Metals Midyear Update: Profits Are Strong, but Supply-Demand Challenges Require Strategic Moves
- midyear update
The metals industry got off to a strong start in 2021, continuing a streak that began in the third quarter of 2020. Metal prices have continued to rise and haven't stopped to date. Strong consumer-driven demand from end markets, including automotive, residential construction, energy, general manufacturing and defense, have fueled the industry’s strong performance.
Supply challenges, including both product availability and logistics issues, have been the main reasons for higher metal prices, and this will continue to be an issue for the remainder of the year. The pandemic has caused a global supply-demand imbalance, with the current pent-up demand, along with limited supply of metal, driving metal prices higher. In addition, various tariffs have made it difficult for imports to come to the U.S. Tariffs aside, inventory hasn't been easy to come by because other countries are in the same predicament: when demand is strong, countries and companies tend to keep their supplies local.
What's helped all metal concerns over the past nine months is that the margins per ton sold have been significant, which have made for a strong earnings outlook for the industry. For example, in the steel sector, hot-rolled coil steel prices jumped from $500 a ton to $1,650 a ton over a 12-month period. The inventory profits alone in that time frame were tremendous, but it’s not sustainable going forward.
The companies we speak with are hoping for an infrastructure bill to pass through Congress this year since roads and bridges require an abundance of metal. Green energy is also providing significant opportunities. For example, the movement toward electric vehicles, or EVs, will benefit some metal companies more than others. New opportunities in electrification are getting all companies to look at reducing their carbon footprint and improving the quality of their metal work. In the steel sector, lighter weight, high-strength steel used in these products requires a high level of engineering and providing alternative uses. Meanwhile, for base metals, prices for copper, cobalt and other metals have been driven higher because those are heavily used in the green energy space, including electric vehicles and other end markets.
Green energy is also driving some of the industry consolidation over the past year, particularly in the steel sector. In January, U.S. Steel completed its acquisition of Big River Steel, thereby increasing its exposure to electric arc furnaces, or EAFs—a decarbonized and more efficient method of making steel. In May 2020, Cleveland-Cliffs acquired AK Steel, and then in December 2020, completed its acquisition of ArcelorMittal USA, thereby consolidating many of the remaining U.S. based blast furnaces while mothballing older less efficient furnaces. These mergers have resulted in a consolidation of domestic capacity and reduction in domestic steel capacity, and an expansion of more efficient methods of making steel through EAFs, which dovetails with the movement toward decarbonization and green energy initiatives.
In the metal service center sector, we’re not seeing a lot of merger and acquisition activity getting completed right now mainly due to high valuation expectations. What we’re finding is that the family businesses up for sale are coming off one of the best first halves of a year that they’ve ever experienced. A company looking to diversify through an acquisition is going to have to pay a hefty multiple on earnings. Thus, it’s clearly better to be a seller than a buyer today.
Labor, Price Concerns
There isn’t a metals company we’ve spoken with that hasn’t struggled with getting many of its employees back, but they are doing what they can to work through it. A lot of metals companies are family-owned businesses, and employees are stepping up by putting in overtime or taking on additional roles, while companies are paying much higher wages for new employees.
China is another concern for the metals sector. China produces and consumes over half of the world’s metal, and it can drive prices rapidly with any major announcements. Metal companies closely monitor what transpires in the Chinese market on a daily basis.
The general movement in metal prices is on everyone’s mind today. Prices will have to level off or general manufacturers will continue to feel the pain, a level of pain that they thought would have corrected itself by now. Manufacturers are already lobbying the Biden administration to remove some of the Section 232 tariffs, something that may occur, at least partially, with their dealings with the EU by the end of 2021.
For the steel sector, supply relief may be on the way soon. Additional capacity—about 6 million tons of new steel production —is set to come online in the next 12 to 18 months from domestic producers. The additional planned domestic capacity, some reductions in Section 232 tariffs, and an increase in imports expected later in 2021 may result in supply catching up with demand, which could have an impact on metal prices. Based on what we know, we expect prices to moderate, but we don’t anticipate supply fully catching up with demand until early 2022. Thus, metal prices should continue to remain elevated, albeit at a lower level.
That’s why metal service centers may want to explore steel price hedging to protect themselves against future erratic price swings. A metal service center’s goal is to make a margin off its services, not to accept a 50% drop in metal prices and take on the price risk while holding the metal. Metal service centers need to accept that this isn’t their grandfather’s steel business anymore. Volatile global factors impact prices, and hedging is one way to mitigate risk. Metal companies also need to continue to manage their cost structure even during the good times.
Preparing for 2022 and Beyond
If you ask the average metals company executive, they'll say that 2021 has been a phenomenal year thus far. Continuing the momentum into 2022 will require sound strategies, positive developments in supply-demand dynamics and constant diligence.
Diversification: The more diversified metals companies performed better during the pandemic, and that's continued to be the case so far in 2021. If you're a metal service center that’s selling more than 50% of your business to the automotive or energy sectors, it may be time to investigate diversifying into other end markets, such as residential construction, appliances, general manufacturing or defense. Given the robust multiples on companies up for sale, we’ll more likely see firms try to diversify organically by developing strategies that include hiring the right salespeople and targeting potential customers.
Diversification should apply across the business and beyond your customer base, including your product lines and your vendor base. The supply challenges have made it clear that it’s important to have relationships with as many vendors as possible, because you don’t know who will support you during tight supply periods, including relationships with steel trading companies and importers.
Inventory Management: In a fast-moving business environment with sometimes erratic metal price swings, inventory controls and inventory management become crucial. For a typical metal service center, that means 1.5 to 2.5 turns of inventory on hand, but each company’s level may differ based on their strategy. The point is to maintain inventory levels as light as possible. That's a challenge today because the lead times to buy metal is anywhere from eight to 12 weeks, which is why diversification and having more vendor relationships on a global basis could help.
Reevaluate Your Strategy: We’re already seeing some of our clients take the opportunity to reevaluate their strategies. A lot of metals companies have looked at customer rationalization and whether they need to continue servicing certain product sectors. Since companies have been able to generate significant profits, they've been able to step back and examine who they should be selling to and why.
Diverse and Younger Workforce: Longer term, the industry is focused on diversity and attracting younger workers. It's not an easy task; getting a young person to work in an older structure or work environment is a challenge. Some companies have responded by moving their corporate headquarters to locations more attractive to the younger generation.
The metals industry (steel in particular) is a volatile industry. Even pre-pandemic, the sector appears to go through a crisis phase every three or four years. That’s why the companies in this space are so resilient; they know how to quickly adjust, cut costs and manage inventory levels when times are tough. It’s also one reason why the pandemic wasn't as dramatic for the industry as the 2008 recession or the 2015-2016 commodities price collapse—it was just another market downturn for the metals industry in 2020, and a shorter one at that.
Managing Director, Team Leader and Head of ABL Metals Group
Andrew is a Managing Director/Team Leader and Head of Asset Based Lending (ABL) Metals within the ABL Group of BMO Harris Bank since March 2011. ...(..)View Full Profile >
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