Worthington Industries’ principal activities are to process steel and manufacture metal products. The company manufactures products such as metal framing, pressure cylinders, automotive past model service stampings, metal ceiling grid systems and laser welded blanks in the company specializes in producing flat-rolled steel to exact customer specification but faces a challenge due to declining production in the automobile sector.

Strengths

Customized offerings

Worthington Steel forms flat-rolled steel to exact customer specifications for industrial customers, including automotive, appliance, and machinery companies. It processes steel to the precise type, thickness, length, width, shape, temper and surface quality specifics as required by customers. Customized products are usually not supplied by steel mills or steel end-users. By catering to this niche area, Worthington Steel has established itself as a leader among independent flat-rolled steel processors in the US.

Increasing return on equity

Worthington’s 5-year average ROE of 11.1% is much above the industry’s average (5.6%). This is also higher than 9.5% ROE of the company’s competitor Steel Technologies. Moreover the company’s return on equity (excluding income from unconsolidated affiliates) has increased from 1.5% in 2001 to 15.2% in 2005. The company’s return on assets (excluding income from unconsolidated affiliates) has also increased from 0.7% in 2001 to 6.8% in 2005. Increasing return on equity and return on assets implies company’s ability to increase profitability on invested capital. This also indicates effectiveness of company’s streamlining operations and improving asset quality.

Strong performances by joint ventures

Worthington, apart from its three primary business units, operates through nine joint ventures that contribute through earnings growth, geographic expansion and product diversity. Some of these joint ventures include TWB Company, Viking & Worthington Steel Enterprise, WAVE and WSP. Worthington’s share of joint ventures is significant. Earnings from the unconsolidated joint ventures contribute over 40% of the Worthington’s profits. Moreover earnings from these unconsolidated joint ventures have been consistently increasing since 2002 at CAGR of 32.6% to reach $53.8 million. Strong performance by joint ventures will enable company to expand its presence in new markets while sharing resources, operating expenses and risk.

Although the sales from pressure cylinder segment have increased, there has been a consistent decline in profitability of the division primarily because of increase in operating expenses. The division’s operating income per ton fell to $0.9 in 2005 from $2.1 in 2004. The operating margins declined to 8.2% in 2005 from 9.5% in 2004 and 10% in 2003. Falling operating margins of the segment could significantly impact the overall profitability growth of the company.

Prime facia, it appears that company has performed well as revenues have risen. But this rise in revenue is either due to increase in its products prices or through current acquisitions. In terms of volume, the company’s sales (excluding acquisitions), has declined across all segments leading to 2% fall in 2005 as compared to 2004. The decline is because of 16% fall in sales from metal framing division and a 3% decrease steel processing division (which contributes over 58% of company’s revenues). Falling volume of sales in all product lines adversely affects Worthington’s operating results and financial position.

Worthington’s operating cash flow has fallen at a CAGR of 57.7% to $32.3 million in 2005 from $180.7 million in 2002. This is in spite of net income increasing at a CAGR of 54.5% during the same period. This reflects the company’s inability to generate cash through internal operations.

Widening product line and customer base

The Worthington Cylinder business expanded its product line with the acquisition of the propane and specialty gas cylinder assets of Western Industries in 2004. Western’s Propane and Specialty Cylinder Group manufactures disposable cylinders for hand torches, camping stoves, portable heaters and tabletop grills. During 2004, Dietrich Metal Framing and Pacific Steel Construction formed a joint venture named Dietrich Residential Construction to focus on the residential construction market particularly for US military. Another joint venture between Dietrich Metal Framing and Encore Coils named Dietrich Metal Framing Canada opened up new markets in Canada. These joint ventures can help the company through earnings growth, geographical expansion and product diversity.

Spending on nonresidential construction in the US started to gain momentum in the second half of 2004, and the so far in 2005 it has achieved a growth of 7%. This is expected to continue during 2005 The growth will continue on account of steady growth in consumer spending, a gradual increase in total employment, high levels of corporate profits and a steady rise in capital investment by the US businesses. Spending on non-residential construction is expected to expand by at least 6% in 2005. Since steel is an important construction material, increasing construction activities will raise the demand for steel providing a boost to company’s sales.

The company is divesting non-core assets in line with its hub and spoke model i.e. all business segments relate to the steel processing core competency. In process of streamlining the company sold Decatur, cold rolling assets to Nucor Corporation in August 2004. The company is divested its non-core assets and reinvested in higher growth businesses such as Dietrich and Unimast in the metal framing segment. The restructuring will enhance company’s asset quality, improve financial performance and provide a base for growth in the future.

Increasing consolidation in the steel industry

Steel industry is getting increasingly consolidated. After Mittal-ISG merger in 2005 the three largest steelmakers command 77% of all domestic shipments of all sheet products. Increasing concentration within the steel manufacturing industry would mean more bargaining power with the suppliers. Since Worthington is a processor of steel (not manufacturer), greater supplier power could translate into margin contraction. This will increase vulnerability of Worthington to economic and market conditions.

The US auto industry is on a decline. The traditional big three – General Motors, Ford Motor and Chrysler Group, the North American unit of DaimlerChrysler, are losing ground to the overseas-based manufacturers. Only Chrysler Group posted a gain in the US market share in 2005, but managed only a little increase. The weakness in the automotive sector is reducing the overall demand for hot rolled steel. General Motors alone reduced first-half North American production by 11%, which reduced the demand for sheet steels by 250,000 tons. Since 30%-35% of Worthington’s consolidated sales are to the automotive sector, the company will be negatively impacted by production cuts by its clients such as Ford.

Demand for consumer-oriented steel products such as sheet has been softening and this has started to pull down the price of flat steel. The decline in prices will continue as world steel production capacity exceeds the world demand by large margin. In 2004, world steel production capacity at 1.016 billion tons, exceeded world demand by more than 100 million tons. It is projected that world production capacity can reach 1.268 billion tons by 2008, compared to a demand of 1.051 billion tons. This is primarily because steel demand in China is slowing without any corresponding decrease in planned capacity. China is expected to produce more than one-third of total global production by 2007. Thus the production of steel could double in the next four years. Moreover low-cost imports from China will further dampen prices in the US. Since the company has stocked large amount of inventories purc

The North American steel industry is vulnerable to non-market interventions in world steel markets including China. These interventions include offering low-interest loans, providing cut-rate energy prices, paying employee health care costs or other subsidies. According to NAFTA, recent steel capacity increases are seen in countries whose governments intervene in the market to create artificial advantages for their steel industries. The government of these countries manipulate their currencies, promote export-driven investment agendas, grant government subsidies, protect their home markets and look to export markets (for steel and manufactured products) to solve their unemployment and social problems. Such interventions are resulting in increased steel production at competitive prices. This massive state supported expansion can distort the steel market in North America and worldwide.