Metal working and service industry in North America

December 05, 2007 By: User Image Arohan Category: Investing, Private Assets

I own businesses in the metal working sector and I believe that this sector is overdue for some structural changes. Metal working (I include machining, fabrication, sales and brokerage and scrap recyclers as part of metal working sector) is a fragmented industry in North America with many small players sprinkled all across the map. It is interesting to take a look at one example: The Purchasing.com top 100 Metal services companies. The list includes the top ranked company Ryerson with about $6 B in annual sales, to the 100th ranked company with about $26 million in annual sales. There is a wide gulf between the largest and the smallest companies with very few companies with sales > $1B. There are maybe another few thousand small companies that are not represented on this list. The basic themes that run across this industry are:

1. Small shops with customers concentrated in one or two industries
2. Limited geographic reach
3. Heavy reliance on repeat business from existing customers
4. Metal working businesses serving some sectors, such as automotive clients, have generally seen their margins thin over the years due to relentless cost cutting pressures
5. Most of the businesses are privately held

The larger and mid-sized companies in this sector have a different problem: most of them manage several thousand customer accounts. This fragmentation in customer accounts becomes difficult to manage

An ideal and efficient company in this sector would be one that has several hundred large customer accounts that are diversified across different industries with multiple locations (so they can optimize inventory, capacity utilization, shipping and logistics across the network).

The industry is ripe for consolidation but most of all it also needs to restructure its customer base and geographic profile

From an economic perspective, a lot of value is currently being created on the raw material side (mining and mills). There is a large and increasing demand at the finished product side due to the growth in the emerging markets (as well as future domestic demand as the US infrastructure starts its upgrade cycle). The metal working/service industry sits right in the middle and will see a lot of value being created here in the next decade or so if the right restructuring and consolidation takes place

And the valuation of the companies in this industry is shockingly low. Most private companies can be purchased for a valuation of about 3 times EBITDA or about 0.2 to 0.4 times sales. Even some of the public companies like Reliance Steel and Aluminum (which has a metal service business) can be had for about 0.5 times sales. Of course, like any other industry, you do have some companies that are richly valued and we tend to stay away from them.

Finding good solid companies in this industry and taking a position in them should produce excellent returns over the next 10 years

In the next few posts, I will highlight a few of these companies that I am finding worthy of investment today. So stay tuned …