China steel outlook: medium-term drivers of demand and margins  :: Macquarie Research,

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China steel outlook: medium-term
drivers of demand and margins
 A two-speed market has developed in China’s steel industry, with construction
steels enjoying solid margins, while flat products suffer at breakeven levels.
Here we look at the medium-term drivers of steel demand (Fig 1) compared to
our estimates of new capacity additions (Figs 23 and 24). We find that
demand for flat products should exceed new capacity additions over the next
2-3 years, leading to improved utilisation rates and margins.
Construction activity has been a major driver in 2011
 Construction growth has been stronger than anticipated in 2011, driven by
regular residential construction and a relative surge in commercial real estate
development.
 Some manufacturing sectors have been weaker this year, with autos and
some machinery sectors dropping to negative YoY growth. However, we are
still comfortable on the fundamentals and see manufacturing becoming a
bigger growth driver in 2012 and 2013.
A two-speed market has emerged – longs producers
making money, flats producers struggling
 Long product (construction steel) output rose by 88% between 2005 and 2010,
while capacity grew by just 46%. The result has been rising utilisation levels –
hitting 100% in 2011 and driving significant margin expansion for the long
product producers (see Figs 19 and 21).
 For flat products, the story is quite different: output rose by 129% over the
same period, while capacity grew by 144%. This has driven down utilisation
rates and put pressure on margins (see Figs 20 and 22 ).
Outlook positive for flats for the next two years – capacity
additions are slowing
 We see incremental demand for flat products outstripping new capacity
additions in both 2012 and 2013, allowing capacity utilisation rates to break
through 80%, compared to 73% at present. This should allow for improving
margins at flat product producers (see Fig 24 ).
 For longs, we also see demand outstripping new capacity additions out to
2013, implying that China will either need to add more long product capacity
or start importing construction steels (in our view, the former is more likely).
China’s latest commodities output and trade data strongly
suggest destocking
 We summarize May trade and production data and create apparent
consumption estimates. The key data show weak apparent demand in 2011,
relative to growth in end-use indicators, pointing to a significant destocking
cycle in this year to-date in response to tighter credit conditions.