Weekly Wisdom – August 16, 2023

By Hightower Great Lakes on August 16, 2023

Onshoring Commodities

We have been discussing the onshoring trend for months now, and we firmly believe it will be a secular theme that will continue for years. The main idea is that manufacturing will come back to North America to strategically protect supply chains from any exogenous events.

There is evidence of onshoring in many sectors, whether it’s semi-conductor chips, automobiles, energy or industrials, the list goes on and on. Most recently, the onshoring trend has been picked up in commodities prices, such as steel prices.

Steel prices have made a significant recovery since the beginning of the year, but prices have come off a bit during the past few months due to an uncertain macroeconomic environment.[1] Despite the recent contraction of steel prices, the two major U.S. steel end markets within the larger macroeconomic environment have recently shown some strength.

Construction makes up about 46% of steel shipments in the U.S. Construction spending has grown 3% y/y.[2] Currently, the biggest steel producing company in the U.S. is Nucor Corporation (NUE), which focuses primarily on construction end markets. Some other major U.S. steel players with a construction end market mix of around 60% are Commercial Metals Company (CMC) and Steel Dynamics (STLD).

The second primary end market for steel in the U.S. is the automotive market, which makes up about 25% of all shipments. Automotive is showing strength recently, with U.S. new vehicle sales increasing 14.7% in July.[3] But, it is worth noting that a potential United Auto Workers Union strike could materially impact automotive production as well as steel prices.

When it comes to automotive steel, there are two main players. The first is Cleveland Cliffs (CLF), which has a 30% automotive end market mix, and the second is United States Steel Corp. (X), which is at about 20%.[4] The remaining 29% of U.S. steel end markets are made up of machinery, energy and appliances, among other industries.[5]

Chart 1: U.S. Steel Shipments by End Market (2021)⁵

‘Steel’ing M&A?

The steel industry is currently an attractive area for M&A due to a few reasons. Firstly, as a result of the pandemic, the Russia-Ukraine war and growing tensions between China and Tawain, onshoring has become a popular trend. More and more companies are trying to localize and diversify their supply chains to mitigate geopolitical risk.

Considering only one out of the top 10 global steel producers is based in the U.S., this poses a significant risk.[6] Secondly, it was evident in steel companies’ second quarter results that most of them had a robust order book, which suggests strong demand for their products. Finally, this demand should continue, driven by this increased construction and automotive spending.

This robust spending should help support steel prices for the long term.[7] The aforementioned factors, along with single digit enterprise value to EBITDA multiples and robust free-cash-flows, make many steel companies in the U.S. attractive M&A targets.

One steel company that proved to be an attractive acquisition target was United States Steel Corp (X)[8]., which received and rejected an approximately $7.25 billion offer from Cleveland Cliffs. The offer was made via cash and shares and represented a 43% premium to X’s August 11 closing price.[9]

If the offer were to go through, the new company would control 100% of the domestic iron reserves as well as over 50% of the exposed automotive steel market.[10] This offer from Cleveland Cliffs caused a privately held company that goes by the name Esmark Inc to also make an offer.

Esmark owns a portfolio of industrial companies and was founded by James Bouchard, who was a former executive at United States Steel. Esmark offered $7.8 billion in cash for United States Steel.[11] Talks are still ongoing and United States steel has not released any decision on the Esmark offer thus far.

Capturing Strategic Market Share

Ingersoll Rand (IR) is embarking on a strategy to use inorganic growth through strategic M&A, which is visible in its three acquisitions year to date. The first of the three took place in January, when it acquired SPX FLOW’s Air Treatment Business in an all-cash transaction for $525M.[12] In February, another $40M all-cash transaction for Paragon Tank Truck was completed.[13]

The acquisition expands upon Ingersoll Rand’s channel reach in coolers, air compressors and liquid segment accessories. Most recently, Ingersoll Rand acquired Roots from Chart Industries in yet another all-cash deal for $300M.[14] The purchase price was valued at roughly 2.6x sales.

Roots is well known in the niche blower industry and is even “synonymous with blowers in the same way that Band-Aids are recognized in consumer markets,”[15] and has a history of more than 150-years. There is a clear trend in these acquisitions: they are all made in cash. Companies that generate strong free cash flow have greater flexibility in M&A decisions and capitalize on opportunities when presented.  

The commodities and industrial sectors aren’t the only places that use an M&A strategy to expand market share. Recently on August 10, Tapestry (TPR) announced that it was acquiring Capri Holdings (CPRI) for $8.5 billion. The deal would create an American fashion giant that brings Coach, Kate Spade, Stuart Weitzman, Versace, Jimmy Choo and Michael Kors under one house.[16]

This consolidates market share in the luxury retail space to compete with their European counterparts. We have seen other similar moves in the healthcare space, as healthcare giant Eli Lilly (LLY) struck a deal to acquire Dice Therapeutics for $2.4 billion earlier this summer. This effort will help Eli Lilly add to its treatment portfolio for immune-related diseases.

The demand for M&A has not slowed this year, which has been a surprise to many, considering the tightness of the financing market. The ability to strike a deal has been powered through strong free cash flow generation that some companies have been able to use as a lever.

We expect this trend to continue throughout the remainder of 2023, which will also give a boost to capital markets. Similarly, the CEO of Morgan Stanley (MS), James Gorman, mentioned on July 18 that he believes capital markets have bottomed. We will keep our eyes on this theme for the rest of 2023.

Click here to read last week’s Weekly Wisdom (8/10).

Disclosures

Investment Solutions is a group comprised of investment professionals registered with Hightower Advisors, LLC, an SEC registered investment adviser. Some investment professionals may also be registered with Hightower Securities, LLC, member FINRA and SIPC. Advisory services are offered through Hightower Advisors, LLC. Securities are offered through Hightower Securities, LLC.

This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is neither indicative nor a guarantee of future results. The investment opportunities referenced herein may not be suitable for all investors.

All data or other information referenced herein is from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other data or information contained in this presentation is provided as general market commentary and does not constitute investment advice. Investment Solutions and Hightower Advisors, LLC or any of its affiliates make no representations or warranties express or implied as to the accuracy or completeness of the information or for statements or errors or omissions, or results obtained from the use of this information. Investment Solutions and Hightower Advisors, LLC assume no liability for any action made or taken in reliance on or relating in any way to this information. The information is provided as of the date referenced in the document. Such data and other information are subject to change without notice.

This document was created for informational purposes only; the opinions expressed herein are solely those of the author(s) and do not represent those of Hightower Advisors, LLC, or any of its affiliates.

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[1] Source: Deutsche Bank Research. As of August 7, 2023.

[2] Source: Census.gov. As of August 1, 2023.

[3] Source: Market Lines. As of August 2, 2023.

[4] Source: Wolfe Research. As of August 7, 2023.

[5] Source: FactSet (chart). As of August 8, 2023. 

[6] Source: Clevland Cliffs Company Presentation. As of August 13, 2023.

[7] Source: Greenwich Capital Group. As of August 24, 2022.

[8] Source: Financial Times. As of August 13, 2023.

[9] Source: Bloomberg. As of August 14, 2023.

[10] Source: KeyBanc Research. As of August 13, 2023.

[11] Source: Bloomberg. As of August 14, 2023.

[12] Source: IngersollRand. As of January 3, 2023.

[13] Source: IngersollRand. As of February 1, 2023.

[14] Source: IngersollRand. As of June 12, 2023.

[15] Source: Yahoo. As of August 3, 2023.

[16] Source: CNBC. As of August 10, 2023.