HSBC Steel Weekly
Signs of weakness in the Chinese iron ore market
Chinese HRC and iron ore prices continue to decline
Narrowing spread between 58% and 62% Fe-content iron
ores is a sign of cost-cutting by Chinese steel mills
Unusually, some recent Vale cargoes have sold below index
pricing, possibly a sign of distressed cargoes reaching China
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Chinese steel and iron ore prices still falling
Chinese prices of both HRC and spot iron ore continue to decline, reflecting concerns of
over-production of Chinese steel and weakening demand into the slower summer months.
China’s RRR cut on 12 May failed to buoy the market; in fact it was widely interpreted as
confirmation the economy is slowing.
Confidence in the market is waning. Steel producers are reluctant to cut production for
fear of losing market share, and yet demand is weak. Chinese steel traders cut HRC prices
by another RMB100/t this week in an effort to shift inventories.
Narrowing spreads between grades
We note that the spread between the price for 62% Fe-content iron ore and the lowergrade
58% Fe-content material has declined sharply over the past few weeks. It reached
an all-time low of just 5.5% on May 9, with 62% material trading at USD141.3/t CFR
China and 58% material trading at USD133.9/t, and has since rebounded to 6.9%.
In fact, the spread has been declining since mid-2010. The average price premium of 62%
material over 58% material was 26% in 2010, 15% in 2011 and just 9% so far this year.
Since iron ore prices were effectively ‘floated’ in April 2010 – one factor behind the destruction of
Chinese steel making margins – steel makers have sought to reduce costs by using a greater proportion of
lower-grade iron ore. Demand for lower-grade ores has strengthened relative to demand for higher-grade
ores, resulting in a narrowing of the ‘grades spread’.
The Steel Index’s 58% Fe-content iron ore index includes material with 55-60% Fe-content, with a
maximum of 8% silica and 5% alumina, regardless of origin. It includes, for instance, most mid-grade
Australian iron ores such as BHP’s Yandi fines (57.5% Fe-content, 5.5-6.0% silica). What the indices do
not show is that most Indian iron ore supplied into China this year has been 50-55% Fe-content material.
This is too poor a quality to be included in the iron ore price indices – but not too poor to be used by
many Chinese steel makers.
It is worth noting that the Platts indices for differing ore grades actually show the opposite trend; the
Platts 62%/58% premium has risen from 12% in early February to 14% now. One reason for this is the
Platts index excludes much of the mid-grade Australian ores because of a silica content cut-off of 5% but
does include Indian ore from producers such as Sesa Goa and Fomento, who sell less than 55% Fecontent
material. Australian ores tend to attract a premium to Indian mid-grade material. As a result, the
Steel Index indices tend to narrow more than the Platts indices when times are tough.
Vale trades seen below index spot prices
Another sign that demand is weak is that since late April, a number of shipments of Vale iron ore have
been sold at (adjusted) prices that are below the 62% Fe-content index. This is unusual because Vale’s
iron ore enjoys both a quality and, in China, brand premium and usually trades above the index price.
Adjusting the Vale prices for the differing silica and alumina contents shows that a typical Vale cargo
may attract a premium to the index of roughly USD2/t. Yet some recent trades have been priced at USD2-
4/t below the index price.
There are a couple of possible explanations. First, some recent cargoes have been of <64% Fe-content
material; the standard specification for Vale’s Standard Sinter Feed Tubarao (SSFT) fines is 65%.
Second, we may be seeing some distressed European cargoes coming into China. Typically for trades to
be included in the iron ore price indices, they have to fall within the 2-8 week ‘forward delivery window’.
For trades that are priced less than 2 weeks before delivery there is the concern the seller was ‘panic
selling’ at prices not representative of the market. This rarely happens with Australian cargoes because
they are usually sold prior to loading, but the long shipping time between Brazil and China means that
Brazilian cargoes are often sold en route.
According to Platts, Vale has sold at least 12 cargoes on spot market terms so far this month. According
to Steel Business Briefing, Platts rejected one cargo of 104,000 tonnes of 63.9% FE-content SSFT fines,
traded on 9 May, precisely because the forward delivery window was too short. Another cargo being
shipped now – 167,854 tonnes of 61.1% Sinter Feed High Silica Guaiba – is expected to reach China on
23 May, and will also miss the forward delivery window.
It’s hard to be too bullish, at least in the short term
We view the recent price data, the narrowing ‘grades spread’, the fact that China is sourcing lower-grade
material from India and the advent of potentially distressed cargoes as good evidence of a weakening
market. We have been encouraged by the spot iron ore market over the past couple of months holding
above cash-cost support around USD120-130/t, suggesting that early indications of very poor steel output
in China were wrong. But with the summer lull about to begin, things are unlikely to improve over the
next couple of months and this cost support level may be freshly tested.
Results
ThyssenKrupp (TKAG.DE, N(V)) reported Q2 FY12 on 15 May, with underlying numbers beating
expectations. Adjusted EBIT (which is normally the number focussed on by the market) was EUR134m
(+61% qoq, -69% yoy), clearly beating Reuters consensus adj EBIT estimate of EUR99m. Marine systems was
notably strong whereas Steel Americas did cut losses by only EUR60m instead of the previously guided
EUR100m. Most other divisions came in as expected. The major problem was on the EPS level with a reported
EPS of -EUR0.59 from continuing operations (down from +EUR0.51 a year ago) and -EUR1.14 all in
(including -EUR0.55 fair value adjustments on divestments with the major portion coming from the lower
Outokumpu share price) versus a consensus of -EPS0.10. TKA reported tiny operating cash flow from
continuing operations of EUR150m leading to a negative FCF of EUR268m and an increase of net financial
debt to EUR6.48bn (excluding pension liabilities of EUR7.4bn) and yielding a gearing of 73% and 156%
including pensions. Management guided for only a mid three digit million adjusted EBIT for FY-12. At H1,
Thyssen has generated EUR217m so the guidance might be prudent but bearing in mind that a normal quarter
should add EUR300-400m, the message seems to be for a few more difficult quarters ahead, despite the solid
order intake of EUR11.6bn (+15% qoq, +2% yoy)
Evraz (EVR LN, N(V)) reported weak Q1 FY12 results on 15 May, implying downside risk to
consensus expectations. As Evraz reports its financial statements on a semi-annual basis, its quarterly
financial reports are limited to the disclosure of just several headline numbers. Evraz’s Q1FY12 revenue
was reported to be in line with Q1FY11 revenue (which was USD3.9bn), while the Q1FY12 financial
performance reported to be "broadly in line with the Q4FY11 performance". We interpret this as
EBITDA margin in Q1FY12 being at the level of Q4FY11, or 13%, which implies Q1FY12 EBITDA of
USD507m (vs USD497m in Q4FY11). Based on the reported timing of production cuts and the size of
production capacity, we have calculated implied potential reduction in crude steel production volumes at
up to 10% q-o-q. The planned repair works in Q2FY12 could lead to a loss of approximately 200kt of
crude steel production at BF5 at Evraz NTMK mill and BF3 at ZSMK mill (c6% of Evraz’s crude steel
production of 3.2mt in Russia in Q1FY12). On top of that, cuts will also include a temporary shutdown of
860ktpa EAF, which could lead to a total loss of approximately 400kt of crude steel in Q2FY12
(approximately 9% of Evraz’s crude steel production of 4.3mt in Q1FY12). The temporary shut downs
will also affect ZSMK rail mill, which will be shut starting from April for 5 months for an upgrade of
capacity from 720ktpa to 950ktpa (incl. 450ktpa of high speed 100m rails) and a related shut down of a
continuous caster, which is scheduled for expansion from 725ktpa to 1mtpa.
JSW Steel (JSTL IN, N(V)) reported 4QFY12 results on 14 May: JSTL reported standalone EBITDA
of INR16.5bn (+32% q-o-q/ 2% y-o-y), 5% ahead of Bloomberg consensus and in line with HSBCe of
INR16.6bn. NPAT at INR6.1bn was 5% below consensus due to higher than expected interest expenses.
Results were good on a consolidated basis, with EBITDA of INR18.9bn (consensus INR15.9bn)
following better than expected earnings at the US operations which reported EBITDA + other income of
USD42.6m as plate/pipe utilizations rose to 44%/16%. This however includes an insurance claim settled
during the quarter, the quantum of which was not disclosed by management, but which was hinted as a
significant part of reported EBITDA. Outlook: In the event that the Category A mines take time to start or
Category B mines (both in Karnataka) do net get approved, utilization levels for JSTL could fall
drastically post July 2012. For now, visibility is only until July with c 5mt (HSBCe) of iron ore available
for JSTL until July, which equates to a max of 3.2mt of steel production.
CSN (CSNA3.BZ, UW) reported disappointing Q1 2012 results: CSN reported revenue of BRL3.9bn
(-7% q-o-q) below consensus estimate of BRL4.1bn and HSBC estimate of BRL4.3bn due to low iron ore
volumes and lower steel prices. Steel volumes of 1.3mt (79% sold domestically) were 3% higher than our
estimates but offset by lower-than-expected net revenue per ton (BRL1,806/t, -4% q-o-q) due to worsethan-
expected product mix and more volumes exported. Iron ore volumes of 6.7mt (100% basis) were less
than our 7.1mt forecasts, but can predominantly be explained by the poor weather in Q1 FY12. EBITDA
of BRL1.1bn (-24% q-o-q) was below consensus estimate of BRL1.4bn and HSBC estimate of
BRL1.4bn. The shortfall was predominantly in the iron ore division, with reported EBITDA BRL590m
(49% margin) well short of our BRL856m estimate due to lower volumes and higher-than-expected costs,
which could also be attributed to the poor weather. EPS of BRL0.08 was well below consensus estimate
of BRL0.36 and HSBC estimate of BRL0.32. Worse-than-expected financial results loss of BRL628m
versus our expectation of a loss of BRL537m, predominantly due to an increased debt level, combined
with lower-than-expected EBITDA contributed to a poor net income.
Macro News
Asia
China: More stimulus needed - PBoC cut RRR by 50bp: Barely a day after the release of April’s
disappointing data, the PBoC announced its second 50bp RRR cut this year, effective 18 May. This was a
well expected and much-needed move, signalling that Beijing is ramping up easing efforts to control
downside risks to growth. Additional easing measures will be critical for stabilizing China’s growth.
Thankfully, the downtrend in inflation allows Beijing to do so. HSBC economists expect more aggressive
delivery of policy stimulus via quantitative easing, substantial tax breaks, fiscal spending and investment
deregulation in the coming months to ensure a soft landing.
EMEA
Eurozone Q1 2012 GDP - recession avoided but few signs of re-balancing: The eurozone economy
narrowly avoided recession, with GDP flat in Q1 2012, following a 0.3% q-o-q contraction in Q4 2011.
This was better than consensus expectations of a 0.2% q-o-q contraction. The country breakdown showed
that Germany continues to power on while other countries, especially in the periphery, moved further into
recession. Spain fell back into recession (-0.3% q-o-q) while other economies witnessed another quarter
of negative growth such as Italy (-0.8% q-o-q), Portugal (-0.1% q-o-q) and the Netherlands (-0.2%
q-o-q). Available data also shows limited signs of re-balancing within the eurozone, with Germany still
very dependent on export growth for its strong Q1 performance.
Germany: ZEW expectations hurt by political worries - ZEW expectations took a leg down in May
but stayed in positive territory. The ongoing political uncertainties in the eurozone seem to have left their
mark. Meanwhile, the ZEW current conditions managed to rise. Overall, the ZEW survey signals that the
economy is likely to keep on growing but maintaining the growth dynamics of Q1 (+0.5% q-o-q) over the
course of the whole year is unlikely.
Germany: Strong start to 2012 - German GDP surprised heavily to the upside in Q1 2012, rising by
0.5% q-o-q compared to consensus expectation of a small increase of 0.1%. This expansion has not only
meant that a recession has been avoided but also that a solid basis has been laid for overall growth in
2012. Overall, indicators in Germany point to a continuation of growth over the coming quarters, but it is
unlikely that pace will stay as strong as in Q1. In particular, headwinds from the eurozone seem to have
intensified according to the latest PMI figures.
Americas
US retail Sales, Empire Manufacturing, CPI: Recent US data releases were mixed, but overall they
corroborate our economists’ impression that GDP is moving gradually along a 1.5% to 2.0% growth path.
April retail sales rose 0.1% m-o-m versus consensus of +0.1% rise, partly reflecting lower sales at
gasoline stations and building material stores. Sales excluding autos, gasoline, and building materials rose
0.4% m-o- m. The May Empire manufacturing index rose to 17.1 versus consensus of 9.0 from 6.6 in
April. Finally, the April headline CPI was unchanged in m-o-m terms, taking the y-o-y rate down to 2.3%
from 2.7%. The core CPI rose 0.2% m-o-m, keeping the y-o-y rate at 2.3%.
US Industrial Production: Utilities output recovers after warm winter - Industrial output climbed
1.1% m-o-m in April, nearly double the consensus estimate of +0.6%. The increase was led by strong
gains in utilities and autos output. The rise in utilities has limited implications, as it simply reflects anormalization in activity after unusually warm weather this past winter. The rise in auto production is a
welcome sign, but further improvement may be slower if auto sales trend sideways for the rest of this
year, which we think is likely. Manufacturing production excluding vehicles rose 0.3% m-o-m in April.
This indicates moderate ongoing growth but does not suggest any acceleration.
Industry-Specific News
Asia
Chinese steel prices decline further amid bearish sentiment: Chinese domestic steel prices declined
further by RMB100/t w-o-w, a fourth consecutive monthly decline, to RMB 4130-4170/t amid bearish
sentiment. We note that Chinese steel inventories had been running high and now with signs of poor
demand, the inventory situation is not expected to improve meaningfully. But production rates continued
at a high rate putting further pressure on inventories and prices – so we think China domestic steel prices
do not have an upside in the short term.
BIS norms to come in force from September 2012: The Economic Times reported that the
implementation of the Bureau of Indian Standards (BIS) in the long products category is likely to
commence in September 2012. These standards specify quality requirements specifically in the chemistry
of steel being produced and could, by means of higher costs, lead to the closure of some of the smaller
induction furnace based producers which cumulatively account for c30% of Indian steel capacity. The
move could also lend some push to long product prices which although significantly higher y-o-y due to
raw material issues, have seen a sharp downtrend (2% in less than a month vs. flattish flat product prices)
due to weak demand conditions and the seasonal dip as India heads into the monsoon seasons.
EMEA
European steel prices expectations remain bearish and prices fall: North European domestic HRC
prices continued to grind down, falling EUR3/t w-o-w to EUR525-535/t while sentiment deteriorated
further leaving bearishness at its highest since October 2011. We note that the premium versus China
export prices continues to contract (now below USD30/t), partly due to the depreciation of the EUR
against the USD. We continue to see a weak demand environment in Europe, which has been confirmed
by European steel companies in their outlook for Q2. However, we also think that inventory is much
better controlled in the system than it was a year ago. Steel prices are close to marginal costs, we also do
not expect to see much downside unless raw material prices fall sharply.
ThyssenKrupp (TKAG.DE, N(V)):Management to investigate strategic options in all directions for
both the US and the Brazil plants – Management indicated during a post-result conference call that it
might use a partnership with or a sale to a buyer whose strategy can better utilize the quality and the
specific market capability and competitiveness of these plants. The move had been mentioned in the press
and we think it is actually a negative sign as management seems to have lost confidence in being able to
make Steel Americas work. The assets are on the books at EUR6.5bn and we would doubt that all of that
would be realizable in a sale. For Thyssen, equity is EUR8.9bn and a EUR2bn impairment would be felt,
given the a group has a gearing of 152%. On the positive side, selling these assets would enable the group
to free itself of the significant portion of the EUR6.3bn financial debt (another EUR7.2bn are pensions),
cut the losses for FY-13 (we expect Steel Americas to have a negative EBIT of cEUR400m) and narrow
the conglomerate discount that is currently above 30%.
ThyssenKrupp (TKA.GR, N(V)) Stainless: Proposed Outokumpu merger to be taken up by EU
commission on 21 May – The European Commission’s anti-competitive authority will review the merger
on 21 May. It may extend that by 10 to 35 working days from filing, to consider either a company’s
proposed remedies or an EU member state request to handle the case. Most mergers usually win approval
but occasionally the Commission opens a detailed second-stage investigation for up to 90 additional
working days, which it may extend to 105 working days. ThyssenKrupp already stated that it might be by
the end of the calendar year before they would have all approvals.
Voestalpine (VOE AV, OW(V)) has raised USD514m in loans: Voestalpine has raised USD514m
(EUR400m) in Schuldschein loans, promissory notes issued privately under German law, in fixed and
variable interest tranches due in three, five and seven years. European steelmakers have been using the
liquidity window provided by the ECB to European banks to raise relatively cheap funding.
Mechel (MTL US, OW(V), USD6.4, TP USD15.8) unveiled new strategy. Mechel’s new strategy puts
financial deleverage and asset disposal at the forefront, aside from completing ongoing projects such as
Elga and Universal rolling mill. Management is allowing two-three months to complete the strategic
review of assets post which a decision regarding divesting unprofitable assets would be made.
Management is also considering the possible consolidation of Estar (a zero operating margin business
with USD1bn of debt, bearing zero interest) despite challenging market conditions. Complete details of
the new strategy can be accesses in our recent note Mechel Oao (MTL US), OW(V): New strategy – asset
review and deleverage, dated 11 May 2012.
Raspadskaya (RASP RM, OW(V), USD2.4, TP USD6.10) board recommended not paying H2FY11
dividends. Raspadskaya said in a regulatory filing that its board has recommended not paying any
dividend for the second half of 2011, as reported by Bloomberg on 15 May.
Americas
North American steel prices continue to slide amid bearish price expectations – The North American
domestic steel prices continued its weekly decline and decreased by USD14/t w-o-w to USD720-730/t while
price expectations remained ultra bearish for the week. We note that the premium over China export prices
continued to contract, now standing at USD75/t. This is already well below the import trigger threshold level of
USD100/t which should ease import pressure on prices for the coming months. Demand expectations, which
had been in optimistic zone, started to deteriorate w-o-w suggesting that underlying demand environment
remains uncertain. We think import pressure on steel prices has already gone but high domestic production rate
along with contracted imports (arriving now) could be putting pressure now.
North American rig count remains stable: According to data from Baker Hughes, North American rig
count remained largely stable. The US rig count increased by 9 w-o-w to 1,974. Rigs employed in oil
production increased by 17 w-o-w, while rigs geared for natural gas production declined by 8 w-o-w.
Canada’s rig count declined by 11 w-o-w to 120.
US crude steel capacity utilisation again above the 80% mark: According to the American Iron and
Steel Institute, for the week ending 12 May, US crude steel production increased 2.1% w-o-w to 2.0m s.t.
The utilisation rate at 81.1% increased from 79.4% the week prior, rising above the 80% mark again.
US flat steel lead times inched up: For the week ending 13 May, US HRC lead times increased to 3.8
weeks (from 3.3 the week prior) while CRC lead times increased to 6.5 weeks from 6.0 the week prior.
However, HDG lead times decreased slightly from the week prior.
US imports licenses increased in April: According to the US Department of Commerce, licenses for
import for April were 2.93mt, up from imports of 2.78mt of steel products in March. This increase was
primarily led by Korea, Russia, China, India and the United Kingdom. However, licenses to import from
Japan and Mexico decreased. Imports continue to remain high but should come down in coming months
as prices have decreased and US HRC price premium over China is close to USD100/t.
Raw materials
Iron ore prices decline sharply: 62% Fe iron ore prices (China CFR) declined sharply by USD5 w-o-w
to USD136/t reflecting steel demand sentiments in China, the biggest consumer of sea borne iron ore.
Prime coking coal prices remained stable for the week at USD208/t.
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