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UBS Investment Research
Asian Steel
Impact of coal supply disruption
„ Coal supply disrupted due to heavy rains in Queensland
Queensland contributed 210Mtpa of the total 950Mtpa global seaborne coal trade
in 2010. Queensland supplies 57% of global coking coal and 10% of global
thermal coal. Heavy rains and flooding in Queensland have led to major coal
producers declaring force majeure, disrupting c40% of global coal supply and
pushing up coal pricing.
„ Impact of coal supply disruption
We view: 1) the coal supply disruption to be temporary as it is due to heavy but
seasonal rains, similar to 2008. Still, it will likely push up spot coal prices in Q1
and contract prices in Q2; 2) major steel mills’ output to be largely unaffected as
the supply disruption is likely temporary and mills hold one to two months of
inventory; and 3) steel prices as likely to rise in H1 as coal cost push is across the
board.
„ Asian steel mills: who wins and who doesn’t
We believe mills with higher captive coal ex Australia and lower Australian coal
dependency are the winners. We believe India to be best positioned given captive
mines (SAIL, Tata), followed by China as most of the coal is domestically sourced.
We believe Japan, Korea, and Taiwan to be least favourably positioned given
import dependency, especially from Australia.
Our long-term top picks remain Baosteel, Hyundai Steel, Sanyo Special Steel, and
Tata Steel. However, we believe vertically integrated mills such as SAIL and
Angang could perform better short term given the rising raw material price
environment.
Coal supply disrupted due to heavy rains in
Queensland
Due to wet weather/flooding, the largest producers in Queensland have in the
past month declared force majeure. This is significant for coking coal supply as
Queensland contributed 210Mtpa of total 950Mtpa global seaborne coal trade in
2010. That is, Queensland supplies 50% of global coking coal and 10% of
global thermal coal.
Glyn Lawcock, Head of the UBS Australian Mining and Energy Team, states
that it is difficult to quantify the impact of the flood or when operations will
normalise. However, he opines that some mines, dependent on the weather, will
return to normal by early February. Please refer to Glyn Lawcock's ‘Australian
Coal Sector: Flood impacts too early to quantify’ dated 4 January 2011 for more
details.
Impact of coal supply disruption
We view the impact to coal supply disruption to be the following:
Q Higher coal price in H1. Coal supply disruption is likely to be temporary as
it is due to heavy but seasonal rains, similar to 2008. Still, it will likely push
up spot coal prices in Q1 and contract prices in Q2
Q Little steel production disruption expected. Major steel mills’ steel output
will be largely unaffected as the supply disruption is likely temporary and
mills hold one to two months of raw material inventory. However, if the
supply disruption lasts longer than a month, we think there could be a
negative impact on steel production.
Q Higher steel prices given cost push. Steel prices are likely to rise in H111
as coal cost push affects steel mills across the board. This is what happened
in early 2008 when heavy floods in Australia led to coal supply disruption
and a subsequent rise in coal and steel prices.
Can steel mills pass on the cost? It is dependent on the steel market environment
but we believe the cost can be passed on in H1 given firm demand and inventory
restocking. Furthermore, mills’ earnings are far more leveraged to the steel price
than raw material costs, which helps in passing on the cost. Our sensitivity
analysis in Table 1 suggests that a 1% rise in the coking coal price lowers EPS
by 2.2%, but a 1% increase in the steel price raises EPS by 12.6%.
Asian steel mills—who wins and who doesn’t
We believe winners are mills with the following:
Q High captive coal supply ex Australia as the mills would benefit from rising
coal prices.
Q Lower Australian coal dependency as mills would have less supply
disruption and hence, less need to source from the spot market.
We believe India is best positioned followed by China. We believe Japan, Korea
and Taiwan are least favourably positioned.
Q India best positioned but be selective. Indian steel mills are mainly
dependent on imported iron ore, and imports are largely from Australia.
However, among the listed mills, SAIL (30%) and Tata Steel (50% for Tata
India and 20% on blended basis) have captive coal mines, which should
shield them from a disruption in seaborne coal supply. JSW is worst
positioned in that aspect, in our view, as it has no captive coal mine and
mostly imports coal from Australia.
Q China next best positioned as China is largely self sufficient in coking coal
supply. Unlike India, none of the major Chinese steel mills have captive
mines. However, as they source coal domestically, Chinese mills have little
direct impact from Australia's production disruption. Rather, Chinese mills
will be indirectly impacted from rising spot prices as mills contract coal on a
monthly basis. However, this impact is mitigated as Chinese mills price steel
on a monthly basis and hence, are well positioned to pass on the cost.
Q Korea, Japan and Taiwan least favourable. Korea, Japan and Taiwan fully
import coking coal, with 40-70% sourced from Australia. Within Korea,
Japan and Taiwan, we view Hyundai Steel as better positioned as its
exposure to Australian coal is the lowest, followed by POSCO, and then
Japan. We view Japanese mills as weaker positioned than Korean mills due
to higher costs and difficulties in passing on the raw material cost hike. We
view CSC as worst positioned due to the high exposure to Australian coal
suppl
Top picks: Baosteel, Hyundai Steel, Sanyo
Special Steel and Tata Steel
Our long-term top picks remain Baosteel, Hyundai Steel, Sanyo Special Steel,
and Tata Steel. However, we believe vertically integrated mills such as SAIL
and Angang could perform better short term given a rising raw material price
environment (
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