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Checking the forecast: AMM/PwC surveys the metals industry

Keywords: Tags  PricewaterhouseCoopers, Robert McCutcheon, global outlook, 2012 outlook,

As the U.S. economy over the past year has continued along its bumpy ride toward recovery, it should come as no surprise that opinions have wavered somewhat among metals sector executives regarding the industry’s financial health.

Chief executive officers at metal companies are less hopeful than they were a year ago about the near-term prospects for improvement in their corners of the economy, according to a survey of global steel and aluminum executives conducted by AMM on behalf of Pricewaterhouse
Coopers LLP (PwC).

But although metal executives might now see a more depressing short-term environment than they did in 2011, about 71 percent are still somewhat or very optimistic that the business climate will turn around during the coming year, the survey results showed. Last year, 94 percent reported some level of optimism.

“There is no question that the past year or so has been a bit of a rollercoaster ride. ... With some of the uncertainty created by sovereign debt issues, especially in Europe, opinions have changed somewhat, starting at midyear last year and carrying over into this year. That is what I think has led to a slightly less hopeful outlook for the time being,” said Robert McCutcheon, U.S. industrial products leader at PwC.

“There was a similar impact with (merger and acquisition) activity. It started off strong, but coming into the back end of the year there was some uncertainty over longer-term investment,” he said, noting that the market overall was nonetheless “pretty healthy,” and that health is keeping things from appearing too dark.

The survey, completed in April, followed surveys last year in April and again in October. The changes in attitudes over the course of the past year showed a slightly growing pessimism on several fronts, although overall the executives told a story about their businesses being prepared to deal with the shifting terrain.

To keep the survey responses anonymous, AMM deployed the survey electronically through Survey Monkey to steel and aluminum executives, and tracked the responses from each sector separately.

“There really was no dramatic difference between steel and aluminum responses, with a couple of minor exceptions,” McCutcheon said. “In many ways, they are facing a number of the same issues in the economy and on a global scale.”

Declining aluminum prices affected the bottom lines of large producers starting last year, reducing the capital available for acquisitions, he said, adding that accumulating inventory levels and soft economic conditions had further affected pricing.

“It should be noted that some companies can profit from mergers as prices are decliningÑreflecting overcapacity in the sectorÑby increasing their competitiveness through inorganic growth,” McCutcheon said.

PwC also sees some challenges to prices and margins in the steel industry, given the potential for weakened global demand and the tighter control of China’s real estate market.

However, both sectors are benefiting from the automotive and aerospace markets, not only because of current demand but also because of the ongoing move to lighter-weight materials. But that race isn’t level right now, McCutcheon said. “Aluminum has the advantage right now, but that is not a given for the long term.”

As the automotive and aerospace sectors increasingly favor lighter materials, aluminum might have to “slug it out” with a steel industry that’s trying to retain market share. “I believe that steel could prove to be a tougher competitor, given what we’re seeing on initiatives with ultralight-gauge steels,” he said. “The competition is not going to sit idly by and let aluminum take that share.”

Beyond overall U.S. economic factors, the survey probed the chief executive officers for their views on strategic priorities, mergers and acquisitions, emerging markets, budgeting, forecasting, risk management, sustainability, greenhouse gases, information technology, talent management, innovation and technology.

All eyes will be on developments in the eurozone, the pace of recovery in North America, and the real estate and construction markets in China. Significant negative news on one of these fronts could continue to tilt downward the balance between optimism and pessimism. Any major weakening of either U.S. or Asian demand is likely to have a negative impact.

But expansion in the energy sector is proving to be a bright spot for steelmakers. New sources of shale gas and oil from tar sands in North America are requiring new pipeline connections and fueling demand for tubular drilling products, and a major expansion of onshore and offshore wind power in Europe is creating demand for turbine steel.

“An under-appreciated part of the shale gas story is the substantial cost benefits that could become available to manufacturers based upon estimates of future natural gas prices as more shale gas is recovered,” McCutcheon said. “The economic benefits to U.S. manufacturers can’t happen if shale gas is not extracted in a profitable and safe manner. To achieve these significant outcomes, manufacturing companies must effectively communicate the value that shale gas can create for U.S. workers and communities.”

Infrastructure growth is a feature of the major markets in Asia and South America. Such growth is coming on top of a healthy rebound in the automotive sector and a burgeoning civil aerospace order book that is having a positive impact on aircraft metals suppliers. An important missing piece of the jigsaw in North America and Europe is recovery in the residential construction sector.

An overall “cautious optimism” might be the best way to describe the results of the survey, McCutcheon said, as sluggish employment figures, gross domestic product growth and an overall sense of market malaise have defined the U.S. economy for much of the past year.

In the face of these conflicting economic signs, the chief executive officers surveyed ranked people/talent management and budgeting/forecasting as the highest priorities in terms of strategic initiatives or challenges that will have an impact on companies within the next six to 18 months. Enterprise risk management, sustainability and innovation and technology also ranked at the high end, while information technology and mergers and acquisitions were at the lower end of strategic initiatives or challenges.

“Notwithstanding the uncertainty, the expectation is for considerable growth in the long term, especially in metals M&A activity, although the volatility that we’re experiencing is the new normal for now,” McCutcheon said.

When it comes to mergers and acquisitions, about one out of five executives said they expect to be aggressive in their strategyÑaround the same as April last yearÑand about 57 percent are either not in the market or are focused on organic growth, up from 48 percent last year.

Merger and acquisition activity will continue to be robust in the metals and mining sector during 2012, McCutcheon said. “(The market) was fairly strong in 2011, and I would expect 2012 to be the same. There’s been more risk appetite for larger investments. During the financial crisis, that kind of deal activity fell fairly dramatically.”

Despite the heightened levels of economic volatility in 2011, optimism remained highÑat least in the first half of the yearÑalthough sentiment began to weaken as the year wore on, McCutcheon said. Overall, PwC still expects moderate deal growth for the rest of 2012 and into 2013, given the current economic environment.

“It is doubtful that we will see robust growth, however, until metal prices and other fundamentals, including margins, improve,” he said. “It’s an indicator of a return to confidence. Another trend we continue to see is further consolidation in the industry. It (the market) is still relatively fragmented. There should be more activity in Asia, where China has considerable opportunity for consolidation.”

Access to raw materials also will be an influential factor as mining and metal companies look to make investment decisions in the coming months, McCutcheon said. “Mineral scarcity and access to critical raw materials are becoming more and more of a strategic risk to metal producers. The concept of access to raw materials will lead to backward integration and acquisition, and will be a continuing trend.”

The value of deals increased substantially during the first quarter of 2012 in the wake of increased activity for megadeals, valued at $1 billion or more, despite the general decline in commodity prices, according to a PwC report. Megadeals comprised more than 68 percent of the total of all deals valued at $50 million or more. Meanwhile, the volume of deals in the first quarter of this year remained fairly consistent with the latter half of 2011.

Mergers and acquisitions have been driven mainly by movements in emerging markets, including China and India, but there is concern over a pullback in demand for raw materials there.

Some 55 percent of executives expect to expand into emerging markets, up from 48 percent last year. However, the number of industry leaders who say they have no plans to expand into emerging markets rose to about one in three from about one in four in the same comparison.

For those who are eyeing emerging markets, the BRIC (Brazil, India, Russia and China) nations dominate the top of the list, with both steel and aluminum executives viewing these markets as good targets for expansion. Nearly 70 percent said their global plans call for either sales only or both manufacturing and sales, up from 60 percent in April 2011.

The metals industry needs to look beyond the BRIC nations for opportunities in markets with stable economies and energy supply, McCutcheon said. “The Middle East is going to be a bright spot in terms of energy availability. You can’t ignore the sheer population size of countries like India and China and what that’s going to mean for demand, but we shouldn’t forget about ‘frontier’ countries in Europe, the Middle East and northern Africa.”

He said that PwC will continue to monitor the situation in Europe as uncertainty remains over whether the crisis can be resolved successfully. PwC’s global metals practice, composed of a network of industry professionals in more than 30 countries, services global clients involved in ferrous and nonferrous primary and secondary metals, and promotes dialogue on trends and issues through active participation in industry conferences and associations.

“China will still have considerable growth, although there’s a bit of caution about whether that will slow down,” he said. “We don’t know what it will do with respect to its real estate market, which would have an impact on commercial and residential construction.”

In terms of merger and acquisition targets, companies are likely to explore the traditional areas of mineral wealthÑNorth America, Africa, Australia and Brazil. “There will continue to be activity associated with foreign interest trying to gain access to (these countries). Follow the minerals, follow the mining,” McCutcheon said.

It is in these areas that budgeting and forecasting are seen as having the most value. A majority of survey respondents said that commodity price volatility and selling price volatility are the primary challenges facing organizations attempting to deliver accurate projections.

The critical importance of resource supply is producing a mix of vertical integration and horizontal alliance moves as metal companies continue to seek greater certainty over raw materials. “We are seeing the emergence of manufacturer alliances, enabling companies to pool investments in order to secure resource stakes,” McCutcheon said.

Vertical integration through minority stakes in miners continues to be a major theme behind metal mergers and acquisitions. This year began with the announcement that a consortium of German manufacturers had been formed to pursue a strategy to secure future raw material supplies. Four Chinese steelmakers also formed a consortium to secure a stake in a South American rare earth metals supplier, following a similar move by a group of Japanese and South Korean companies.

Two areas that saw some major attitude changes were those associated with enterprise risk management (ERM) and sustainability issues.

A big change in survey results was the question of whether organizations have ERM programs and strategies. In April, 61 percent said yes vs. just 49 percent a year earlier. “I think this shows that, despite other priorities created by the economy, executives are beginning to take a closer look at the need for technology to take a more active role in their businesses,” McCutcheon said. “However, they still feel they have to approach this in ways that do not disrupt other priorities too much.” In fact, of those that do see a greater need for this, more than half maintain somewhat or very formally structured programs, little changed from last year.

Other areas in the survey that remained relatively consistent were information technology, and innovation and technological issues. The use of information technology for strategy objectives remains an important part of planned business practices, with about 86 percent of survey respondents saying such projects were somewhat or very critical.

“The metals sector, and this has been particularly true of steel, has been slow to embrace the development of their own technologies,” McCutcheon said. “To be fair to them, they have had to direct their resources and attention to other places during the downturn. But I think they are beginning to realize that when they can make such investments in technology, they should.”

Chief executive officers see business intelligence and reporting, data quality analysis, sustainable cost reduction and consolidation of critical systems as the most likely strategies to receive an information technology plan as a potential solution, close to the priorities cited in the April 2011 survey.

As to sustainability, less than half of all respondents said that the regulation of greenhouse gases will have little or no impact on their businesses, up from about one-fourth who held that view in April 2011. “As 2011 passed without any major changes in regulation or taxes, I think many executives saw this as less of a problem to deal with,” McCutcheon said. “With other issues dominating the political discourse later in the year, some of that fear of uncertainty fell away.”

One viewpoint that hasn’t changed is that most survey respondentsÑnearly 90 percentÑbelieve that emerging markets have a significant advantage when it comes to greenhouse gas emissions. “There is a legitimate concern here about how, globally, some nations do have an advantage because of their internal political situations,” McCutcheon said. “Given China’s significant market share, particularly in the steel sector, achieving reductions to business as usual in this developing market will be particularly critical.”

But chief executive officers said that probably the biggest challenge is finding and keeping the right talent in the right markets. People and talent management ranked highest on a list of strategic initiatives, an increase from last year’s survey. About 70 percent said that attracting and retaining talent is somewhat or very difficult right now, especially at the middle manager level.

Why is talent management so high on metals executives’ agenda? It might have to do with the recent recession. “During the downturn there were layoffs and hiring freezes, and that created a disruption in continuity within many of these businesses,” McCutcheon said. “Now they’re looking at the future a bit more and finding gapsÑgenerational gaps and institutional gapsÑin having the right people with the right experience in the right positions.”

So what does the survey suggest overall about where 2012-13 might be heading? “(Chief executive officers) in every sector are now focusing on the upside more than the downside,” McCutcheon said. “They’re restructuring their companies to cope with a world where the risks and opportunities are increasingly interconnected but the sources of growth are often local. It’s even more important for (chief executive officers) in the metals industry, where the picture looks gloomier, to develop new ways of doing business in this changed environment.”

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