Metal Matters - Really It Does, a view on inventory build

Commentary:

Last week the Fabricators and Manufacturers Association held their annual executive level conference and this year they combined with their Toll Processing meeting which is the session that attracts all the major steel industry players. The conversations within this meeting were highly instructive as far as identifying what trends are really starting to shape up and what factors appear to be having the most influence. For the past several weeks there has been intense discussion over the apparent rebound in inventory that is taking place in the manufacturing sector. It is this inventory build that seemed to drive the recovery in the fourth quarter of last year and has been responsible for the progress that has been made at the start of this year. The manufacturers were remarkably uniform in their assessment of what is driving the build and this is somewhat different from what has been suggested in some of the popular analysis.

The first factor is that most of these manufacturers have been watching their financial situations shift radically. Their lines of credit have been reduced and their loan limits have been reduced. The majority of these decisions have less to do with their own business than it has to do with the status of the banks. In reaction to these bank changes many of the companies are rushing to make production decisions before these limits are further heightened and that has meant buying equipment they think they will need in the future, acquiring raw materials they think they will need sooner than later and essentially using the financing they have access to now in anticipation of losing some of that access later. The banks are less willing to advance financing for many of the smaller manufacturers in the future and thus there is some apprehension about the longevity of the inventory build. It was also noted that companies that had more inventory available were receiving better reactions from banks that were seeking collateral. This is despite the fact that carrying that extra inventory could actually make their business more vulnerable.

The second factor is that manufacturing is currently one of the hottest sectors in terms of acquisitions, mergers and other combinations. The timing of this recession has as much to do with this trend as anything else. The majority of small to medium sized manufacturers have management that is getting close to retirement age and many are looking for ways to cash out of their ownership positions. The recession has exposed which companies are stronger and weaker and that has made the decision to buy or sell easier. The companies that are looking to go on the market have been taking steps to strengthen their valuations and for some of them that has meant adding inventory that will prove of interest to potential buyers. It is expected that hundreds of companies will be bought and sold in the months ahead and these are all deals that will affect inventory decisions.

The third factor in the inventory build is close to what has been posited by many analysts. There is an anticipation of demand that will require attention from manufacturers that are generally hard to distinguish one from another. The average company is not in a position to lose ground to a more active competitor and they are attempting to prepare themselves for that demand when it arrives. In addition to this rationale there is another issue. The manufacturers that supply other manufacturers are well aware that these consumers are engaged in some last minute strategic decisions that will leave them very little flexibility in their supply chain. The usually quick decisions regarding who will supply what will be made even faster in the next few months. That has already been the experience of many in the sector and they know they will have no time with which to build inventory once these orders are received.

Trouble Ahead for the Construction Sector

The companies that supply the construction sector with steel are passionately interested in the future of this much beleaguered industry and their latest prognostications are as bleak as they have been in some time. There is an expectation that things will get marginally better in the course of this year but expectations are that it will be the second half of 2011 before anything positive starts to develop in the industry as a whole. The numbers from 2009 were spectacularly bad - market square footage was down by 42% and steel square footage was down by 41%. This year's decline will b e much less dramatic but the 3% los that will occur this year certainly does nothing to rebuild the damage from before. The most disheartening data comes from examining the impact of the stimulus package as it relates to construction. If one looks at the total allocated it swiftly becomes apparent that construction has received a tiny share and one that is shrinking despite all the rhetoric to the contrary.

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