading them to hire more people, Bouchard says.
"We would take advantage of it and every other steel company I talk to would take advantage of it. It wouldn't take a whole lot, but it would definitely stimulate manufacturing."