Hedging Improves Return on Capital Employed for ABC Metals

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copper spool abc metals

Like many of you, I like to start a business conversation with “how’s business?” One never knows what one might hear.

And Dan Kendall, president of  ABC Metals, didn’t disappoint. “2010 was our best year ever, 2011 was our second-best year and 2012 beat 2011,” he said.

Now we all know copper prices have increased significantly since 2010 (average copper prices then at $3.42 per pound or $7,539 per metric ton), so before I chucked off his success solely to rising copper prices, I managed to ask Dan to reconcile for me the information I’ve heard in the market – that manufacturers have recovered since 2008, but haven’t hit their pre-2008 levels.

Dan’s next response surprised me: “We are doing true [metal] hedging and I’m not talking about forward buys with the mills per se but actual hedging…real return on capital employed (ROCE),” he said.

Commodity Risk Management

Now, we all talk about managing commodity risk, but what I learned from my conversation with Dan went beyond commodity price risk management and included the following:

  1. ABC Metals took market share away from competitors by offering “true hedging capability”
  2. ABC offered a large automotive OEM 2.5 years of fixed copper prices (yes, you read that correctly)
  3. The company has just had its three best years since the company began operations nearly 40 years ago

That sounds like competitive advantage, taking care of the customer and locking in margins (okay, we’ll give that one to commodity risk management).

As Dan mentioned in our conversation, “most business leaders don’t get upset about high prices, but they do get upset when their forecast is off – unpredictability is the bane of business, they watch it very carefully.”

When the market crashed in 2008, ABC already had two years of hedging experience under their belts and this time the strategy helped them to stay solvent.

In turn, ABC Metals became an important customer to their bank because they worked closely with the bank and both parties came to truly understand hedging vs. formal buying. (We’d argue that the majority of MetalMiner readers have formal buying programs as opposed to formal hedging programs). ABC Metals significantly increased their availability of capital.

Dan worries about 2013-2014 in terms of currencies and inflation. He feels some of his clients will struggle to gain access to cash, particularly in a rising copper price market. He wishes his customers knew the value of commodity hedging.

“I’m convinced that if more companies truly understood how they can lock in gross value-add via hedging, they would have a solution, particularly if the company is cash-strapped,” he said. “By having access to firm pricing front and back for 2013 (incoming inputs and outbound scrap), I’m convinced that our clients would sleep better at night.”

How to Improve ROCE

The benefit of establishing this type of program through a distributor that hedges involves flexibility. The buying organization doesn’t need to specify the exact quantities and forms like they do when they buy forward with a mill.

With a distributor, they only need to commit the aggregate volume and can specify forms/grades/sizes, etc., as needed. The buyer pays a hedging premium for this, but secures and locks in the margin for the life of the contract.

And that improves ROCE.

Image source: ABCMetals.com

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