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MCN Mid-Year Report

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Have We Seen the Best of 2012? North American service centers enjoyed a fairly pleasant business climate in the first half, but economic uncertainty around the globe has had a chilling effect on prospects down the road. By Dan Markham, Senior Editor Most service center operators look back on the first half of the year with a feeling of accomplishment, but their outlook for the rest of the year is considerably less bullish. Interviews with service center executives for this mid-year report revealed a general sense that the best of 2012 is behind us. “We continue to be optimistic, but so far our optimism has been misplaced,” says Nathan Kahn, president and CEO of Fort Lee, N.J.-based Empire Resources. Thus far, most service centers report excellent results, with improved year-over-year performance during the first six months, at least from the perspective of the amount of metal sold. “Volumes have been fairly strong across our product lines and geographies,” says Gary Stein, president of Triple S Steel Supply Co., Houston. Esmark has enjoyed similar results. “Our business has been stronger, volume-wise, than it was in the first half last year. Pricing-wise has been a different story,” says Tom Modrowski, CEO of Pittsburgh-based Esmark Steel Group. Moreover, most operators reported similar breakdowns about the first half itself, with outstanding performance through the first three months, followed by a slower second quarter. “The first quarter was stellar, exceeding expectations by quite a bit,” says Brian Robbins, CEO of Mid-West Materials, Perry, Ohio. “The fact the first was so strong downplayed the second’s activity. It was by no means bad, just not as good as the first quarter.” Other distributors echoed those remarks, particularly in regards to profitability. “The margins were pretty good in the first half, but we started to see a change in the price in April. That’s when the average selling prices started to fall, and they’ve continued to fall,” says Wayne Bassett, president and CEO of Mississauga, Ont.-based Samuel, Son & Co., Ltd. “As they’ve gone down, our margins and our profitability have gone down. It’s not a disaster, but not as good as it was.” The story is similar in specialty metals. Jeff Wise, vice president of sales and marketing for Rockaway, N.J.-based Titanium Industries, says his company enjoyed a robust first quarter, but activity slowed considerably around April. The result was a first half on par with the second half of 2011, “but not the booming market we had anticipated.” As for the back half of this year, few service center executives are expecting the next six months to match the first. Their fears are based on several macroeconomic factors the industry simply can’t escape. Economic data released in recent months is, at best, confusing, and has caused buyers to pull in the reins. “I don’t see any business having enough faith in the future to place long-term orders or increase order quantities,” says Wise. “There’s too much uncertainty in the world right now.” The upcoming election is curbing growth, as businesses proceed cautiously while awaiting the outcome in November. “People are watching it very closely. The issues of business-friendly government vs. unfriendly will have an impact on purchasing managers’ view of the world,” says Kahn. “The political distraction is overwhelming. The overall manufacturing sentiment is one of frustration with the political environment,” Robbins adds. On top of that, service centers continue to keep an eye abroad, as Europe remains an economic mess and activity in the emerging markets has slowed considerably. “I think we will have a slower second half as a result of the upcoming recession in Europe and the slower growth in China and India, plus the uncertainty in D.C. and the normal summer and early winter slowdown in business,” says Roy Berlin, president of Berlin Metals, Hammond, Ind. “Obviously, Europe is a huge concern, both directly and indirectly,” says Bassett. “It’s a fairly significant export market out of the United States and Canada. But it also affects people’s feelings about the world. When people are nervous, stock markets go down. And a lot of the industries that we sell metal to slow down. That’s a problem.” Even if the second half slows, it likely won’t hit every market equally. Transportation markets, including automotive, truck trailer and railcar, are expected to stay strong, while construction is expected to remain weak. Prospects in even the most robust markets are being called into question. Most service center operators report good demand from the energy markets, a consistent trend for several years. But the recent drop in oil prices has had a dampening effect in some quarters. Bassett reports that his company’s energy business has tailed off as activity in Western Canada has slowed. “It needs [a price of] $85 per barrel, because it’s a high-cost oil to take out of the ground. As the prices have pushed on, we’ve seen projects slowed or delayed.” Stein sees a similar threat to energy-related activity in the Gulf area where Triple S operates. Supply chain concerns With wild price swings now a part of daily life for distributors, holding stock carries a much bigger risk. Almost four years removed from the devastating market collapse in late 2008, most service center operators remain wary about building up inventories. As a master distributor of aluminum and steel, Empire Resources bucks that trend, maintaining a healthy supply of material at all times. But Kahn sees firsthand the attitudes other service centers have toward carrying metal. “Our customers hate inventory. We’ve been doing consignment programs where they keep no inventory on the floor. We keep it in our warehouse and they call as needed,” he says. That change in attitude is reflected in Metals Service Center Institute numbers that show months on hand for all service center products now consistently in the mid two-month range. Berlin says he’s not a believer in changing inventories based on price, instead focusing on where demand is strongest and the existing agreements he has with customers. “I do think the industry was burned in the recession, and that everyone I know is being very cautious.” Esmark’s cautious attitude toward inventory predates the recession. “We’ve always had a lot of discipline on inventory,” Modrowski says. “We don’t go long, we don’t speculate. We don’t think we’re smarter than the market.” Not every company puts such a premium on running bare bones levels of inventory. Stein says Triple S “has always believed in keeping deep stocks. While that positioning has really burned us a few times lately, we simply believe it is our supply chain role, not that of the steel mills, to be the holder of inventories.” Of course, if the mills would lock in prices for longer periods, that would provide an incentive for service centers to stock up. But there is too much volatility in raw material prices for the mills to make any guarantees. With current steel production levels outpacing demand, the oversupply situation provides shorter lead times, which makes inventory control a little easier, Berlin notes. But it also puts downward pressure on prices. “In the last few weeks, domestic mills have taken steps to manage their output through shutdowns, outages and maintenance. These steps are bringing domestic supply more in line with market demand,” says Tom Innis, director of corporate relations for Majestic Steel, Cleveland. But there’s a limit to the mills’ responsiveness, Robbins says. “The fear of losing market share is pervasive.” With demand on the wane in other parts of the world, the possibility of surges in low-priced imports weighs heavily on domestic suppliers. “China is slowing down significantly, and I think India is in the same boat,” says Bassett. “We’re a little concerned that these two countries won’t chew up as much metal as expected.” Excess steel that can’t find a home in Asia or Europe will likely make its way stateside. “Unless the world cuts down on production, it’s going to put more stress on imports coming into North America,” he adds. With U.S. steel prices near their lowest levels of the past 12 months, few service center executives expect any major declines in the second half. But most admit their forecasts are just speculation. “I expect we’ll see some firming, and possibly some modest increases, until we hit the fall," says Robbins. “But that doesn’t mean it has to happen.” “Prices never go down forever, they never go up forever and they never stay the same for more than a few weeks,” says Berlin. “So we can be assured of movement one way or the other.” M&A: Where are the deals? With the economy slowly improving, many service center executives expressed confidence that merger and acquisition activity was set to pick up steam in 2012. Consolidation of the distribution industry remains largely stalled, however, as sellers’ expectations continue to exceed what acquirers are willing to pay. “There are always going to be those service centers for sale that are small, privately held, single-location where the next generation doesn’t want to come in to the business, but I think the timing is off for sellers,” says Modrowski. Kahn believes much of the industry’s consolidation has already run its course. “I think a lot of the M&A activity we’ve seen has snapped up a lot of the better prospects. There’s an issue of diminishing returns.” Still, others expect the deal making to resume eventually. “We still see the service center sector as overly fragmented, which represents an opportunity for further consolidation,” Innis says. “Continued market volatility and uncertainty may have slowed the pace of M&A for the time being, but ultimately we see consolidation continuing.” Bassett hopes so. His company has been among the more aggressive acquirers in North America, and growth through acquisition remains an important part of Samuel’s strategy. In fact, there is no shortage of potential targets, though consummating deals in the uncertain economic environment has not been easy. “We’ve never seen this much activity. I have five people dedicated to M&A, and they’ve got more companies coming in for sale than we can possibly deal with. But it’s difficult to get pricing together right now between the two sides’ expectations.” Nevertheless, he hopes his company can complete one or two deals before the end of the year.