Navigating volatility

The decade leading into 2020 was a volatile one for the scrap recycling industry, with fewer highs experienced than one would expect considering the United States had experienced the longest bull market in modern history. As we enter the 2020s, current market trends are expected to continue with a few potential bright spots.

Assessing the last year

Throughout 2019, the price of ferrous and nonferrous scrap metal fell sharply, devaluing inventory and inducing losses across the board. In fact, industry revenue fell at an annualized rate of 7.6 percent to $29 billion during the five-year period to 2019, which includes a 10.7 percent decline last year.

Low metal prices have been the result of weakened demand coupled with oversupply in the world markets. For example, a ferrous scrap price rebound in April 2019 didn’t last long, falling from $329 per ton for No. 2 shredded scrap to $220 seven months later in October. The rebound came close to, but did not match, 2018 year-over-year numbers and, ultimately, fallout became visible late in the year with the bankruptcy of Troy, Michigan-based Rivore Metals and the court-supervised auction of United Milwaukee Scrap, headquartered in Milwaukee.

Industry staying power

However, the industry has enormous staying power; if anything, scrap metal recycling will arguably only become more integral as sustainability efforts grow worldwide. While industry revenue is expected to rise only marginally at an annualized rate of 1.9 percent to $31.9 billion in 2024, metal margins are expected to normalize and perhaps increase at a faster rate over the same time period. Either way, crucial questions must be asked to better understand current market trends, their drivers and the implications that lie therein.

Demand and pricing are highly contingent on trends in downstream industries, including the automobile, machinery and construction.

Moreover, the 2019 market reminded recyclers that geopolitical circumstances also can breed substantial disruption, creating deteriorating, uncontrollable conditions in global commodity market prices.

Major markets

Generating an estimated 41.3 percent of industry revenue in 2019, downstream manufacturing industries are the largest supply market for scrap metal. This includes the automotive industry and equipment and machinery manufacturers. For these manufacturers, recycled metals are typically sources of secondary revenue, while they also are less expensive and save on carbon emissions from the metals producers’ perspectives.

Overall, the global automotive industry is in better shape than it was five years ago, particularly in the U.S., where profits and sales have recovered following the recession, and in China, where growth has remained consistent. In a report on the industry, McKinsey & Co., London, expects this upward progress to continue, citing that profits for automotive original equipment manufacturers will rise by as much as 50 percent in 2020—a boon for the scrap metal market in terms of supply generation. (However, the coronavirus outbreak, COVID-19, could interfere with this growth as automakers in the U.S. and Europe have announced temporary closures of their operations in an attempt to lessen the spread of the virus.)

Another major source of supply, generating an estimated 39.3 percent in 2019, is the construction industry. Scrap metal is generated extensively by bridges, railways, irrigation systems and other public infrastructure projects, including “green” buildings. A bright spot, the use of scrap metal in the steel that comprises construction projects has been encouraged by regulatory and tax benefits that promote the use of recyclables.

Moreover, according to new research by Selbyville, Delaware-based Global Market Insights, the rising prevalence of green construction may prove to be a significant driver for the scrap metal market.

That said, despite an anticipated decline in U.S. construction in 2020, brighter prospects abound for global construction growth, forecasted to edge up 3.1 percent this year.

External influences

For decades, the U.S. has exported nearly one-third of its scrap metal to China, but the advent of the National Sword policy in 2017 and ensuing trade negotiations and tariffs in 2018 caused a sharp decline in Chinese demand. Even so, according to the Washington-based Institute of Scrap Recycling Industries (ISRI), China has remained the biggest market for scrap exports, followed closely by India, Mexico and South Korea.

In response to China’s pullback, U.S. scrap exporters developed new markets—with India becoming the largest growth market in terms of net gain in export sales by value (up $586 million to $1.5 billion). Additional growth markets included Malaysia, Taiwan, South Korea and Germany.

Feb. 18, China announced importers could apply for tariff exemptions on duties of 25 percent for copper scrap and 50 percent for aluminum scrap shipped from the U.S. Additionally, phase one of the U.S.-China trade deal helped alleviate some concerns, but the exemptions are not expected to materially increase shipments of the material in the short term as metal demand has dropped because of the coronavirus outbreak. The outbreak has had a negative impact on China’s economy, and the impact may continue into the near future.

As mentioned earlier, the fortunes of the scrap metal market generally fall prey to geopolitical disruptions, including mass protests, trade tariffs and outbreaks of illness. The full business impact of COVID-19 is unknown. We recognize a sizable impact to the market is likely but cannot speak to specifics at this time as the situation is still unfolding. Moreover, the economic health of end markets also plays an incredibly important role, particularly as scrap metal recyclers shift toward exporting to developing countries.

Another potential risk facing the market this year hits a little closer to home. The U.S. presidential election takes place Nov. 3, and the election process as well as the final result could affect financial markets, and scrap metal recycling, into next year.

Expect consolidation

The U.S. scrap metal recycling industry remains highly fragmented, with the majority of operators catering to localized buyers of recycled scrap metal. The profitability of recycling recently has been low, and it sunk further over the past year. The majority of operators are small to medium in size, with the top four companies generating a small share of industry revenue; this high degree of fragmentation along with current market challenges are expected to drive continued consolidation.

Consolidation has long been a theme in the industry. In the face of ongoing geopolitical disruptions that affect the global market, further consolidation will be a prevalent theme in 2020 and 2021. Following a year of price declines, scrap operations that are on shaky footing may be looking for opportunities to exit the industry. Vertically integrated steel mills looking for captive raw materials supply will make acquisitions, as will midsized to large processors that want to deepen their territorial footprints and the consistency of their own supplies.

Technology leads the way

Metal recycling has a long history; basic metal sorting attempts began in World War II to aid the war effort, focusing on sorting ferrous and nonferrous metals. In the decades since, modern recycling technologies and innovations have developed to identify many different kinds of metals using a range of sorting technologies; but, overall, the level of technological shift taking place in the industry has remained relatively moderate. The end result, or goal, always has been the same: to pull more value out of the waste streams that producers already control or have access to.

Optical sorting technology can determine alloys and chemistries within individual material pieces or a stream of material. In our experience, recyclers also are pursuing automated solutions that can identify and separate aluminum scrap in bulk and on a much more efficient scale; many use sensors that can analyze the chemical and metallurgical makeup of each scrap piece by measuring, for example, copper, iron, magnesium and zinc levels.

This capability allows the businesses we speak with regularly to sort materials automatically, upgrading and adding value to that material while adapting—as they must—to the fundamental increase in aluminum usage and scrap generation that is occurring in the markets.

Ultimately, many in the industry are seeking to make themselves more competitive, not just via consolidation, but by investing in technology and processes to better sort all manner of aluminum alloys into their fundamental groups, making it much easier and more efficient to tie into the supply chain.

As technology innovations are embraced within the industry, including sensors and computerized components to enable automation, operators can anticipate either a boost in profit or, perhaps more importantly, a greater ability to insulate themselves from swings in commodity prices.

Automated technologies are more efficient and less wasteful, allowing operators to improve their emissions to take advantage of tax credits offered by local and state governments. This provides a benefit of reducing costs—by way of landfill fees—while at the same time providing a more valuable product for the recyclers to sell.

It is estimated that for every dollar spent on wages, metal operators spend 18 cents in capital investment. As the industry continues to be adversely affected by commodity price swings and resulting margin compression, recyclers embracing innovation stand to benefit the most in terms of cost-cutting efficiencies, adding value to their clients and profits to their bottom lines.

Technological shifts do not have to be massive either. Small increases in capital investment over time can result in big changes. New markets, both domestic and international, will open up as materials achieve greater purities and recyclers attempt to move up the value chain by providing furnace-ready products.

The winners of the global recycling market, particularly as we grapple with the unknown of COVID-19, will be made up of companies able to adjust to price cycles and volatility by buying right, adding value to the materials they control, including gleaning more value from existing waste streams, turning those materials around quickly to mitigate pricing risk and generating scale via consolidation. Generating scale via mergers and acquisitions is a tried-and-true method, ensuring consistency in supply for secondary raw materials consumers.

Michael Jenny is a partner in Livingstone Partners’ Global Industrials Group. He is based in Chicago and has more than 15 years of experience executing M&A, restructuring and capital raising transactions and can be contacted at jenny@livingstonepartners.com. More information on Livingstone Partners is at www.livingstonepartners.com.