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We’re a logistics company that coincidentally trades in metals

07/03/07

From: TheMarker, 7 March 2007

Ami Ginzberg

 

When Shmuel Shiloh, the controlling shareholder, Chairman and General Manager Scope Metal Trading and Technical Services Ltd. (TASE: SCOP), is asked to summarize the company is a single sentence, he says, “We’re a logistics company that coincidentally trades in metals.”

 

He then retracts and says that trading in metals is not a coincidence. “We’ve specialized in this sector for years, and we’re good at it.”

 

But when you look for Scope Metal’s relative advantage and the basis for its growth strategy – logistics at the highest level – that appears to be the main story. This is what it intends to use to drive its overseas growth strategy as well. Scope Metal was floated on the Tel Aviv Stock Exchange (TASE) on the wave of IPOs of 1992. In contrast to many other companies that raised capital then, and later vanished or got stuck, Scope Metal has continued to grow, and most of all, to profit. “Scope Metal has always been profitable,” says Shiloh. “The company has posted a profit every quarter since its IPO until today.”

 

Scope Metal’s strong performance improved even more last year, and many investors have begun to notice the company on their radars. This radar began operating a year ago, when First Israel Mezzanine Investors Ltd. (FIMI), headed by General Manager Ishay Davidi, made a major investment in the company and acquired 27.6% of its shares for NIS 157 million. FIMI has an excellent track record of spotting companies with potential for improvement, and the investment in Scope Metal was one of the largest the fund has made to date. FIMI bought its holding in Scope Metal at NIS 53 per share, and has made a profit of about 70% on its investment so far.

 

The surge in the value of Scope Metal corresponded to the dramatic development of the company’s business. Scope Metal posted NIS 743 million in sales in the first nine months of 2006, a 66% jump compared with the corresponding period. Operating profit shot up 70% to NIS 117 million, and net profit almost doubled to NIS 63.3 million. Investment house Clal Finance Batucha Ltd. predicts that Scope Metal will post NIS 1.03 billion revenue in 2006, an operating profit of NIS 160 million, and a net profit of NIS 86 million.
 

Meanwhile, Shiloh is satisfied with the NIS 150 million bond issue for Israeli investors. Maalot The Israel Rating Company Ltd. rated Scope Metal’s bond series A .

 

60,000 items in inventory

Scope Metal specializes in trading in metals. The company specializes in the purchase of metals from international metal producers, such as Alcoa Inc. (NYSE: AA) or Alcan Inc.(NYSE; TSX: AL), and selling them to customers in Israel. The metals mainly include stainless steel, commercial and aviation aluminum, steel and steel alloys, titanium, copper, bronze, brass, lead, and nickel alloys, as well as engineering plastics. The company is considered the Israeli leader in the white metals sector (stainless steel, aluminum), while competition against it in the metals sector is more aggressive. Metals arrive in various forms of finishing, such as pipes and sheets. Except for cutting to various sizes to meet customers’ specifications, Scope Metal does not do any processing of the metals.

 

Scope Metal’s added value comes from the services it provides its customers, in speed of delivery and availability of every possible metal. For this purpose, Scope Metal keeps in its warehouse near Moshav Bnei Ayesh a huge inventory of 60,000 items worth NIS 500 million – half the company’s annual sales. Most of the warehouses are among the world’s most automated, enabling control and management with a minimum of manpower and a maximum of efficiency. Thanks to Scope Metal’s level of service, the company can charge its customers more than its competitors.

 

Scope Metal’s business strategy is based on the one-stop shop model; in other words, you can get everything you want from us. The huge inventory requires the company to maintain large liquid assets and avoid over-leveraging of credit. This is also the reason why, when the company began to expand overseas and speed up the procurement of its inventory, Shiloh preferred increasing shareholders’ equity through a partner like FIMI, rather than the temptation of raising more debt, even though the Israeli capital market would have gladly financed him a year ago.

 

“In order to exploit market opportunities, you must have money all the time,” explains Scope Metal CFO Gil Haber. “If a good deal for buying goods suddenly falls into our lap, we want to be able to make it immediately, and not wait until the bank approves credit for it.”

 

The large inventory is also the company’s biggest operational risk. In recent years, when metal prices were rising, Scope Metal was doing great. Inventory bought at low prices was sold at high prices because market prices had risen. If the market changes direction, and prices for metals fall, the company is liable to lose money on its large accumulated inventory. Maalot notes the subject of inventory in its report. “Maintaining large volumes of inventory is liable to weigh on operating results during sharp falls in prices of raw materials, falling domestic demand, or as the result of changes in the interest rate when bonds are recycled in the future,” states Maalot.

 

You screwed up? Bring a cake

Shiloh believes that this risk is not great since global market conditions and competitive structure continue to support the current level of prices. “The metals market has changed,” he says. “I tend to divide the market into two periods: before the September 11 attacks, and afterwards. Before the attacks, metals prices would rise strongly for one year, then fall for four years, and this cycle always repeated itself. This was because of the large number of producers in the market who rushed to boost output when prices were high, and were then stuck with inventory.

 

“After September 11, the market changed, and began to consolidate (mergers and acquisitions). Today, four huge companies dominate the global market, and they ensure that prices don’t fall.”

 

Shiloh says there is no price fixing, but a mechanism based on long-term ties with customers, which enables producers to moderate volatility in the industry. Whatever the case, it’s hard to know whether this is a stable equilibrium. The risk of falling prices in the metals industry, whether or not it appears high, definitely exists. Scope Metal’s accumulated inventory has been accompanied in recent years by a negative cash flow from operations. The trend is supposed to change this year, and the company should again generate high cash flow from current operations.

 

 Scope Metal’s warehouses are the core of its commercial activity – the trading room where 80 salespeople sit bound to their computer screens and telephones. It’s easy to see that sales and salespeople are Scope Metal’s strong point. Shiloh and Haber’s instructions to their salespeople is clear – you do not lower prices and don’t be tempted to narrow profit margins to build market share. We’re here to make profits. This is how Scope Metal has been able to maintain a gross profit margin of 25-35% and never post a quarterly loss during the 15 years that it has been a public company.

 

Every morning, Scope Metal’s 80 salespeople get a lesson from one of the company’s professionals. One may be about a new product and another about marketing. On Thursday, there is a test on the material. Shiloh used to lead the classes, but in the past two years, he has been assisted by other company executives. Haber says that while the company’s salespeople have sales targets, they receive a fixed salary and paid incentives on the basis of performance.

 

Shiloh knows the company’s 600 employees personally. “We have three meals a day, lunch, dinner, and night,” he says. “There is no breakfast, but we have a practice whereby a salesperson who made a mistake and sold a product at too low a price brings a cake the next day, so that there’s something to start the day with the morning coffee. People are the most important thing to me, and I’m pleased that everyone brings his friends and family. This improves the quality of work.”

 

Night-shift employees are responsible for preparing the next day’s orders and loading the trucks for a 4 AM departure.

 

Heading overseas

Shiloh still remembers how, just over 20 years ago, he would stand at the door of an apartment that served as a small warehouse on Rothschild Boulevard in Tel Aviv, and sell metal accessories to a small clientele. Since then, Scope Metal has grown and become a leading metal trading company in Israel. The domestic market has become too small for the company, and nine years ago, the decision was taken to head overseas. The decision was implemented in two stages: exports from warehouses in Israel, followed by the establishment of trading branches in target markets.

 

Scope Metal now exports metals from its Israeli warehouse to nearby target markets, such as Egypt, Jordan, Cyprus, Turkey, as well as to countries in Eastern Europe, such as Romania, Russia and Ukraine. Export activity was subsequently expanded to Asia, especially China and India.

 

“Usually, transport charges are only a negligible addition to the cost of metal,” explains Shiloh. “In most cases, we realized that that export markets gave us flexibility because they can absorb goods we bought but could not sell in Israel.”

 

The second stage of Scope Metal’s international expansion includes copying the company’s successful business model in other countries. This activity includes maintaining warehouses and trading rooms in target countries based on the strategy of large inventory and providing high-quality service. Shiloh nevertheless makes it clear that international activity will not include the full range of products found in Israel, but will focus on niches where it is worthwhile for the company to do business.

 

Scope Metal’s international business model includes the setting up of local branches run by local sales staff and managed by an Israeli. The first foreign branch was set up in New Jersey, and the company set up another in the Czech Republic in early 2005. The Czech branch currently has a staff of 30 and services customers in that country as well as in Germany and Poland.

 

On the basis of the initial experience gained in the United States and Czech Republic, Scope Metal accelerated its international expansion. In early 2006, the company made its first large acquisition when it acquired a Florida metals trading company for $3 million plus $8 million for inventory. This company was bought from a local 88-year old Jewish man who decided to quit the business, although he still works for Scope Metal. The Florida branch has 130 employees and almost $30 million in annual turnover.

 

In 2006, Scope Metal established branches in Romania and China. “The Chinese branch is managed for us by a Hebrew-speaking Chinese engineer,” relates Shiloh. “He took care of the elderly in Israel for several years. We came across him just when he was looking for a new job.”

 

Exports and the branches’ activity are Scope Metal’s main growth engines. Whereas international activity accounted for just 10% of total sales five years ago, it accounted for 35% of sales in 2006. Shiloh’s next target is for international activity to reach half of total sales, even as the company continues to expand its domestic business. “We have many more opportunities and places for growth,” he says. “We have the know-how and the resources to do it. The challenge is to do it right and in a balanced way, and ensure that the growth is also profitable.”