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UBS Investment Research
Asia Steel Insights
Rising costs drives up steel prices
Coking coal price up sharply; Iron ore price firm
Coking coal price rose sharply to US$310/t as near 40% of global seaborne coal
supply are disrupted and timing of Australian mines resuming operation is
unknown. If it stops raining, coal prices could adjust but we note Australia is to
enter cyclone season soon. Iron ore prices were also firm last week. If current price
prevails, steel making cost could rise by US$74/t QoQ for 2Q11 contracts
Steel prices on the rise; Expect a strong 1H
China HRC price rose to US$591 (excl 17% VAT) vs. US$549 on 1Dec. Baosteel
raised Feb prices by US$15/t, while SAIL hiked Jan price by 3% and JSW by 4-
5%. We expect steel prices to be strong in 1H driven by restocking, seasonality and
input cost. But unlike 08, it may be difficult to pass on cost given lower global
utilization (91% vs. current 75%). Still, rising steel price is positive for stock
Key issues to watch
POSCO and SAIL will start off the earnings season on 13Jan. Results are expected
to be mixed and we see POSCO, JSW, NSC and JFE disappointing, while
Baosteel, HSC, Tata Steel, Sanyo Special Steel and CSC should come in line or
above consensus estimates. We expect CSC to announce 3-8% increase in Mar
steel pricing on 13Jan.
Selective IN and CH plays better positioned than KR, TW and JP
We view India and China best positioned to weather out rising input cost due to
domestic coal supply, followed by Korea, Taiwan then Japan. Our most preferred
picks are Tata Steel, Baosteel, HSC and Sanyo Special Steel. Our least preferred
stocks are CSC, Wuhan and Sumitomo Metal Industries.
India
What happened and what it means:
We believe impact of Australia's flood is less for India and China given
domestic coal supply. SAIL receives 30% of its coal need from domestic
sources while Tata India source 50% of its annual needs (Tata Europe however
is not vertically integrated). However, JSW has to import 100% of its needs,
mostly from Australia.
According to Reuters, Tata Steel (TISC.BO, Buy, TP Rs710) is not averse to
Rio Tinto's interest in Riversdale (US$3.9bn). Tata Steel has 24% stake in
Riversdale. We view this interest of global majors in Riversdale to be positive
for Tata Steel.
SAIL increased January steel prices by 3% due to increased rising raw material
costs. JSW also raised price by 4-5% across products.
What to look out for:
SAIL is to announce Q3 results on 13 January. We expect Tata Steel 3Q results
to be strong, likely above our estimates and will be announced on 15 January.
We think JSW though will likely miss and will be announced on 20 January.
Our stock call:
Our top pick remains Tata Steel (TISC.BO, Buy, TP Rs710).
China
What happened and what it means:
Baosteel (600019.SS, Buy, TP Rmb10.6) announced Rmb100/t (US$15/t) price
hike for most products for February delivery. Benchmark HRC rose
2%MoM/13%YoY to Rmb4,792/t (US$753). The company also issued a
positive profit alert today with 2010 EPS up 123%YoY to Rmb0.73, in line with
UBSe of Rmb0.74. ROE recovery is more encouraging: 2010 ROE rose to 13%
(in line with UBSe), up from 6% in 2009. Significantly beats industry average
and also above its mid-cycle ROE of 12%. Baosteel will announce full results on
30 March.
While the Australia flood makes coking coal headlines ex China, it is less a
concern to China as China is more self-sufficient than Japan and Korea. Some
mills we talk to are only mildly concerned about the indirect impact, ie, a higher
regional price could attract China export, thus probably lifts domestic price.
Domestic traders see iron ore spot price to touch $200 in H1, as spot CFR
already climbed to $178/t last week, up from $160 in early Nov and $170 in
early Dec.
China’s steel (semi & finished) exports declined by 2%MoM/15%YoY to
2.85mt in December, among the lowest level in 2010. Meanwhile, steel imports
came in at 1.48mt (+1%MoM/-6%YoY). For 12M10, steel exports rose
73%YoY to 42.7mt while import down 23%YoY to 17.1mt, netting out 25.6mt
exports, 10 times of 2009’s.
Iron ore imports up slightly to 58.1mt (+1%MoM/-7%YoY) in December, the
second highest volume in 2010 at an average price of US$146. China’s total ore
imports actually contracted by 1.4%YoY to 618.6mt in 2010, while total value
increased by 58.4%YoY to $79.4bn. This has pushed average price $128 in
2010, up from $80 in 2009. But according to SBB, steel traders state that
overseas buying activity, especially for hot rolled coil and coated products, has
increased significantly since the beginning of January. Foreign traders have been
buying with the aim of avoiding a future increase in export prices.
What to look out for:
We see a tactical opportunity emerging, after analyzing Chinese New Year
(CNY) effect on trader’s inventory change. We believe China’s to enter a
restocking cycle in mid-February as this Spring Festival falls on Feb.3.
Historically, China banks lend out 38% of full-year quota in Q1 (2006-10 avg)
providing ample liquidities. In addition, improving manufacturing and
construction activities in March over January and February, drives up traders
restocking. We see little reason why 2011 should be an exception. Risk though
is government's stricter-than-expected tightening measures to tame inflation.
Our stock call:
Buy companies either with ability to pass through rising costs (Baosteel) or high
exposure to upstream raw materials (CMR). Our least preferred stock is Wuhan
given increased competition. We believe vertically integrated stock such as
Angang could also perform well near term given rising costs.
Japan
What happened and what it means
Japan’s steel supply-demand situation is not particularly good. Orders for
construction-use products are recovering, but levels are low. Government
support measures meant that demand was high for automobile and home
appliance products through H1 FY10, but a decline is now taking place on the
non-recurrence of such demand. Capacity utilisation surpasses 90%, though this
is being buoyed by exports. Steel product prices were lifted for major customers
alongside higher raw material prices, but only 80% or so of the cost push has
been absorbed. Earnings in export industries are sluggish due to the strong yen
and dollar-denominated prices for domestic steel products are high relative to
international prices. Export prices and domestic spot market prices decreased in
October-December 2010.
We note though that in November 2010 inventories fell as exports expanded and
the steelmakers cut production, and as a result supply-demand gradually
improved. An incident at blast furnace facilities operated by Sumitomo Metal
Industries led to a decline in supply from that company and December data is
also likely to reflect improvement.
What to look out for:
Given their reliance on the seaborne coking coal market, Asian blast furnace
steelmakers are likely to be negatively impacted by the flooding in Australia, but
considering the ability to pass on costs to product prices we believe Japan’s blast
furnace companies are likely to be most disadvantage. First, the strength of the
yen presents a large obstacle to raising steel product prices. In order to secure
profit, the export price for HRC would need to be lifted from the current level of
about $650/tonne to $750-$800/tonne. We forecast that market prices can rise to
this level, but if supply-demand for raw materials eases there is a risk that steel
product prices could also soften. Second, earnings in such export industries as
automobiles and shipbuilding are lacklustre due to yen appreciation and even if
price hikes are accepted a time lag is likely to arise. Finally, if prices for
construction-use steel products are raised when the yen is strong, there is a risk
it could lead to an inflow of cheaper imports. We believe the advance in raw
material prices may prove temporary, but we note the risk that margins could
deteriorate in April-June 2011.
Korea
What happened and what it means:
POSCO (005490.KS, Buy, TP Won650,000) announced in end December to
leave 1Q11 domestic steel price unchanged QoQ with listed HRC price at
Won900,000/t (cUS$800/t). We believe actual prices are closer to US$730-750/t.
We had expected 1Q11 steel price to fall as lower priced 4Q10 raw material
contracts will be used in 1Q11 due to inventory effect. But the rise in spot steel
and raw material prices has allowed POSCO to keep 1Q11 steel prices flat. We
expect this to be positive for profits in 1Q11. Key risk is for POSCO to have to
buy high priced spot coking coal if Australia coal supply disruption continues as
POSCO is 60% reliant on Australian coal.
Hyundai Steel (004020.KS, Buy, TP Won150,000) announced it would begin
construction of its #3 blast furnace (4mt) in 1H11 and complete by end 2013.
This will raise Hyundai Steel (HSC) blast furnace (BF) capacity from 8mt to
12mt, and total steel making capacity from 18mt to 22mt. HSC expects cost to
reach US$3bn or US$750/t which is below the industry breakeven US$1,000/t
mark. We believe HSC will add a 2mt HRC, a plate mill and semi product line
to utilize the new crude steel capacity from #3 BF. We believe #3 BF to be
negative for HSC and the sector as we believe majority of the product will be
sold in the open market rather than to captive group customers. Separately,
commercial production of #2 BF has started from January, and HSC has stated it
is running at near full utilization rate. #2 BF will be used to produce high end
auto sheets.
Korean steel mills are not vertically integrated and imports all its coal needs
from overseas. POSCO has the highest exposure to Australian mines at 60%
followed by HSC at 40%. Dongkuk Steel has the least impact as it does not need
coking coal, but rather uses slab and scrap to produce steel products. Currently,
both POSCO and HSC states that they hold sufficient inventory at around
1.5months. But we believe mills would need to tap the spot market if the
disruption in Australia is prolonged.
Property market is improving with property prices up in January YTD. Property
prices have been on the uptrend since August 2010. Construction companies
expect housing starts to pick up from 2Q2011, with more accommodative
government policies to stimulate the market.
What to look out for:
We expect POSCO 4Q10 results to disappoint given weak steel pricing and high
cost in 4Q. Q4 result is to be announced 13 January after market close. In
addition, press reports indicate POSCO to be interested in buying Korea Express
(000120.KS), the largest logistics company in Korea, which we think could cost
around Won1.7-2.0tn at 50-80% premium to current price. We believe these
issues could lead to short term share price weakness which could create an
attractive buying opportunity given rising steel pricing.
India Environment Minister to decide whether to approve POSCO's Orissa steel
mill construction. The Minister is expected to announce his decision in end
January, although we believe further delay possible. The Expert Appraisal
Committee (EAC) within the Ministry had provided the environmental clearance
to POSCO's project on 4January.
Our stock call:
We prefer Hyundai Steel (HSC) the most given strong auto demand and
recovering construction activities in 2011 should allow HSC to pass on cost
better than its peers. In addition, operation of #2 BF should allow HSC to enjoy
sharp increase in EPS in 2011.
Taiwan
What happened and what it means:
The sentiment of property market is getting stronger post the municipal election.
In November, total housing transaction reached the highest in 2010. Year to date,
total construction permits issued showed 66%yoy increase in terms of floor area.
For the week starting Jan 10, Feng Hsin (2015.TW) kept scrap, rebar, and
section prices flattish. Previously, Feng Hsin had hiked prices for 5 consecutive
weeks.
According to SBB, Formosa Plastic Group has delayed start up of the first blast
furnace (BF) in Vietnam from March 2013 to August 2014 due to prolonged
land clearing by Vietnamese government. The BF capacity is expected to be
3.85-4.24mtpa, and is the first of three phases. Timing of the remaining two
phases are not yet schedule.
What to look out for:
We expect China Steel (2002.TW, Neutral, TP NT$33) to announce 3-8%
increase in March domestic steel price given rising cost and lower steel price vs.
its peers. China Steel (CSC) listed HRC price is at US$630/t compared to
Baosteel's US$753/t (February price) and POSCO's US$800/t (1Q11 listed
price). CSC is to announce its March pricing on 13 January.
Our stock call:
We affirm Neutral on CSC given high exposure to Australian mines at 72% and
fair valuations. However, we believe potential increase in March steel prices and
subsequent prices in 1H could provide upside risk to share price.
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