BY MIKE PETRUSKI
Metal commodities are soaring to record highs in 2021 as supply chain issues threaten to hinder a solid rebound from economic contraction in 2020. A similar recovery is taking place for asset-based lending to metal service centers.
Metal commodities such as steel, aluminum and copper currently have market prices at or near historical highs and are facing supply chain issues. However, just as the COVID-19 pandemic and subsequent uneven economic recovery threw an unexpected curveball into the marketplace, price volatility may still emerge at any time. We have seen the variance between the market price and the cost for a company's metals inventory can shift significantly based on the effective date, impacting recovery values.
Manufacturing data from March 2021 demonstrated the highest growth level since August 2018. Analysts are predicting a V-shaped recovery for total GDP that is expected to continue throughout the first half of 2021 and possibly to the end of the year.
The Institute for Supply Management® (ISM®) reported the March 2021 manufacturing Purchasing Managers Index (PMI®) at 64.7%, an increase of 3.9 percentage points from the February 2021 reading of 60.8%. This figure indicates expansion in the overall economy for the 10th consecutive month after contraction during the months of March, April and May of 2020. Respondents to the ISM survey cited soaring prices, shortages of key raw materials and supply chain issues as drivers of the increase.
Metals Market Recovery Analysis
In the U.S. steel industry, market prices for flat-rolled carbon steel products — hot-rolled coil, cold-rolled coil and galvanized coil — have reached historical highs, jumping more than 60% in the past four months.
Typical mill lead times have doubled and many metal service centers cannot restock fast enough. Machinery and equipment manufacturers as well as commercial truck and trailer manufacturers are seeing strong orders and increased backlogs. Overall, the steel market is currently buoyed by a release of pent-up demand as the economy recovers from the earlier restrictions of the COVID-19 pandemic coupled with limited supplies and higher raw material costs.
Merger and acquisition activity has been significant, with Cleveland-Cliffs' recently acquiring the U.S. assets of ArcelorMittal for $1.4 billion and U.S. Steel Corporation purchasing the remaining equity in Big River Steel for $774 million. The Cleveland-Cliffs acquisition created the largest flat-rolled steel producer in North America based on the combined companies' 2019 mill shipments of 16.5 million tons. The U.S. Steel transaction will combine U.S. Steel's blast furnaces and steel intellectual properties with Big River Steel's modern electric arc furnace technologies and mini-mill operations into the same company.
A similar V-shaped recovery is taking place for asset-based lending to metal service centers serving the automotive, appliance, machinery and equipment, transportation, infrastructure, and oil and gas industries. Appraisals of metal inventories such as steel, aluminum and copper are extremely time-sensitive, given the volatility of market prices, and this is especially true with the recent and sharp recovery in the metals market. Because of this, the effective date of an appraisal has a direct effect on borrowing base availability.
As a result of the impact of shutdowns and curtailments in the supply chain and manufacturing, North American automobile assembly operations were suspended in April and May of 2020, forcing numerous steel mills, though deemed essential businesses, to idle basic steelmaking. By May, carbon steel prices for hot-rolled coil fell 25% from mid-January 2020. In addition, raw steelmaking fell to 51% of total capability, a level not seen since 2009, versus 82.5% in late February 2020.
The Impact to Lenders and Borrowers
Many of our metal service center clients experienced sales declines of 25% to 30% in Q2/20. It took nearly four months, or until early September, for carbon steel market prices to show meaningful appreciation as manufacturing activity resumed.
Asset appraisals for lending purposes are based on a specific point in time, so the effective date of an appraisal is critical for lending against metal commodities. The effective date uses financial reporting data as of month-end. Here is an example: The inventory appraisal of "XYZ Metals," a metals service center with multiple locations, performed with an effective date of June 30, 2020. The trailing three-month sales for "XYZ Metals" declined more than 30% and the company's overall perpetual inventory cost base was 6% higher than prevailing market prices. The overall net orderly liquidation values (NOLVs) provided a baseline valuation, which proved to be ready for a collateral update after market price volatility.
Flat-rolled carbon steel prices increased weekly through the months of September, October and November as the U.S. economy improved. Automobile assembly, appliance manufacturing, recreational vehicle manufacturing and general manufacturing resumed faster than anticipated. However, the restarting of blast furnaces at the integrated steel mills was a carefully structured process that lagged behind the demand rebound, with supplies playing catch-up to rising demand. By the end of December 2020, hot-rolled carbon steel prices had more than doubled from May 2020, hitting $1,000 per net ton, a level not seen since 2008.
Hot-rolled carbon steel prices continued to climb, reaching more than $1,100 per net ton by the end of January 2021. As part of the asset-based loan agreement, "XYZ Metals" had a new inventory appraisal engagement in 2021 with an effective date of Jan. 31, 2021. "XYZ Metals" experienced improved sales and a gross margin in the trailing six months, and with the company's overall perpetual cost base being more than 20% below prevailing market prices, the variance between cost and market price shifted to a more favorable relationship. The inventory appraisal results showed NOLVs appreciating measurably overall when compared to the perpetual inventory cost since the previous effective date of June 30, 2020. Consequently, borrowing base availability increased under the ABL line of credit.
Steel industry analysts and market participants are revising their forecasts on prices for flat-rolled carbon steel over the next three to six months, as market prices for hot-rolled coil, cold-rolled coil and galvanized steel continued to surge in February, March and April 2021 to historical highs. Domestic raw steelmaking capability continued to improve, reaching 78.7% for the week ending May 1, 2021, as steel mills strived to catch up to demand, according to the American Iron and Steel Institute. Yet lead times from both integrated mills and mini-mills are more than nine weeks versus the usual four to five weeks, with mill deliveries having the option to be late by up to three weeks.
Steel is not the only metal to experience rising prices over the past six months. The London Metal Exchange (LME) base metal prices for aluminum and copper have steadily increased as the Chinese economy recovers from COVID-19. Copper prices have bounced back after hitting an 11-year low in March 2020, as China's manufacturing and construction sectors consume nearly half of the world's copper. The LME three-month copper price closed at $4.53 per pound on May 6, 2021. By a wide margin, China is the world's largest importer of copper ore, accounting for 43% of global copper ore imports. According to the International Copper Association (ICA), global copper demand for solar and wind energy systems is expected to rise 56% by 2027 from 2018 levels, providing support to copper prices.
In 2020, China continued to be the world's largest producer of aluminum, and for the first time, in June 2020, the country also became a net importer of aluminum. China's commissioned aluminum smelter additions will reach 45 million tons by the end of 2021 compared with the excluding-China smelter capacity of 32 million tons. China added 1.8 million tons in 2020 and plans to add 2.8 million tons in 2021. Nearly 80% of China's smelting is powered by coal-fired utilities, while only 27% of smelting outside of China is coal-fired (the balance is hydroelectric, natural gas or nuclear). Reducing reliance on coal is key to the aluminum industry's decarbonization process. Similar to copper, aluminum prices rebounded sharply from a May 2020 LME low of $0.67 per pound to $1.10 per pound on May 3, 2021, and tight market supply conditions have boosted the Midwest premium for primary aluminum to a 32-month high of $0.26 to $0.27 per pound.
Similar to steel, the improvements in copper and aluminum prices have increased recovery values for related inventory appraisals with more recent effective dates.
Underscoring the Importance of Timing and Experience
Asset-based lenders and portfolio managers need to be attentive to the volatility in commodity prices as well as related factors such as mill lead times, metal scrap prices and the effects of tariffs on imports. This can only be done by a trusted appraisal and valuation services firm with qualified metals market knowledge, experience and market acceptance. As the effective date of a commodities asset appraisal can heavily influence a borrower's inventory availability, a strong understanding of the market and appropriately timed appraisals are key to maximizing results. Frequent appraisals are valuable in keeping abreast of trends and avoiding surprises. •
Mike Petruski is a managing director with B. Riley Advisory Services (formerly known as Great American Group), a B. Riley Financial company. Petruski leads the firm's metals and mining advisory services vertical in the valuations of ferrous and non-ferrous metal inventories, fabricated metals products, and machinery and equipment assets. With more than 30 years of industry specialization, Petruski has deep knowledge of international metals market pricing trends and works closely with asset-based lenders, investors and private equity groups on complex, syndicated ABL credit facilities and the valuations necessary to expedite such transactions. He is a member of the Secured Finance Network and the Turnaround Management Association. He can be reached at firstname.lastname@example.org.