Date March 2019
- Tariffs levied in March 2018 continue to cause uncertainty across the manufacturing and consumer industries. Some previously exempt countries are no longer exempt and have since levied retaliatory tariffs on U.S. exports
- Market prices in steel were stable from mid-June 2018 until the beginning of 2019. Domestic steel employment has seen numbers dip every year since 2015. Although employment numbers are down, U.S. steel production increased in 2018 to 86.6 million metric tons, from 81.6 million metric tons in 2017
- Tariffs and countervailing duties applied for trade cases resolved in 2018 have fully rolled through the industry so the impact of tariffs is fully included in most inventories
- The February 2019 Purchasing Managers’ Index fell slightly to 49.2 from 49.5 in January. However, as new orders trended higher, future activity hints toward expansion and improved domestic demand for Chinese steel
Approximate net recovery on cost
Tariffs create uncertainty across the supply chain: In March 2018 the Trump administration imposed a 25 percent tariff on all steel imports and a 10 percent tariff on all U.S. aluminum imports. Initial exceptions were made for Canada, Mexico and European Union (EU) countries as well as Australia, Brazil, South Korea, and Argentina. However, in June 2018 some exemptions were pulled back and tariffs were extended to include Canada, Mexico and the EU. In July 2018, Canada imposed matching retaliatory tariffs on U.S. goods going into Canada. China then accused the United States of starting a trade war, and also implemented tariffs to match the U.S. tariffs. The European Union and Mexico have also responded with similar retaliatory tariffs. As of early 2019, the only countries exempt from the steel and aluminum tariffs were Australia, Argentina, Brazil, and South Korea; however, all but Australia are still subject to U.S.-mandated import quotas. Additionally, steel articles from Turkey are subject to an ad valorem duty rate of 50 percent as of June 2018. Many economists believe the tariffs will result in a net loss for the U.S. economy.
Despite these actions, market prices in steel were stable from mid-June 2018 until the beginning of 2019. Domestic steel employment has seen numbers dip every year since 2015. Although employment numbers are down, U.S. steel production increased in 2018 to 86.6 million metric tons, from 81.6 million metric tons in 2017.
One state has attempted to quantify how the tariffs have impacted its business; Ohio State professor Ned Hill stated that for most Ohio companies, the tariffs have meant increased costs, which can sometimes be passed on to customers but which result in higher prices across the country for consumers in the United States.
Potential to end U.S./China trade tariffs: In late February 2019, the Trump administration continued its efforts at negotiating updated trade agreements with China. As part of this effort, the United States delayed an increase in import duties, which was set to take place on March 1, 2019, that would have increased levies on imported Chinese goods from 10 percent to 25 percent. This move could be viewed as a softening of the trade war, and possibly the two sides moving to some type of agreement, which could either reduce or remove the tariffs currently in place.
The February 2019 Purchasing Managers’ Index fell slightly to 49.2 from 49.5 in January. However, as new orders trended higher, future activity hints toward expansion and improved domestic demand for Chinese steel. Additionally, the Producer Price Index for Cold Rolled Steel Sheet and Strip and Iron Ores have been relatively flat since June 2018. If the tariffs were to be lifted, the steel and aluminum industries could see significant increases in production and trade movement.
Certifications important: In order to achieve maximum value for inventory collateral, each item must have current and up-to-date material certifications from the appropriate vendor. The documentation specifies all relevant certifications including grade; alloy, ASTM, SAE, or UNS specifications; size; mill of origin; heat number; and other information that would be required by a potential buyer. Without these certifications, the value of the inventory would be lower as fewer customers would purchase the material, and in essence the inventory would become secondary-grade material. Lenders should ensure that record keeping related to certifications is being maintained and audit this paper trail in the same fashion that proof of deliveries are checked for accounts receivable.
Inventory costing and mark-to-market reserves: When a company’s inventory contains commodity-type items, like steel, which are subject to frequent price fluctuations, it is imperative to understand the company’s inventory costing methodology. A standard cost approach includes updating inventory costs periodically and, depending on the frequency of the update, can result in the company’s reported cost varying from the market in an inflationary or deflationary environment. A rolling weighted cost approach utilizes an average weighted cost for each purchased item that equates to a rolling perpetual average. This methodology is useful for commodity-type items as a company’s reported cost will remain more in line with the market, although costs will still trail market prices by a set period. Given the volatility in the steel market, lenders should be aware of the target company’s costing methods and should consider incorporating a mark-to-market reserve to adjust the cost basis to market and ensure that an advance rate based on a percentage of cost remains relevant even in a volatile market, or a lower-of-cost-or-market reserve to adjust the balance sheet value of these inventories when their market values change.