Steel downstream buy frenzy likely to continue: 2022 preview

Steelmakers have been using some of their windfall profits to acquire downstream businesses at a higher-than-average rate, and industry participants believe this trend will continue through 2022

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“There have been a lot of transactions, and more every day it seems,” according to Michael Jenny, a partner on the global industrial team at Chicago-based mergers and acquisitions advisory firm Livingstone Partners.

Nucor Corp’s planned purchase of a controlling interest in California Steel Industries Inc, Commercial Metals Co’s (CMC) procurement of Tensar Corp and Steel Dynamics Inc’s (SDI) acquisition of a 45% interest in New Process Steel are just a few recent examples.

Consolidation in downstream distribution and processing was also a hot topic at Fastmarkets’ Steel Success Strategies conference in Miami in November, with McKinsey & Co partner Jeffrey Lorch predicting the trend will continue for the next few years and result “in few independents remaining alongside large distributors.”

Jenny agreed.

“I think we’re going to see continued benefits to consolidation and strong supported markets, so we can expect to see more of this activity for [at least around] the next 12 months,” he said.

Motivation and benefits

With steel producers expecting to enjoy continued record earnings amid ongoing supply chain problems in 2022, downstream purchases remain a savvy business move that can benefit everyone, from mills to end users, if done well, according to Jenny and Vincent Pappalardo, managing director at financial advisory firm Brown Gibbons Lang & Co.

Some benefits cited by mills when acquiring businesses include expanding their geographic footprint, growing their portfolio, increasing internal shipments, providing product to their existing downstream businesses and better serving existing customers.

As far as current market conditions inspiring an uptick in such acquisitions, “logistical issues, higher pricing, import tariffs – that definitely drives market changes and behavior,” Jenny said.

Downstream processing purchases benefit mills through “furnace efficiency, closeness to the end user, and margin enhancement and continued growth beyond the organic mill projects in place,” Pappalardo said.

“They’ve already set up their mill projects... which will create organic growth. But beyond that, you can’t saturate the market with more mills just for the sake of it, so [downstream acquisition is] a way to continue to grow,” he said.

Ongoing steel industry supply chain issues are a motivating factor for producers to keep acquiring downstream processors, Jenny noted.

“If [a business] is having trouble getting supply and that mill can provide all or nearly all of what [it] needs, it makes sense in the current environment,” he said. Right now, “pricing is high, activity is strong; but there is uncertainty of supply.”

Of course, as mills simultaneously grow their profits and controlled market share, some market participants might view these purchases as simple cash grabs.

“We have seen that time and time again, profit is the main motivator,” a reinforcing bar distributor source said. “They control the supply of steel, so if they can control the downstream markets they have control from scrap to product. The only reason the current market climate is contributing to this is the huge amount of cash the mills have and the extremely cheap cost of money.”

Liabilities and limitations

Still, it ultimately benefits the mills to create value for their customers, which they sometimes do at their own expense, Pappalardo said.

“[When] you’ve got the mills controlling downstream tons, they’re taking the commodity risk onto themselves,” he said. “The volatility of steel prices becomes more their issue than what smaller downstream customers benefit or lose as volatility increases in steel prices.”

In CMC’s fiscal 2021 10-K report, the steelmaker wrote that it plans to continue expansion via acquisitions but noted that this also comes with risks.

These include increased debt, particularly in volatile market conditions, and potentially the high interest and poor credit that could come with that debt; failing to identify the best candidates or achieve the best financial terms for an acquisition; losing money and resources in the research process of an acquisition that does not come to fruition; and failing to successfully integrate a business’ operations into their own.

Some acquisitions never live up to their hoped-for potential even in a strong market, a rebar fabricator source said.

“Not all of what they’ve touched has turned to gold,” he said. “There are some things they own that I think if they had to do it over again they may not have [acquired at all].”

But “it’s all accretive – you throw [the successful and failed acquisitions] all in a box, and the pile keeps getting bigger,” he said.

When an acquisition does fail, the mill can usually absorb the loss easily, while end consumers experience reduced selection and higher prices, both rebar sources said.

“I think it’s a smart business move in that it helps to stabilize your cost,” a second rebar distributor source said. “It’s risky because you start competing with your customers, but like most things once we get used to it everything just moves along.”

Producers are also limited in how far they can expand their reach, Pappalardo said. Specifically, they can’t quite crack the service center industry.

“Buying a service center and losing maybe some of the products the other mills make going into that service center would be a big issue,” he said. “So it’s hard to go into service centers because then each of the mills are buying from their competition as well.”

As long as service centers remain independent, the mills are also somewhat beholden to maintaining good relationships with them, Jenny said.

“They wouldn’t make a tube and sell directly to an [original equipment manufacturer, or OEM] if that tube were destined for a service center who was selling the same product to the same OE[M],” Jenny said. “There’s a margin capture opportunity if you can avoid those conflicts. And more often than not it’s in their best interest to avoid those conflicts.”

Looking forward

“This coming year is a bit of a mystery in a lot of ways... However, money is still cheap and the mills are still sitting on a lot of cash. On all things, I am only predicting through July. But I do see this trend continuing through then,” the first distributor source said.

The second distributor source said consolidation seems inevitable in the steel market these days.

“I think that it’s possible we [will] see more facilities owned by some big names, but not more overall locations. The market demand has a limit somewhere, so small mom-and-pop places [will] start losing ground at some point,” this source said.

After record earnings for many steelmakers in 2021, and expectations that this success will continue, it seems their growth strategies have largely done well and they have more financial strength than ever for continued investments and acquisitions.

Such was the case with Nucor, which in its 2020 10-K filing predicted that it would “continue to take advantage of our position of strength to grow Nucor’s long-term earnings power and stockholder value by continuing to successfully focus on profitable growth strategies... We are utilizing Nucor’s financial strength to execute on investment opportunities to further grow our long-term earnings capacity.”

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