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May 1, 2007

A FULL PLATE

IPSCO's David Sutherland enjoys his perch as a low-cost producer at a time of buoyant demand. But he worries that China's ascension is skewing the market.

Life has been good at IPSCO Inc.

Portraits by Chris Lake
 

The Canadian-born steelmaker enjoyed record sales and shipments in the past five years as demand for its pipe, tube and plate in the energy and construction markets blossomed. Earnings last year rose nearly 10%, and sales climbed by nearly a quarter.

Things were so good that the company was bound to attract suitors, and IPSCO confirmed in April that it was in talks that could lead to a buyout. On May 3, IPSCO said it agreed to be acquired by Sweden’s SSAB Svenskt Stal AB for $160 per share, or $7.7 billion. IPSCO CEO David Sutherland said the acquisition would reinforce the company’s “already solid position as a leading supplier of steel plate and energy tubulars in North America.”

IPSCO shares, which languished at less than $10 during the early decade recession, climbed in the first quarter and traded in the $150 range in the days after IPSCO confirmed the takeover talks.

With capacity of 4.3 million tons and 2006 revenues of $3.78 billion, IPSCO could be considered a small to mid-sized player. Yet it enjoys market-leading positions as the biggest plate producer in North America and one of the top producers of tubular goods for the oil patch. That gives it influence beyond its size. “They’re big in the markets that they are in,” says Michael Willemse, an analyst at CIBC World Markets in Toronto.

The company wasn’t always a powerhouse in its markets. Its origins date to 1956 in Regina, Saskatchewan, where it began as Prairie Pipe Manufacturing Co. to serve Western Canadian demand for welded line pipe. The company subsequently acquired Interprovincial Steel Corp., a troubled steel mill that had been launched by some of the same investors. Prairie ultimately changed its name to Interprovincial Steel and Pipe Corp., shortened in 1984 to IPSCO.

It wasn’t until the 1990s that IPSCO expanded steelmaking to the United States, building plate mills with the capability of producing plate up to 120 inches wide that could be shipped flat or rolled into coil. With 90% of its assets in the United States, the company in 2000 relocated its corporate headquarters to the Chicago suburb of Lisle. But it remains registered in Canada and trades on both the New York and Toronto stock exchanges. Its single biggest complex remains in Regina, where it employs more than 1,600.

The newer facilities give IPSCO a considerable low-cost producer advantage, says Randy Cousins, a steel industry analyst at BMO Capital Markets in Toronto. “They will be in a position to thrive and prosper at the bottom of the cycle and enjoy the icing on the cake at the top.”

Leading the company through this period of unprecedented prosperity is Sutherland, a native of picturesque Moose Jaw, Saskatchewan, who assumed the posts of president and CEO near the depths of the downturn in January 2002. A 30-year veteran of the company, he started in industrial relations, and then rose through the ranks, holding managerial positions in Western Canada and then overseeing much of IPSCO’s expansion in the U.S.

Sutherland made a bold move last year with the acquisition of Newport, Kentucky-based NS Group Inc., a maker of seamless and welded tubular goods for energy drilling and production. The acquisition increased the company’s dependence on the volatile energy industry to two-thirds of revenues, compared with slightly more than one-half previously.

There were other concerns. Fourth-quarter earnings tumbled 18%, and IPSCO forecast that first-quarter earnings would be lower than its fourth-quarter earnings of $2.92 per diluted share, largely a result of the high inventories at service centers. Rising prices for scrap are expected to depress margins.

But the biggest anxiety these days comes from China, which has been boosting steel capacity in excess of domestic demand, sending exports to a peak last year. That’s one wild card that IPSCO and other producers cannot control.

Sutherland in an interview conducted before IPSCO confirmed the buyout talks, reflected on the threat of China’s growing dominance in steel.

The meteoric rise of China’s steel industry concerns many North American steelmakers. What are the implications for the West?
We can compete against anybody in the world, but we can’t compete against a government. We’re competing against a fixed currency rather than a floating currency that doesn’t reflect at all its true value. We’re competing against governments that actually own steel companies, governments that have actually given them the land, underwritten the business to get it going and given interest-free loans.

Does China have any real advantages when it comes to steel?
China is putting in way more production capacity than it needs. It’s fine for them to put in capacity in other sectors to make something that is touched by many hands, where it’s highly people- or labor-intensive. This is where they have a competitive advantage. Let countries that pay very low wages compete on things that are labor-intensive.

But the steel industry is capital-intensive. In the case of steel, [China] is investing in capacities far in excess of its domestic needs, expecting to export it anywhere in the world. But it has no natural advantages in this area as compared to much of the world.

Countries tend to have an advantage in the fertility of the land for agriculture, in the size of the population they have in terms of cost of labor and especially if they’re educated or blessed with significant amounts of raw materials. As an example, Brazil has a lot of natural advantages. It has the richest iron ore in the world. It’s more of a natural place to make steel. You shouldn’t be allowing governments to invest heavily in industries—especially in which they have no advantage—and support them to export into other countries where companies there can be harmed.

China probably would say it doesn’t mean to disrupt our markets; that it wants to keep the U.S. as a customer. What do you think is China’s true intent? 
Its intent is to continue to invest in this capacity and try and drive many others out of business. They think they have a right to it. They pick certain markets, and they somehow think they have a right to those markets—whether they have an advantage or not. Well, they have no comparative advantage in steel.

The Bush administration hasn’t moved on the currency issue, perhaps for fear of offending China. Do you expect the Democratic Congress to push through a policy change?
The pressure is not going to [subside], and it’s coming from both Republican and Democratic directions. The political momentum here in the U.S. is that somebody has to do something with China sooner than later. Either there will be enough pressure put on this administration to do something, or there will be enough momentum that it will have a significant influence on the next election.

Will this resonate as a campaign issue?
It won’t be put just in the context of the currency. It will be in the context of the unfair advantage that China and its manufacturing enterprise is being given from a variety of directions, not just currency, and the impact that it’s having on the closing of factories and the undermining of the middle class here in America. Lou Dobbs [the CNN anchor critical of outsourcing and the export of North American manufacturing jobs] is right, and [his viewpoint] is resonating with the viewers. They happen to agree with him, by the way, for all the right reasons. If it’s not affecting them, it’s affecting their next-door neighbor.

What have you done to educate your own constituencies?
We haven’t held big town hall meetings, but we certainly make sure our employees understand what’s at risk here. We make sure that all of our employees and all the other stakeholders that are betting on the fortune of IPSCO understand what it means to ensure the playing field is free and fair.

What would be your preferred remedy? 
I don’t know what is the best remedy, but it’s pretty clear that rhetoric and jawboning aren’t working. We can’t continue to placate the population here just by making speeches that sound good but have no material impact. At the end of the day, it takes action, and in the end, China will not come to the table unless it sees that there’s a risk if it doesn’t. China probably is in a good position to compete economically on a lot of fronts, but I can’t imagine why it would want to fight over steel, because it doesn’t have an advantage.

In fact, quite the opposite. These industries are significantly harming the country; the pollution is serious. For all the jobs it creates, it consumes enormous amounts of electricity and water, and places much demand on a weak infrastructure. It should invest more heavily in areas that generate domestic consumption and play to its advantages from an export standpoint. It can do what it wants to support itself, but in the case of steel, it’s investing in a lot of steel factories that, no matter what happens in that country over time, it will never have enough domestic consumption to [justify] all this capacity.

What is the urgency? 
When China is challenged, what it will say is, “We’ll do it at our own pace.” If they keep doing it at their own pace, they’ll just continue to hollow out this country. What they need to do is increase domestic demand. China has a savings rate of 50%. Can you imagine paying people such a low wage and still saving half
of it?

But it may be too late for many of the industries in the rest of the developed world that are every bit as productive, if not more so. [North American manufacturing] could be undermined to such an extent that industries can’t recover. [The Chinese] are just going to continue to ‘rope-a-dope’ as long as it takes in the hope that their competitors elsewhere in the world collapse.

What are the similarities and differences between Canada and the United States in dealing with the decline of the manufacturing base?
There certainly has been a fairly significant amount of harm done in Canada as well by the Chinese or by other countries where there’s an unfair advantage. But significantly, the U.S. is Canada’s single largest customer by many orders of magnitude.

For the longest time, Canada had a couple of quite significant advantages. It had a low Canadian dollar relative to the U.S. dollar, and it had nationalized health care. The health care burden of an individual company was a fraction of what it is in the U.S. The Canadian dollar, at 65 cents, also gave Canada a significant advantage.

You ended up having many companies locating or growing in Canada and moving goods into the U.S., or you had Canadian entrepreneurs setting up companies in Canada to compete in the U.S. Unfortunately, because Canada isn’t nearly as productive as the U.S., we frittered away the advantages we had. The health care advantage is still there.

When the [Canadian] dollar went up to 90 cents, all these firms were harmed because they lost a great deal of their advantage. But they kept putting in more capacity without it being productive capacity just to put out more volume. As soon as the dollar changed, they couldn’t compete with their U.S. counterparts, and much of the work either remained [in the U.S.] or moved back [to the U.S.] from Canada, or went elsewhere.

That has had a significant effect in Southern Ontario, where much of the manufacturing base in Canada resides. Because Canada is still so resource-rich, and with the prices of commodities being as high as they are today, Canada as a country is still doing very well. But the manufacturing base is under significant strain.

What is the solution?
There is a movement in Canada at both the federal and the provincial level to start dealing with this whole productivity question. It goes to the heart of many of the same things you see [in the U.S.] in terms of education, government intrusion and tax levels.

Your acquisition of tubular products company NS Group Inc. increased your dependence on energy markets to about two-thirds of revenues from slightly more than half. Is there a danger in being too dependent on this market, given its historic cyclicality?
We believe that with the secular changes going on in the world today, the demand on energy—both oil and gas—will continue in an upward trajectory. Not that there won’t be some cyclicality around that trajectory, but nonetheless, the trend is up.

Half of the drilling in the world takes place in Canada and the U.S. Not only do you have to drill for it and find it, but you also have to gather, transmit and distribute it. We think it’s a decent place to be for a while. Our bet is that you won’t see oil and gas go down to the levels of the past where the market absolutely collapsed and oil patch activity dried up.

How much does size matter, and where does your company fit in? 
Size matters, and I think it varies a bit by product. For sure size matters regionally; you have to have regional scale. There are certainly benefits of global scale as well. Arcelor Mittal is the largest, but there are others that have much more global scale than we do.

If you look at IPSCO, we’re certainly large in the North American businesses that we’re in. In fact, depending on how you define it, we could be considered the largest in the two games we play in Canada and the U.S.: energy tubular products and plate. If you look at global players in pipe and plate, we’re in the top half dozen in both of those globally as well.

If you just measure a steel company by tons, then in fact we’re quite modest in size. But again, we’re a niche player, but we have both regional and global scale in those two niches.

You have been extremely profitable compared to your peers. How do you do that?
You have to be in the right markets, be a low-cost producer, have very strong customer relationships and add as much value as you possibly can.

Achieving and maintaining our low-cost producer status is a continuous process. First, you need to have well-maintained manufacturing assets using state-of-the-art technology. This requires disciplined investment of capital each and every year. Second, low-cost producer status requires rigorous application of Six Sigma and lean manufacturing techniques to ensure continuous improvement of key processes, higher productivity, and migration of best practices throughout the organization. Third, you must focus your workforce on quality and safety. Poor quality not only drives costs higher, but also over time will result in lost customers. We make safety the responsibility of every employee and make it visible throughout the company. We celebrate good safety records with awards and incentive pay.

We also measure success in many ways including gross margins, operating profit per ton, asset utilization, man-hours per ton of liquid steel, material rejects and accident rates. We benchmark our performance against integrated steel mills, mini-mill producers and energy tubular manufacturers around the globe. By nearly every measure, we are consistently a top performer.

You make it sound easy.
It only took us 50 years to get here.

Can you give an example of a strategy that contributed to this consistent profitability?
We make a high grade of steel, so a lot of value is added. Then we make it into a high value-added tubular product for the oil patch. Since we make the steel as we make the pipe, we’re making profits on both of those products. Many people that we compete against either only make the steel or only make the pipe. We’re reporting profits in both of those activities.

Do you find those oil patch customers to be less price-sensitive or more so? 
Everybody’s price-sensitive, but many of our customers look at the whole package. You have to be competitive on price, but there are costs to having poor service. What you want to do is deliver a wonderful product at a competitive price, and deliver it when the customer wants it.

What keeps the metals supply chain from being more efficient?
OEM demand for plate has not changed much at all: Our customers continue to be as busy today as they were two quarters ago. Yet the market has weakened to the point that we took capacity out of the market in the fourth quarter. Why did we do that if the OEMs are busy?

It’s because there are too many distributors chasing the same piece of business and trying to have enough inventory on hand to serve those accounts. Only one of them is going to get the business.

The business is exceptionally fragmented today, and you’re seeing new [distributors] still popping up all the time. They have a book of accounts and a relationship with a mill. They rent a warehouse, and they’re in business. Until the distribution business consolidates, or until entry barriers are substantive enough to give this consolidation some legs, the disruptions will continue. Everybody thinks they have a better deal than the next person, and that isn’t the case. The fragmentation of the service center industry is quite a significant barrier to a more cost-effective supply chain.

How exactly will that consolidation be beneficial? 
If consolidation of service centers follows the mills, you end up with larger firms that are more sophisticated, where the information is more accurate and the relationships are stronger. The issue during the last quarter has been that too many people bet on too much inventory. The inventories got out of whack relative to demand. In some parts of the business, there may have been a softening in demand as well. Bigger firms in a consolidated market can deal with that more easily than smaller firms in a fragmented market.

What is the outlook for the rest of this year? 
Underlying demand by the OEMs is quite strong, so we think that 2007 will continue to be a good year. But in some of the areas in which we participate, the supply chain is over-inventoried. It’s going to take some time before that’s worked off.

What makes a great metals company? 
You must develop a culture for success, where you’re respectful to all the participants, and where everybody still has their eye on wanting to succeed and there’s something in it for them. You have to put out a wonderful product and be a low-cost producer. Put another way, you have to make it really well, and you have to sell it really well. If you make and sell it well, you’ve got a happy customer, and if you are a low-cost producer, there’s enough left over to handsomely reward the shareholders.

At the end, though, you still have to participate in a marketplace that’s free and fair, and right now, we happen to live in the freest market in the world. But many of our offshore competitors are not playing fair.