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DBS Asian Insights

DBS Group Research July 2016

Oversupply in the
Global Steel Sector
Challenges and Opportunities

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Oversupply in the
Global Steel Sector
Challenges and Opportunities
Eun Young Lee
Equity Analyst
DBS Group Research
eunyoung@dbs.com

Addison Dai
Equity Analyst
DBS Vickers Securities
(Hong Kong)
addison_dai@hk.dbsvickers.com

Produced by:
Asian Insights Office DBS Group Research
go.dbs.com/research
@dbsinsights
asianinsights@dbs.com
Chien Yen Goh
Jean Chua
Geraldine Tan
Martin Tacchi

Editor-in-Chief
Managing Editor
Editor
Art Director

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05
09
24
30
34
38

Executive Summary

Macro Outlook

Challenges and Opportunities

Outlook for Steel Sector

Supply and Demand

Price Forecasts for Steel and Raw Materials

Efficiency and Cost Analysis of Chinese Steel Mills

World Steel Trade Flows

Trade Conflicts on the Rise

Sifting Out Winners in Steel Sector

Growing M&A Deals Post-Depression

Risks Abound in Current Landscape

High Mortality Rate for Major Steel Companies

Bumpy Road Ahead for Chinas Steel Sector Reforms

Pain of Rising Interest Rates

Findings From DBS Steel Survey

Appendix

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Executive Summary
Macro Outlook
Demand outlook: Demand is stagnant. Since 1950, crude steel production has been
growing 3.4% annually from 188 million tons to 1.62 billion tons in 2015. The sector
experienced strong growth from 1950 to 1975; stagnancy from 1975 to 2000; and
astronomical expansion led by strong demand growth in China from 2000 to 2014. We
expect the global steel industry to enter a stagnant demand growth stage for the next
10-15 years. The rationale driving this outlook: i) Chinese steel demand and production
might have already reached their peaks and are likely to stabilise or decline in the coming
years; ii) there wont be any economies to buffer the slowdown in China; and iii) major
steel-consuming industries are also facing overcapacity issues or are expected to see lower
growth. In the near term, the World Steel Association (WSA) expects that global finished
steel consumption in 2016 is likely to reach 1.49 billion tons, a fall of 0.8% from 2015,
on top of last years 3% drop from 2014. The key reason for the bearish forecast is the
4% contraction in Chinese consumption.
Supply outlook: Oversupply to persist despite restructuring efforts. Excess capacity in the
global steel industry has increased significantly since the financial crisis. Despite slowing
demand growth in the global market, there continue to be new investment projects in
many parts of the world, especially China. According to the Organisation for Economic
Co-operation and Development (OECD), the worlds steel-making capacity reached 2.32
billion tons in 2014, more than double the 1.06 billion ton capacity recorded in 2000.
Furthermore, global steel-making capacity is expected to climb another 100 million tons
to 2.42 billion tons in 2017, factoring in projects that are already underway. China and
India, in particular, have the most aggressive expansion plans of 28 million tons and 31
million tons of new installations, respectively, accounting for 59% of the total increase.
Steel mills will try to retain their production in the oversupply phase, as long as selling
prices are above the cash cost, as this could reduce the fixed cost by increasing production
especially since the recent steel price hikes have prompted steel mills to restart their
facilities. Hence, we project global production volume to be stagnant in 2016 and 2017,
with the oversupplied volume to remain at 15 million tons. Following the addition of
new capacity, the global utilisation ratio is expected to decline up to 66% in 2017. The
exacerbation of global steel imbalances and declining utilisation continue to pose risks to
the industry for the foreseeable future, unless more concerted efforts are made by the
industry and governments to address the challenges.

We expect the global steel industry to enter a stagnant

demand growth stage for the next 10-15 years

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Price outlook: Rangebound prices following weak raw material prices and overcapacity.
Dampened by oversupply, hot-rolled coil (HRC) benchmark prices for exports and domestic
Chinese HRC prices have declined, on average, 32% and 29%, respectively, in 2015
compared to the previous year. The key reason for weak prices are Chinas cheap exports,
which have increased 2.6-fold in the last five years, with a whopping 50.4% and 19.8%
growth in 2014 and 2015, respectively. Chinas exports stood at 112.4 million tons in
2015, which was slightly lower than US steel consumption of 121 million tons. Also, weak
iron ore and coking coal prices are another key reason for steel price weakness of note,
both sectors suffered from overcapacity on weak demand attributable to Chinese steel
productions decline. Despite the sluggish demand for raw materials, the major mines are
reluctant to cut their production volumes as they aim to increase market share, leading
to industry restructuring by competitors who are falling behind in the race. In 2016, we
expect HRC benchmark prices to drop another 3.3% in view of the continuing global
oversupply, which is mainly due to Chinese exports and weak iron ore prices in 2016 (a
12.5% on-year decline is expected). We expect steel prices to edge up following global
steel demand growth, with more tangible restructuring measures from China in 2017.
However the improvement is likely to be limited, as the excess capacity should hamper
any sustainable price hikes.

Challenges and Opportunities

Trade conflicts. Steel exports, mainly from China, and steel trade conflict cases have
increased significantly the world over. The US has filed 14 anti-dumping and countervailing
duties cases the largest number of lawsuits from a single country. The European Union
(EU) has filed 13 lawsuits against imported steel products and Asia has 22 cases of trade
conflicts, with ASEAN countries and India filing the most number of such cases. At the
same time, emerging countries that have relatively high World Trade Organisation (WTO)bound rates have raised tariffs for steel imports.
Obstacles to Chinas sector restructuring. Facing overcapacity, Chinas government
plans to cut excess steel capacity by 45 million tons this year and 150 million tons by
2020 endorsed by the central governments supply-side reforms. Earlier in 2016, the
Ministry of Finance released a special subsidy fund amounting to 47 billion Chinese
yuan to spur the capacity curtailment of the steel and coal industries. However, local
governments are inclined to keep steel mills in operation, given their strong value-added
tax (VAT) contributions (17% charged on revenue). Government subsidies for 24 listed
companies surged 80% to 6.3 billion yuan or 24 yuan per ton on average. We deem local
governments vested interests as the key challenge for steel capacity shutdown.
Interest rate hikes and currency depreciation. The probability of further interest-rate
hikes in the US has fuelled concerns over a rising interest-rate environment for the global
economy. This would lead to emerging-currency weakness, including the yuan against

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the US dollar. A rising interest-rate environment should also increase the financial burden
for steel mills in emerging countries by raising interest cost and increasing the repayment
amount for US dollar-denominated debt. While exports from China will benefit from
weak currencies in terms of price competitiveness, this will be offset by the higher cost of
raw material imports and trade protectionism. Of note, 79% of iron ore requirements in
China were imported from Australia and Brazil in 2015. Also, the growing protectionism
in export markets will dampen the export price advantage arising from the yuans
depreciation.
Last standing mills. We have ranked major global steel companies based on their financial
information, reputation and information available in the steel market. The most respectable
steel companies in the world are characterised by high economies of scale, exposure to
growing markets and downstream industries, pricing power and less competition in their
home markets, value-added products that harness tech innovations, cost competitiveness
and profitability. US-based Nucor is the top ranking, followed by South Koreas POSCO and
Japans Nippon Steel. Even though it is not a perfectly objective observation, companies
with high rankings have been registering more stable earnings than peers. The average
shipment of the top 36 companies was 19 million tons and the size of a steel mill was a
sufficient, but not a necessary, condition. The analysis suggests that Chinese steel companies
need to improve their qualitative competiveness rather than quantitative growth. Chinese
companies accounted for 24% of the top 50 makers in terms of size, but made up only
14% of the top 36 world-class steelmakers in 2015.
Mergers and acquisitions (M&As) from restructuring to growth strategy. Before
1990, M&As among steel companies were engineered to increase scale amidst a growing
need to restructure domestic steel industries. In 1990, Europe and the US became the
starting point for full-scale M&As, peaking in 2006 to 2007 on the back of Mittals merger
with Arcelor and Tatas takeover of Corus. M&A deals tend to increase in business up-cycles
with an accompanying uptrend in metal prices. This is obvious given M&A engagements
are more affordable to undertake using equity and the valuation for deals would be
higher during up-cycles. In 2015, the number and value of deals in the steel sector hit 321
cases and US$11.4 billion, representing declines of 4% and 32%, respectively. Due to the
current down-cycle and companies cash burn rate, deals in 2016 will remain close to the
levels seen in 2015. However, we expect some companies to divest assets that are not
contributing to their enterprise value or to raise cash to avoid financial disruption. Also,
there is a move away from the vertical integration pursued during good times.
The down-cycle has provided an opportunity for companies to review and redefine their
core business. The reorganisation of the business could follow divestments and M&As.
We expect the deal market to turn around in 2017, with 2015 and 2016 marking the
trough. Steel sector deals contributed 29% and 45% of total metal sector deals, based on
the deal values in 2014 and 2015, respectively. Geographically, metal sector transactions

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in the Asia Pacific region, including steel, have grown continuously since the 2000s,
contributing 68% of total metal deals in 2012 with a deal value of US$68 billion. This
declined to US$5 billion in 2015, accounting for 46% of global metal deals.
Potential growth of overseas investment by Chinese mills. China has stepped up
overseas investments of late, in a bid to make potential inroads into new markets to cope with
rising global trade protectionism and in line with the governments One Belt, One Road
initiative. Small-scale plants are already operating in Vietnam, Malaysia, Indonesia, etc., mainly
targeting long steel products consumed in the construction sector. These targeted areas have
huge potential for demand growth, in light of the low self-sufficient steel production levels
in ASEAN countries. The investment preference is skewed toward joint ventures rather than
sole ventures. Chinese steel companies have announced a number of plans so far, but due
to the current stagnation of the global steel industry and the deterioration in their financial
condition, the investment process is expected to face delays.

China has stepped up overseas investments to cope

with rising global trade protectionism and in line with the
governments One Belt, One Road initiative

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Outlook for Steel Sector

In 2015, global crude steel output slipped 2.8% on-year to 1.62 billion tons, which implies
a 68.5% utilisation ratio based on the 2.44 billion tons of global capacity measured by the
OECD. The global finished steel apparent consumption was 1.50 billion tons, a decline of
2.6% compared to the previous year. Of the total crude steel production volume, 74% is
produced by blast oxygen furnace (BOF) and the other 26% by electric arc furnace (EAF). Flat
and long products accounted for 46% and 52% of total steel products in 2014 respectively,
with casting and forged products and semi-finished products, such as ingots, slabs and
billets, accounting for the remainder.
Construction is the largest steel consuming sector. Long steel products such as railway,
sections, rebars, and beams are consumed by the construction sector, which accounts for
50% of global steel consumption. Flat products are used in the transport (16% contribution),
machinery (14% contribution) and other manufacturing industries.
Weaker bargaining power of steel sector compared to upstream. For iron ore, the
production volume of the top four miners (Vale, Rio Tinto, BHP Billiton, and Fortescue)
accounted for 53% of global production volume in 2015. China is the biggest supplier
and consumer for metallurgical coal but the BHP Billiton Mitsubishi Alliance had 49%
market share for seaborne coal in 2014. The top ten steel players share of global steel
production was only 27% in 2015, which suggests the steel market is fragmented and close
to perfect competition. Although the global overcapacity of iron ore and coal has weakened
key players bargaining power in pricing, the steel sector has been the weak against the
upstream. (Refer to Appendix A for global steel sector value chain.)
In China, crude steel output declined 2.1% on-year to 804 million tons in 2015 following
robust output growth in the past decade. Chinese crude steel production registered a
12% compound annual growth rate (CAGR) from 2004-2014, with crude steel capacity
utilisation hitting 73% in 2015 versus 77% the year before. Long steel and flat steel products
accounted for around 50% of finished steel output in 2015. Around 94% of Chinas crude
steel output is produced by BOF and 6% by EAF. The country produced 246 million tons of
iron concentrates in 2015, implying its crude steel output was 21% fed by domestic ore and
79% fed by imported ore. Chinas 2015 coking coal output decreased 14% on-year to 483
million tons, implying the countrys self-sufficiency ratio for coking coal was around 90%.
(Refer to Appendix B for China steel sector value chain.)

The steel market is fragmented and close

to perfect competition

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Supply and Demand

Global Steel Sector Growth
Since 1950, crude steel production has been growing 3.4% annually from 188 million tons to
1.62 billion tons in 2015. (There is no data for steel demand for long time horizons; we think that
production is the other side of demand). We have divided the last 65 years into three periods:
i) The first strong growth stage from 1950 to 1975, when global production grew
5% annually, driven by Europe, the former USSR and Japans economic growth.
Japans contribution to global steel output, in particular, increased from 2% in
1950 to 11% in 1975.
ii) The stagnant period from 1975 to 2000 when global steel demand inched up 1.1%
annually. Despite the strong growth in rising Asian economies such as Korea (11%
annual growth rate), Taiwan (10.4%), Malaysia (8.9%) and China (6.5%), stagnant
demand growth in Japan (0.6%) and demand decline in the former USSR (down
4.9%) after the end of the Cold War hindered the sectors growth.
iii) The 2000 to 2015 period, when robust Chinese economic growth led to strong steel
demand growth which, in turn, fuelled annual steel output growth of 13% and a
super cycle for all commodities.
Diagram 1: Global crude steel production

Source: WSA, OECD, Platts, Bloomberg Finance L.P, DBS Bank

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Long-term outlook: Entering low growth stage. We expect the global steel industry
to enter the stagnant growth stage for the next 10-15 years. This outlook is driven by the
following rationale: i) Chinese steel demand and production might have already reached
their peaks and are likely to stabilise or decline in the coming years; ii) there wont be
any economies to buffer the negative growth of China; and iii) the major steel consuming
industries are also facing overcapacity issues or are expected to decelerate in terms of
growth. Global steel intensity (the amount of steel used to produce one unit of GDP) is
likely to decline, as Chinas steel intensity decline is expected to continue as its economy
undergoes structural change. After three decades of extraordinary economic development,
China is now shifting to a lower, but likely more sustainable, growth path.
The first stage of the curve during an emerging economys rapid growth is the most steel
consumption intensive, driven largely by high levels of government investment that boosts
construction and infrastructure demand in many rapid growth markets. In general, the steel
intensity curve stabilises or starts to decline at around US$15,000-20,000 GDP per capita, as a
country becomes more developed and urbanisation rates begin to decelerate. While Chinas GDP
per capita hasnt reached the level of US$15,000, Chinas steel consumption per capita is located
at a much higher level than other economies at the same stage of economic development.
Diagram 2: Chinas steel consumption and intensity to GDP

Source: WSA, OECD, Platts, Bloomberg Finance L.P, DBS Bank

We expect the global steel industry to enter the

stagnant growth stage for the next 10-15 years

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Near-term outlook: Revising down forecasts. The WSA has cut its forecast for 2016
global steel consumption to a 0.8% on-year drop from 0.7%. Finished steel consumption
this year is likely to reach 1.49 billion metric tons, a fall of 0.8% from 2015, on top of last
years 3% drop from 2014. The key reason for the bearish forecast is the 4% contraction
in Chinese consumption. Nonetheless, global steel consumption ex-China is expected
to register 1.8% growth, backed by 1.7% growth in developed economies, and 1.8%
growth in the emerging and developing countries excluding China.
The WSA forecasts that global steel demand will edge up by 0.4% to 1,494 million tons
in 2017, as global consumption ex-China will grow 3%, mainly driven by Europe, North
American Free Trade Agreement countries and the Middle East and North Africa (MENA).
MENAs demand growth, in particular, is expected to accelerate to 4.8% in 2017 from
3.2% in 2016. However, the WSA expects Chinas steel demand to decline further by 3%
in 2017.
Among the top ten biggest steel-consuming countries, India has been registering the
strongest demand growth since 2015. The country is expected to register 5.4% annual
demand growth from 2016 to 2017. We believe that the steel demand outlook for India
is promising, as the country is now at the stage of high steel demand elasticity to GDP and
is constructing national infrastructure on a massive scale.
Diagram 3: Global steel demand forecasts
million tons

y-o-y growth rates, %

Regions

2014

2015

2016
(f)

2017
(f)

2014

2015

2016
(f)

2017
(f)

European Union (28)

149

153

155

158

5.0

2.8

1.4

1.7

Other Europe

37

40

41

43

0.1

8.1

3.0

3.1

CIS

56

50

46

48

-4.6

-10.8

-7.4

4.5

NAFTA

147

135

139

142

11.4

-8.4

3.2

2.5

Central and South America

49

45

43

44

-4.7

-7.3

-6.2

3.3

Africa

37

39

41

43

3.6

4.3

3.8

6.4

Middle East

54

53

54

56

4.5

-1.0

2.5

3.9

Asia and Oceania

1,018

985

969

959

-0.9

-3.3

-1.7

-1.0

World

1,546

1,500

1,488

1,494

0.7

-3.0

-0.8

0.4

416

399

406

410

6.4

-4.0

1.7

1.1

1,132

1,101

1,082

1,083

-1.2

-2.7

-1.8

0.1

China

711

672

645

626

-3.3

-5.4

-4.0

-3.0

MENA

73

72

74

78

5.7

-0.6

3.2

4.8

Em. and Dev. Economies excl. China

420

429

436

457

2.6

2.0

1.8

4.8

World excl. China

836

828

842

868

4.5

-1.0

1.8

3.0

Developed Economies
Emerging and Developing Economies

Source: WSA,DBS Bank

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Diagram 4: Top ten steel-consuming countries

million tons

y-o-y growth rates, %

2014

2015

2016
(f)

2017
(f)

2014

2015

2016
(f)

2017
(f)

China

710.7

672.3

645.4

626.1

-3.3

-5.4

-4.0

-3.0

United States

107.0

95.7

98.8

101.5

11.8

-10.6

3.2

2.7

India

76.1

79.5

83.8

88.3

3.1

4.5

5.4

5.4

Japan

67.6

62.9

64.4

63.6

3.7

-7.0

2.4

-1.2

South Korea

55.5

56.0

56.3

56.4

7.3

0.9

0.5

0.2

Russia

43.0

39.4

35.9

37.4

-0.7

-8.4

-8.9

4.2

Germany

39.6

39.0

40.5

39.9

3.7

-1.5

3.8

-1.5

Turkey

30.8

34.4

35.5

36.7

-1.8

11.7

3.2

3.4

Brazil

22.9

24.2

25.0

26.2

-8.6

5.8

3.3

4.8

Mexico

25.6

21.3

19.4

20.1

11.7

-16.7

-8.9

3.6

Source: WSA,DBS Bank

Global Capacity Development and Supply

Excess capacity in the global steel industry has increased significantly since the global
financial crisis. Despite slowing demand growth in the global market, there continue to
be new investment projects in many parts of the world, especially China. According to
the OECD, the worlds steelmaking capacity reached 2.32 billion tons in 2014, which is
more than twice the 1.06 billion ton capacity level in 2000. With continuing investment
in projects, global steelmaking capacity is expected to climb a further 100 million tons
to 2.42 billion tons in 2017. This projection has only factored in the projects already
underway and global capacity will reach up to 2.72 billion tons when planned projects are
constructed. The global steel demand slowdown will aggravate the global steel imbalance
between demand and capacity in the near future.
China and India to lead capacity growth. Despite the fact that OECD countries are
planning to reduce or retain their capacity, non-OECD countries are expected to increase
their capacity by 71% in 2017 compared to 2014 especially as China and India have the
most aggressive new installation plans of 28 million tons and 31 million tons, respectively.
This accounts for 59% of the total increase, while other Asian and Middle Eastern countries
are constructing 13 million ton and 18 million ton capacities by 2017, respectively.

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Diagram 5: Global steelmaking capacity forecasts

Source: WSA, OECD, DBS Bank

Diagram 6: Global steelmaking capacity expansion plan

2014
(m ton)

2017

2017

Underway

Planned

Low

High

OECD
Europe

281

281

285

NAFTA

160

10

161

172

Asia

217

-1

216

217

Japan

131

-1

130

130

Korea

86

87

88

Sub total

670

21

669

690

CIS
Latin America

147
68

4
5

10
17

151
73

160
90

Africa

34

15

36

51

Non-OECD
Europe

58

18

34

76

110

1,338

72

256

1,409

1,666

China

1,140

28

13

1,168

1,181

India

108

31

207

139

346

Other Asia

90

13

36

103

139

Sub total

1,652

100

331

1,753

2,084

World total

2,322

100

352

2,422

Middle East
Asia

2,774
Source: WSA, OECD, DBS Bank

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Oversupply and low utilisation ratio to persist. Steel mills will try to retain their
production cost in the oversupply phase, as long as selling prices are above cash prices, as
they could reduce fixed costs by increasing production especially as the steel price hikes
in March and April prompted steel mills to restart their facilities. Hence, we project global
production volume to be stagnant in 2016 to 2017, with the oversupplied volume to remain
at 15 million tons. Following the addition of new capacity, the global utilisation ratio is
expected to decline to 66% in 2017. The exacerbation of global steel imbalances and lower
utilisation will continue to pose risks to the industry in the foreseeable future, unless more
concerted efforts are made by the industry and government to address the challenges.
Diagram 7: Global steel demand and supply outlook

Source: WSA, OECD, Platts, Bloomberg Finance L.P, DBS Bank

Diagram 8: Global steel production and utilisation ratio

Source: WSA, OECD, Platts, Bloomberg Finance L.P, DBS Bank

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China supply and demand outlook: Chinas 2015 steel product consumption dropped
4.8% on-year to 668 million tons, mainly dragged down by weakened investment in the
housing sector. The property and infrastructure segments account for an aggregate 60%
of the countrys total steel consumption. The machinery and auto segments contribute
18% and 9% of steel consumption respectively.
In our view, Chinese steel product consumption peaked in 2014 at 702 million tons. We
anticipate steel product consumption to be range-bound between 642 and 674 million
tons in 2016 to 2020. Correspondingly, we believe Chinas crude steel output peaked in
2014 at 813 million tons. We expect crude steel output to be range-bound between 765
and 796 million tons in 2016 to 2020, indicating a capacity utilisation of 74-78%.
Diagram 9: China crude steel capacity and utilisation forecasts till 2020
2008

2009

2010

2011

2012

2013

2014

2015

2016F 2017F 2018F 2019F 2020F

Capacity (mt)

634

670

740

910

990

1,040

1,055

1,100

1,080

1,064

1,038

1,008

978

Capacity
Utilisation
rate (%)
Crude steel
output (mt)
Finished steel
(mt)
Import (mt)

79%

85%

85%

75%

72%

74%

77%

73%

74%

74%

75%

77%

78%

498

568

627

684

709

775

813

804

796

788

780

773

765

579

689

799

878

955

1,067

1,117

1,123

1,115

1,098

1,085

1,072

1,060

15

18

16

16

14

14

14

13

13

13

13

13

13

Export (mt)

59

25

43

49

56

62

94

113

95

92

91

90

89

Net export
(mt)
Apparent
consumption
(mt)

44

26

34

42

48

79

100

82

79

78

77

76

535

682

773

844

913

1,019

1,037

1,023

1,032

1,019

1,007

995

984

2.1%

14.1%

10.3%

9.2%

3.6%

9.2%

5.0%

-2.1%

-1.0%

-1.0%

-1.0%

-1.0%

-1.0%

3.4%

19.1%

15.9%

9.9%

8.8%

11.7%

4.7%

0.6%

-0.8%

-1.5%

-1.2%

-1.2%

-1.1%

-3.9%

-84.0% 272.7%

29.2%

24.9%

14.4%

64.6%

26.0%

-17.9%

-3.5%

-1.6%

-1.3%

-1.3%

4.0%

27.5%

9.2%

8.1%

11.6%

1.8%

-1.3%

0.9%

-1.3%

-1.2%

-1.2%

-1.1%

Steel:

y-o-y growth:
Crude steel
production
Finished steel
production
Net exports
Apparent
consumption

13.3%

Source: China Metallurgical Industry Planning and Research Institute, Custeel, Mysteel, CEIC, DBS Vickers
Note: *Chinas statistics of steel-product has overlapping calculation of hot rolled coil and cold rolled coil steel
output given hot rolled coil is a feed product for cold rolled coil steel

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Price Forecasts for Steel and Raw Materials

Steel Prices
Benchmark Chinese HRC prices for exports and domestic sales declined 32% and
29%, respectively, in 2015 on average from the previous year. This was attributable to
oversupply and negative demand growth in China and a whopping 43% plunge in iron
ore prices. Chinas overcapacity has triggered the strong growth of exports in the region
and dragged down regional steel product prices as well.
In 2016, we expect HRC benchmark prices to drop another 3.7% in view of the continuing
global oversupply, which is mainly due to China exports; and weak iron ore prices (a
15.6% on-year decline is expected in 2016). However, we expect Chinese HRC export
prices to grow 4.7% on-year in 2016, narrowing the gap with benchmark prices on the
back of the recent strong domestic price rally.
Steel prices bottomed in January 2016 and registered strong growth in March. Chinas
domestic HRC prices increased 20% in March and rose further in April. However, a
number of factors have seen steel prices turn downward since the beginning of May
the restocking process for middlemen and clients has ended; supply has increased with
the restarting of idled plants in China and Commonwealth of Independent States (CIS)
countries; and demand fundamentals are not likely to improve this year. We expect steel
prices to remain volatile in the near-term before stabilising in the second half of 2016.

We expect steel
prices to edge
up in 2017

We expect steel prices to edge up in 2017 following global steel demand growth on the
back of more tangible restructuring measures from China. However, the improvements
are likely to be limited, as excess capacity should hamper any sustainable price hikes.

Raw Material Prices

Iron prices rallied in March and April, backed by improved market psychology even as
more mills restarted their idled capacity, especially in China. However, after reaching a
peak of US$70 a ton (China import iron ore fines 62% Fe, CFR Tianjin port), iron ore
prices fell below US$50 a ton on June 20. We expect iron ore prices to decline further in
2016 but edge up in 2017.
The sizable new capacities planned at the peak have been started operations recently
or will commence operations soon. Major producers added around 80 million tons in
production to the market in 2015 and will add more than 90 million metric tons new
capacity in 2016. Vales mammoth 90 million ton per annum S11D Carajas project will
start up in the second half, pushing the companys capacity to more than 400 million
tons in 2016 and 459 million tons in 2019. Rio Tintos recent Pilbara expansion pushed

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output to record levels in the 2015 third quarter as it moved closer to 350 million tons
per annum capacity, with an eventual 360 million tons per annum targeted for 2017.
BHP Billiton will increase volumes by 7% this financial year in Western Australia Iron Ore,
as it works toward delivering annual production of 290 million tons, up from the current
output of 247 million tons. The 55 million ton per year Roy Hill joint venture in the Pilbara
has already come on stream.
Game of chicken bolstered by reduction in cash cost in the major mines. Cash cost
reductions have been dramatic at the majors, mainly through automation and increased
production scale. Rio Tinto reduced its cash cost to US$15.2 per ton in the second half of 2015,
down from US$16.20 a ton in the first half of 2015 and US$20.40 a ton in 2014. Brazils Vale
says significant cost cutting in the 2015 third quarter made it the lowest-cost company in the
sector, reaching an unprecedented US$12.7 per ton for iron ore, down from US$15.8 per ton
in the 2015 second quarter and US$22.5 per ton in the 2014 third quarter. According to BHP
Billitons CEO, its unit cost had dropped to around US$15 per ton in the 2015 fourth quarter.
Fortescue Metals Group, which has reached its capacity target of 165 million tons per annum,
reduced cash costs from US$34.9 per wet metric ton in early-2014 to US$16.9 in the second
half of 2015. The cost reduction was also driven by the drop in energy prices and depreciation
Diagram 10: Price forecasts
(US$/ton)

Iron ore

Coking Coal

Steel Prices

China import Iron

Ore Fines 62%
Fe spot

Hard coking coal

MB benchmark HRC
prices

China Export
Rebar FOB Main
China Port

2012

128

209

598

599

2013

135

151

566

524

2014

97

126

544

453

2015

56

103

370

321

2016F

49

95

358

337

2017F

57

100

370

350

2012

(23.4)

(27.6)

(15.1)

(13.7)

2013

5.3

(27.9)

(5.3)

(12.5)

2014

(28.4)

(16.7)

(4.0)

(13.4)

2015

(42.5)

(18.0)

(32.0)

(29.1)

2016F

(12.5)

(7.7)

(3.3)

4.7

2017F

15.9

5.3

3.5

4.0

% Chg y-o-y

Source: Platts, Bloomberg Finance L.P, DBS Bank

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of currencies. The strengthened cost competitiveness in the major mines forces higher cost
mines to leave the market. Sizable capacity has already exited the market and more mines are
expected to close this year. Half of the closed mines were in China and other half in the rest of
the world.

Efficiency and Cost Analysis of Chinese Steel Mills

We think the variation in competitiveness across Chinese steel mills lies in cost efficiency
arising from geographic location and finance expenses. Our study of 24 A- and H-share
listed companies shows that steel mills in East China and Northern China Hebei provinces
outperformed the industry in terms of steel business gross profit margin, overhead cost and
finance expenses. The steel mills in Southwest China underperformed on all three metrics.
Relatively speaking, East China possesses the advantages of solid management concepts as
well as convenience in shipments of raw materials and finished steel products as coastal
provinces have long-term commitments to learn from foreign manufacturing enterprises and
easy access to ports. As Chinas top-producing province, North China Hebei has a relatively
good marketing network. In contrast, the steel mills in Southwest China are inefficient mainly
because of inconvenient logistics due to the need to transport raw materials from coastal
regions to inland Southwest steel mills and transport finished steel products from inland
Southwest steel mills to coastal end-users.
Diagram 11: Comparison of gross profit margin, overhead cost, and finance expenses across H- and A-share
listed steel companies in 2015
Region/province

Company name

Business nature

GP margin (%)

SG&A of sales
revenue (%)

Finance expenses of
sales revenue (%)

Baotou Steel

Local SOE

-15.0%

5.8%

3.6%

Hebei Iron & Steel

Local SOE

13.1%

6.3%

6.1%

Xinxing Ductile
Iron Pipes Co.
Shougang

Central SOE

4.5%

3.6%

1.9%

Local SOE

1.0%

7.4%

2.6%

Taigang Stainless
Steel

Local SOE

4.5%

5.4%

2.4%

1.6%

5.7%

3.3%

North China:
Inner Mongolia
Hebei

Shanxi
Average North
Northeast China:
Liaoning

Average
Northeast

Lingyuan Iron &

Steel
Bengang Steel

Local SOE

3.0%

5.6%

3.2%

Local SOE

-2.1%

5.7%

3.6%

Angang Steel

Central SOE

5.8%

7.8%

2.6%

2.2%

6.4%

3.1%

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East China:
Jiangsu

Fujian
Shanghai
Shandong

Shagang

Private-owned

4.0%

4.0%

-0.1%

Nanjing Iron &

Steel
Sansteel
MinGuang
Baosteel

Private-owned

2.5%

6.8%

3.2%

Local SOE

-4.7%

1.9%

1.7%

Central SOE

8.6%

5.8%

1.5%

Shandong Iron
& Steel

Local SOE

2.1%

4.4%

3.0%

2.5%

4.6%

1.9%

Average East
South/Central:
Guangdong

SGIS Songshan

Central SOE

-12.6%

3.3%

6.6%

Guangxi

Liuzhou
Iron&Steel
Hunan Valin
Steel
Wuhan Iron &
Steel
AnYang Iron &
Steel
Xinyu Iron &
Steel
Maanshan Iron
& Steel

Local SOE

2.8%

4.3%

2.9%

Local SOE

2.5%

5.6%

6.7%

Central SOE

-1.9%

6.7%

4.2%

Local SOE

1.0%

4.8%

4.6%

Local SOE

3.1%

3.2%

1.8%

Local SOE

-1.3%

4.8%

1.8%

-0.9%

4.7%

4.1%

Central SOE

9.3%

15.3%

9.9%

Local SOE

-25.9%

18.1%

15.1%

-8.3%

16.7%

12.5%

Local SOE

-0.8%

8.9%

3.0%

Local SOE

-10.0%

7.8%

4.3%

-5.4%

8.4%

3.6%

-1.4%

7.7%

4.8%

Hunan
Hubei
Henan
Jiangxi
Anhui
Average South
and Central
Southwest China:
Sichuan

Pangang Group
Vanadium Titanium
& Resources Co
Chongqing Iron
& Steel

Chongqing
Average
Southwest
Northwest China:
Gansu

Xinjiang
Average
Northwest
Average 24
listco

Gansu Jiu Steel

Group Hongxing
Iron & Steel
XinJiang Ba Yi Iron
& Steel

Source: Companies, DBS Vickers

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World Steel Trade Flows

The global steel trade volume has been growing 4.8% annually from 115 million tons in 1975
to 452 million tons in 2014, accounting for 29% of global steel production. In 2015, the
steel trade volume is estimated to have increased more than 4% despite the 2.8% decline
in steel production. The export-to-production ratio has fluctuated between 25% and 39%
for the last 30 years and came in at 29.1% in 2014. In terms of product, HRC is the major
trading product that contributed 18% of the total trading volume, followed by semi-finished
products (12%), steel tube and fittings products (9%), and cold rolled coil (CRC, 8%).
The analysis of the global steel trading flow can be summarised as follows:

The EU has been promoting intraregional trade for steel products, with intraregional
trade accounting for 76% of steel exports.

CIS countries are strong exporters to other regions, especially to the EU via exports of
53 million tons, or 75% of their total exports, in 2014.

The biggest export country is China with an export volume 93 million tons, followed
by Japan (41 million tons), and Korea (34 million tons). The biggest destination for
these three countries exports is the rest of Asia, mainly ASEAN.

International specialisation of China and Korea. Interestingly, Korea is the largest

export market for China and Japan as a single country despite being an active net exporter
of steel. We think this is mainly due to the countrys lower level of protectionism for
imported steel compared to other developed countries, and the fact that Korea imports
commercial grade steel products from China while exporting high-grade products to the
rest of the world including the US. This could be deemed an international specialisation.

Trade Conflicts on the Rise

Stellar growth of Chinas exports to increase trade conflicts. Chinas overcapacity
has led to strong growth in exports in the region. Chinas exports have increased 2.6-fold
in the last five years. Chinas 2015 steel-product exports surged 20% on-year to 113
million tons in 2015, following a 51% spike in steel product exports in 2014. Exports stood
at 113 million tons in 2015 which, was slightly lower than US steel consumption of 121
million tons. Of note, the US is the second-largest steel-consuming country in the world.
After taking into account imports by China, its net exports came in at 99.6 million tons
in 2015. Going forward, we expect Chinas implied net exports (capacity consumption)
to decline from the peak of 104 million tons in 2016, following the governments effort
to cut capacity. However, the absolute volume of overflow from China should pose a
significant burden on regional steel prices.

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Diagram 12: World steel trade flow

Exporting
Region

EU
(28)

Other
Europe

CIS

NAFTA

Other
America

Africa
and
Middle
East

EU(28)

101.3

5.1

13.6

0.4

0.9

1.1

6.2

0.3

1.9

2.8

0.0

133.6

32.3

Other
Europe
CIS

9.7

0.7

5.8

0.0

0.3

0.1

1.3

0.3

0.7

0.4

0.0

19.3

18.6

1.7

0.6

11.9

0.0

0.0

0.0

2.2

0.1

0.5

0.0

0.0

17.0

5.1

NAFTA

8.9

2.8

2.5

20.1

5.8

0.5

5.1

4.1

6.4

4.3

0.4

60.9

40.8

Other
America
Africa

1.5

1.4

2.5

1.9

2.6

0.1

8.8

1.2

0.1

2.2

0.0

22.3

19.7

8.1

2.8

5.7

0.2

0.1

1.7

6.7

1.1

0.4

1.2

0.0

28.0

26.3

9.2

1.8

2.0

2.7

0.0

29.2

29.1

6.2

5.0

2.0

0.0

15.0

15.0

4.3

0.7

0.0

6.7

6.7

2.2

0.0

33.4

33.4

Destination

China Japan Korea Other Oceania Total of which:

Asia
Imports
extraregional
imports*

Middle
East
China

1.8

5.7

5.5

0.2

0.2

0.1

1.5

0.0

0.1

0.1

0.1

0.0

Japan

0.1

0.0

0.0

0.0

0.0

0.0

1.6

Korea

0.8

0.3

1.9

1.8

0.0

0.4

14.8

11.2

Other
Asia
Oceania

2.9

0.1

3.5

0.4

1.2

0.7

36.4

14.7

12.5

9.5

0.2

82.1

72.6

0.2

0.0

0.0

0.0

0.0

0.1

0.7

0.3

0.0

2.6

0.3

4.2

3.9

Total
Exports
of which
: extra
regional
exports*

138.5

19.5

52.8

23.5

11.3

4.9

92.9

41.3

33.7

30.7

1.0

451.7

287.0

37.1

18.8

40.9

3.4

8.7

3.0

92.9

41.3

33.7

21.2

0.7

301.7

Net
Exports
(exportsimports)

4.7

0.1

35.7

-37.5

-11.1

-52.1

78.0

34.7

0.3

-42.0

-3.3
*Excluding intra regional
trade marked
Source: WSA, DBS Bank

In 2015, Southeast Asia (mainly Vietnam, the Philippines, Indonesia, and Thailand), Korea,
India, Singapore, and Japan accounted for 31%, 12%, 4%, 2.9%, and 1.2% of Chinas total
exports, respectively. Europe and the US accounted for 8.5% and 2.2% of Chinas total exports,
respectively. Exports hit a historical record high in 2015 due to cheap export prices. In 2015, we
estimate Chinas HRC CFR export price of US$355 per ton is US$50-70 per ton cheaper than
the Europe ex-work price and US$70 per ton lower than the US import price. About 12% of

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Diagram 13: Chinas net exports (top) and implied net exports (below)

Source: CEIC, DBS Bank

Following the
increase in steel
exports mainly
from China, steel
trade conflict
cases have surged
all over the world

exports from China went to Korea in 2015, representing around 20% of Koreas consumption.
Among ASEAN nations, Vietnam is the second largest export destination, accounting for 9%
of exports. This clearly shows that steel companies earnings have been dampened by the poor
profitability of cheap Chinese steel imports and the gloomy outlook bodes ill for any earnings
improvement.
Following the increase in steel exports mainly from China, steel trade conflict cases have surged
all over the world. The US has filed 14 cases for anti-dumping and countervailing duties, making
it the largest single-country complainant. The EU has also filed 13 lawsuits against imported
steel products and Asia has 22 cases of trade conflict cases, with ASEAN countries and India
filing the most number of such cases. Emerging countries that have relatively high WTO-bound
rates have raised tariffs for steel imports.

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Sifting Out Winners in Steel Sector

We have ranked the major global steel companies based on their financial information and
reputation and information available in the steel market. The purpose of this exercise is to
gain a better understanding of the steel companies attributes rather than to imply that
one company is better than another. However, the factors for evaluation could illustrate the
characteristics a respectable global steel company should have. We could summarise the
key characteristics as follows:

Economic scale in terms of size (10%)

Exposure to growing markets and downstream industries (10%)
Pricing power and less competition in the home market (12%)
Value-added products that harness tech innovations (10%)
Cost competitiveness and profitability (20%)
Managements capability in the areas of growth strategy (10%)
Financial soundness (10%)
Skilled labour and labour cost (10%)
Eco-friendly production process (8%)

Nucor, POSCO and Nippon Steel have high rankings. Nucor in the US has top ranking,
while South Koreas POSCO and Japans Nippon Steel also rank highly. Though it is not a
perfectly objective observation, the companies with high rankings have been registering
more stable earnings than peers. The average shipment of the top 36 companies is 19
million tons, and the size of a steel mill is a sufficient, but not necessary, condition.
Diagram 14: World-class steelmakers ranking (2015)

Source: WSA, OECD, Platts, Bloomberg Finance L.P, DBS Bank

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China steel
companies need
to improve
more on their
qualitative
aspects rather
than quantitative
factors

The comparison of the score distribution of the companies among the top 50 players in
terms of shipment volume and the top 36 world-class steelmakers suggests that Chinese
steel companies need to improve more on their qualitative aspects rather than quantitative
factors. Chinese steel companies accounted for 24% of the top 50 makers in terms of size,
while making up only 14% of the top 36 world-class steelmakers in 2015. In the case of
India, the country contributed only 3% of the global volume but its steel players made up
17% of the top world-class steelmakers in 2015. This is attributable to the strong growth
potential of the home market, cost advantages arising from competitive labour cost, and
availability of iron ore mines.

Diagram 15: World-class steelmakers ranking (2015)

Top 50 companies shipment volume

Top 36 companies for world-class steelmaker

# of companies

Share

# of companies

Share

Asia

32

32%

Asia

16

44%

China

24

Japan

24%

China

14%

2%

India

17%

India

3%

Japan

6%

Korea

2%

Korea

6%

EU

3%

EU

14%

Russia

4%

Russia

11%

USA

3%

Brazil

6%

Brazil

1%

USA

8%

Others

16%

Others

19%

Total

50

100%

Total

36

100%

Source: WSA, OECD, Platts, Bloomberg Finance L.P, DBS Bank

Before 1990, M&As among steel companies were engineered to increase the scale of steel
companies amid the growing need to restructure domestic steel industries. In the 1990s,
steelmakers in Western Europe carried out M&As to deal with the supply glut after breakup of
the Soviet Union. Riva Group was the first to spark full-scale M&As among large-scale European
steelmakers in 1995.
M&As a strategic option to reinforce competitiveness. The consolidation of European
steel companies from the end of the 1990s through 2000 began to transcend national borders.
A good case in point is the birth of Corus and Arcelor. They took into account the synergetic
effects from the expanded scale of downstream/upstream or duplicate operations, indicating
that M&A activities evolved into a corporate strategy, not a mere restructuring tactic.
Preemptive and voluntarily M&As in Japan. In the past, Japan experienced oversupply
pains for an extended period of time. In response, the countrys steel players established a

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cooperative custom of production cuts to support the sectors sustainability. The country
has seen voluntary mergers between steel companies to enhance competence levels. In
2001, JFE emerged as an integrated steel company with a 29 million ton capacity via the
merger of two companies, Kawasaki steel and NKK. In 2011, Nippon Steel announced
plans to merge with Sumitomo Metal Industries. With Nippon Steel producing 26.5 million
tons of steel per year and Sumitomo making 11 million tons, the merged entity would
produce close to 37 million tons of crude steel per year. In February 2016, it was reported
that Japans top steelmaker, Nippon Steel & Sumitomo Metal, plans to buy the worlds
fourth-biggest player Nisshin Steel. Nisshin Steel is considering closing a blast furnace at
its Kure Works in Hiroshima Prefecture as part of its consolidation.
M&As transcend geographical boundaries for integration with upstream
operations. Consolidation through M&As is now actively occurring in the global steel
industry as a corporate strategy rather than the restructuring tactic of the mid-2000s. In
our view, this stems from the free cash flow generated by the intrinsic qualities of the
steel industry, the oligopoly of supply/demand industries, and high raw material and steel
prices. This M&A trend sparked by Mittals acquisition of Arcelor continued with Tata
Steels M&A attempts vis--vis Corus.
Giants suffering from aggressive M&As. In December 2008, ArcelorMittal announced
several plant closings, including the Bethlehem Steel plant in Lackawanna, New York, and LTV
Steel in Hennepin, Illinois. Its headcount was scaled back from 57,000 to 30,000 employees.
In 2009, Corus (renamed Tata Europe in 2010) cut 1,000 jobs in the Netherlands and
2,500 in the UK due the economic downturn with the mothballing of several plants,
including the Teesside plant. By late-2014, Tata Group remained 13 billion in debt, a
figure which had increased following the acquisition of Corus in 2007. The sale of Tata
Groups long products division to Greybull Capital for a nominal 1 was agreed on April
11, 2016, with Greybull taking over the assets and liabilities of the division. At the end
of March 2016, the Tata board announced it would seek to sell all (or part) of its UK steel
business. Its UK steel operations had lost 68 million in the three months to February
2016, from a profit in the previous year.

Growing M&A Deals Post-Depression

The outlook for economic growth is very relevant to the metals sectors M&As, given the
cyclical nature of the sector and the way that it can be significantly affected by general
economic conditions. M&A deals tend to increase during up-cycles with an accompanying
uptrend in metal prices. This is obvious given that M&A engagements are more affordable
to undertake using equity and the valuation for deals would be higher during up-cycles.
Historically, the number of deals peaked at over 1,000 in 2008 versus around 200 per
annum in the early 1990s, according to Thomson Reuters.

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In 2015, the number and value of deals came in at 321 cases and US$11.4 billion, representing
declines of 4% and 32%, respectively. This was driven by increased downside risks following the
downward revision of global growth forecasts. At the current pricing levels, many companies
are facing cash burn. This could result in transactions at bargain prices or even capacity simply
evaporating from the market as plants shut down without any buyers. Hence, the value of deals
in 2016 will remain close to the level seen in 2015.
Demerger moves emerge amid the downturn. We expect some companies to divest assets
that are not contributing to their enterprise value or to raise cash to avoid financial disruption.
Also, there is a reversal of the vertical integration pursued during good times. In some cases,
depressed commodity prices are putting a strain on vertically integrated companies, which have
resource supply footprints that far exceed the capacity of their own production. In other cases,
as companies move toward greater specialisation, they are seeing value opportunities from
disintegration. Tatas divestment of its European business and POSCOs sale of POSCO Special
Steel to SeAH Besteel are the obvious examples. In the metal sector, Alcoa recently announced its
intention to split into an upstream business comprising bauxite, alumina, aluminium casting and
energy units as well as a downstream company specialised in metals and products. Completion
of the split is expected in the second half of 2016.
Expect a turnaround in M&A deals in 2017. The down-cycle has provided companies with
the opportunity to review and redefine their core business. The reorganisation of the business
could follow divestments and M&As. We expect the deal market to turn around in 2017, with
2015 and 2016 marking the trough. The deals in the steel sector contributed 29% and 45% of
total metal sector deals, based on the deal values in 2014 and 2015, respectively. Geographically,
metal sector transactions in the Asia Pacific region, including in steel, have grown continuously in
the 2000s, contributing 68% of total metal deals in 2012 via a deal value of US$68 billion. This
declined to US$5 billion in 2015, accounting for 46% of global metal deals. Of note, cross-border
deals peaked in 2006 to 2007, signified by Mittals M&A with Arcelor and Tatas takeover of Corus.
Diagram 16: Number of M&A deals (left) and value of M&A deals (right)

Source: PWC, Thomson Reuters, DBS Bank

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Diagram 17: Metal sector deals in Asia Pacific (left) and cross-border metal sector deals (right)

to global M&A deals

to global M&A deals

Source: PWC, Thomson Reuters, DBS Bank

Chinese Mills Venture Into ASEAN

The oversupply of steel in the Chinese market has compelled local steel players to venture
into overseas markets. Recently, China has been actively announcing overseas investment
plans to make potential inroads into new markets, in order to cope with rising global
trade protectionism and as part of the governments One Belt, One Road initiative.
Small-scale plants already operating in Vietnam, Malaysia, Indonesia, etc., are mainly
targeting long steel products consumed in the construction sector. The targeted areas
have huge potential for demand growth, in light of the low self-sufficient steel production
levels in ASEAN countries. The investment preference is skewed toward joint ventures
rather than sole ventures.
The Chinese steel companies have announced a number of plans so far, but due to the
current stagnation of the global steel industry and the deterioration in their financial
condition, the investment process is expected to face delays.

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Diagram 18: Chinese iron and steel companies overseas expansion

Operating and under construction

Expansion plan

Downstream Baoshan Iron & Steel Co. ()

process
Joint establishment of seamless steel pipe
mill in Thailand (12). *Capacity: 0.2 million
tons, operating since 2013
Anshan Iron & Steel Co. ()
Acquired a French-based company (14)
*Spent 13 million euros acquiring SAS VALDUNES
Panhua Group Co. ()
Color Factory under construction at the Subic
Bay, Philippines (15)
*Capacity: 0.5 million tons, Completion by
2016 first quarter
Steel mills

Kunming Iron & Steel Co. ()

Hebei Iron & Steel Co. ()

Joint establishment of steel mill in Vietnam

(14.9)

Joint establishement of steel mill in South

Africa

*Capacity: 0.5 million tons, Produce billet

*Capacity: 5 million tons (17.3, 19.2)

*Collaborate with VNC

Signed MOU with Zelezara Smedervo (15.11)

*Capacity: 2.2 million tons

Shougang Group Co. ()

Anshan Iron & Steel Co. ()

Joint establishment of steel mill in Malaysia

(15.2)

Planning of 5 million tons capacity steel mill

in Indonesia passed on (15.6)

*Capacity: 0.7 million tons (up to 3 million

tons), Produce slab
Nanjing Group Co. ()

Wuhan Iron & Steel Co. ()

Joint establishment of steel mill in Indonesia

under construction

5 million tons capacity steel mill in Indonesia

(14.3)

*1st phase 0.5 million tons (15), 2nd phase

0.5 million tons (17)

Establish steel mill in Liberia, Bong mines

(15.10)

*PT Gunung Garuda

*Capacity: 0.5 million tons

Guangxi Beibu Gulf Iron & Steel Co. (

)

Wuhan Iron & Steel Co.,Sinosteel ()

etc.

Steel mill under construction in Malaysia,

Gebeng

PSM Pakistan Steel mills acquisition plan

*Capacity: 3.5 million tons, Investment of $1

billion

*Capacity: 1.1 million tons

Ma Steel ()
Signed MOU with Kazakhstan for establishment of steel mill (15.3)

Stainless

Tsingshan Holding Group ()

Tsingshan Holding Group ()

NPI Factory under operation in Indonesia,

Morowali

Establish a Stainless Slab Steel mill in Indonesia

*1st phase 0.3 million tons (15.5), 2nd phase

0.3 million tons (15.12)

*Capacity: 2 million tons (by 2017)

Source: POSRI, Mysteel, Custeel, DBS Bank

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Risks Abound in Current Landscape

High Mortality Rate for Major Steel Companies
The global steel industry also suffered from oversupply in the 1990s, largely due to exports
from Japan and the former Soviet Union. With Japans steel demand trending down since
the 1970s, it needed to export the excess supply of steel products. And steel demand in
the former Soviet Union (CIS countries) had plunged in the post-Cold War era from 165
million tons in 1988 to 30 million tons in 1998, prompting it to dump steel products in
overseas market at cheap prices.
In 1998, US steel imports rose 25% due to the sudden crash of the East Asian economies
that eroded their demand for steel. This affected some US firms, resulting in the
bankruptcies of Bethlehem Steel (second-biggest steel company in the US) and LTV Steel
(third-biggest steel player in the US) in 2001, with total steel firms losses rising to US$3.8
billion. In 2002, National Steel (founded in 1929) went bankrupt and was acquired by US
Steel in 2003.
During the Asian Financial Crisis, many steel companies found it difficult to survive. In
Korea, Hanbo Steel, Sami Special Steel, Kia Special Steel, and Kangwon Industries went
bankrupt in 1997 and 1998 and were put under court administration for three to five
years post-bankruptcy. Hanbo Steel and Kangwon Industries were merged with Hyundai
Steel, and Sami Special Steel was acquired by POSCO, while Kia Special Steel became a
member of the Seah Group in early 2000s.
More losses in Chinas state-owned steel players. According to the China Iron and
Steel Association, Chinas 101 big steel companies lost a total of around US$10 billion in
2015. State-owned enterprises (SOEs) were the main contributors to the loss, while the
most efficient private-sector firms managed to squeeze out marginal profits. The debt
default of local SOEs has been rare in China, as local governments have so far sought
to avoid such defaults out of fear of a ripple effect. The heavy debt load of state-owned
companies may make reform difficult.
ASEAN companies at risk. With rising costs and increasing competition, ASEANs steel
companies are increasingly defaulting on bond interest payments. According to Focus
Malaysia, listed Malaysian steel players have huge debts totalling 12.7 billion Malaysian
ringgit (US$3.1 billion). The poor performance of Malaysian steel companies was
largely due to less cost competitiveness, with the lack of government intervention and
enforcement on dumped Chinese imports. Thailands Sahaviriya Steel partly blamed the
countrys economic slowdown, which had a direct impact on consumer confidence, for its
default. Indian steel companies, which are built with huge borrowings from banks, have
been hit hard by falling steel prices globally.

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Diagram 19: Chinese bankruptcy cases and firms at risk

Company Name

Year

Capacity
(m tons)

Amount of
debt (US$m)

Comments

Haixin Iron & Steel

Group

Mar-14

5.2

1,600

Dongbei Special Steel

Group

Mar-16

6.2

131

Fufeng Steel

Jan-15

Factory closed (Steel plant on the outskirts of

Tangshan)

Qingquan Steel

Dec-13

Factory closed

Sinosteel

2015

0.7

315

Bohai Steel

2015

20

29,000

Sansteel Minguang Co.

2016

8.2

30,000

Xining Special Steel Co.

2016

1.3

Liuhou Iron & Steel Co.

2016

11.3

Bankruptcy
Second largest private steel company
Cause of bankruptcy: Industry overcapacity,
stagnant market, capital shortage, tightened
credit and management issues
Consolidation of the state-owned special
steel enterprises in China including Dalian
Iron & Steel Group, Fushun Special Steel
Group and Beiman Special Steel Group

Firms at risk
A major Chinese state-owned miner and
steel trader
Lacked the funds to repay principal and
interest on US$315 million in bonds sold in
2010
Chinas state-owned Assets Supervision and
Administration Commission and the National
Development and Reform Commission have
intervened in Chinas bond market to prevent a default by state-owned Sinosteel.
Struggling to meet debt obligations following years of aggressive expansion
Missed a payment on a 350 million yuan
trust plan that promised investors yields of
more than 9 percent.
Under default risk due to low cash flows.
Source: POSRI, Mysteel, Custeel, DBS Bank

The heavy debt load of (Chinese) state-owned

companies may make reform difficult

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Diagram 20: ASEAN and India bankruptcy cases and firms at risk
Company Name

Year

Capacity
(m tons)

Amount of
Comments
default (US$m)

Sahaviriya Steel
(Thailand)

Sep-15

1,400

Failed with defaults on 50 billion Thai baht

of loans from Thai banks, biggest default
for Thai banks since 1997 Asian crisis

Megasteel (Owned by
Lion Group Malaysia)

Nov-15

1.5

8.8

Due to the challenging steel operating

environment resulting from rampant
import of steel products into the country
at dumping prices
The weakening of the ringgit also resulted
in the default of the partial redemption of
the bonds, which are denominated in US
dollars

Perwaja Steel Sdn Bhd

(Malaysia)

Mar-14

0.8

Cause: rising costs and increasing

competition, unable to fulfil the coupon
payment of 9.8 million ringgit for its
280 million ringgit nominal value of 7%
redeemable convertible unsecured loan
stock

Uttam Galva Steels

(India)

Apr-14

Challenging operating environment

Inability to refinance its long-term
borrowings

Jindal Steel & Power

(India)

Feb-16

Delayed payment of interest on term loans

due to weakened liquidity
Source: POSRI, Mysteel, Custeel, DBS Bank

Bumpy Road Ahead for Chinas Steel Sector Reforms

China plans to cut excess steel capacity by 150 million tons by 2020, as endorsed by the
central governments supply-side reforms. Earlier in 2016, the Ministry of Finance released
a special subsidy fund amounting to 47 billion yuan to spur capacity curtailment of the
steel and coal industries. However, local governments are inclined to keep steel mills
in operation, given their strong value-added tax (VAT) contributions (17% charged on
revenue). Besides, private capital players are also keen to make equity investments in steel
mills, in view of the fact that the National Development and Reform Commission will no
longer approve new production licences for blast furnace capacity construction.
Our review of the 2015 financial reports of 24 A- and H-share steel listed companies
found that the government subsidies included in the non-recurring profit or loss for the

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SECTOR BRIEFING 27
33

aggregate 24 companies surged 80% to 6.296 billion yuan, indicating a government

subsidy of 24 yuan per ton, on average. Four out of the 24 steel companies received
subsidies of up to 140-350 yuan per ton. These hefty subsidies were given to three local
SOEs and one central SOE. In the medium- and long-term, we deem the local governments
vested interests as the key challenge for steel capacity shutdown.

Pain of Rising Interest Rates

Interest rate hikes and yuan depreciation to increase the financial burden of Chinese
steel mills. The probability of further interest rate hikes in the US has fuelled concerns over
a rising interest rate environment for the global economy. This would lead to emergingcurrency weakness, including in the yuan against the US dollar. A rising interest-rate
environment would also increase the financial burden of steel mills in emerging countries by
raising interest costs and increasing the repayment amount for US dollar-denominated debt.
Better export price competitiveness from weak yuan will be offset by higher raw
material import cost and trade protectionism. While exports from China will benefit
from weak currencies in terms of price competitiveness, this could be offset by lower
steel export prices in oversupplied export markets and rising raw material costs as the
bulk of raw materials are imported. Of note, 79% of iron ore requirements in China were
imported from Australia and Brazil in 2015. Also, growing trade protectionism in export
markets will dampen the export price advantage arising from the yuans depreciation.

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Findings From DBS Steel Survey

DBS surveyed its Institutional Banking Group customers operating in the metal ferrous
vertical in April, with respondents distributed evenly between steel mills and traders. The
steel mills were primarily located in the northern province of China (Hebei, Tianjin, Shanxi
and Liaoning) and a third of traders were located outside China.
Diagram 21: Steel survey respondents by location and type
Classification

Central

East

North South Outside

China

Grand
Total

% to
Total

Steel Mill respondents mix by location

14%

9%

59%

5%

14%

100%

46%

Ferrous Trader respondents mix by location

0%

46%

19%

4%

31%

100%

54%

China POE

Total

8%

8%

69%

8%

8%

100%

59%

Production volume <=5mt

8%

0%

46%

8%

8%

69%

Total

29%

14%

57%

0%

0%

100%

Production volume>10mT,<=25mt

29%

14%

14%

0%

0%

57%

Production volume >25mT,<=50mt

0%

0%

43%

0%

0%

43%

China SOE

41%

Source: DBS Bank

Diagram 22: Outlook on steel market: Cautious

Steel sector bottomed out?

Central

East

North

South

Outside
China

Grand
Total

% Yes - Steel Mills

33%

0%

46%

0%

100%

45%

% Yes - Traders

0%

50%

40%

100%

75%

58%

% Yes - All

33%

43%

44%

50%

82%

52%

Classification

Price hike sustainable? (1 - optimistic; 5 - pessimistic)

1

Steel Mill Response Mix

5%

9%

9%

50%

9%

Trader Response Mix

8%

8%

27%

38%

8%

Steel Mill Response Mix

6%

8%

19%

44%

8%
Source: DBS Bank

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SECTOR BRIEFING 27
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No expectation on sustainable steel price growth. Most of the respondents agreed

that steel prices bottomed out in the beginning of this year. However, they do not expect
the price rebound seen in March to April to last as they see a HRC price of US$360 per ton
for the rest of 2016. Of the companies surveyed, 59% expected their margins to improve
due to the recent price hikes, while around half of the steel companies located in South
China did not expect profit improvements. More privately owned mills expected improved
margins than did SOE mills. Anecdotally, this matches the intelligence from the market
that privately owned enterprises (POE) tend to have older and fully amortised machinery,
whilst SOEs have high staff costs and more recent capital expenditure investment, often
financed by bank lending.
No threat from trade conflict. SOE mills with large-scale steel capacity export their
products all over the world, while small-scale POE mills, with around 5 million tons of
capacity, export mainly to Asia only. The most interesting finding was that most respondents
have not flagged anti-dumping measures as a real issue. We interpret this several ways: i) A
biased sample was surveyed; ii) Korea and ASEAN, which are the major Asian markets for
Chinese steel products, have no significant measures to block Chinese imports; and iii) the
cost competitiveness of Chinese companies is superior to regional peers, enabling them to
export at a competitive price even after considering anti-dumping margins.
Diagram 23: Export market and trade conflicts
SOE/POE

Main Export Regions

Mix

Asia only

39%

China - POE

EMEA only

6%

Nil response

6%

Asia only

6%

EMEA only

6%

EMEA And Asia

17%

Nil response

11%

Asia

6%

Nil response

6%

China - SOE

RoW

Is antidumping
an Issue?
% No

Central

East

North

Outside
China

South

Grand
Total

100%

100%

54%

100%

100%

73%
Source: DBS Bank

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No permanent measures for restructuring; and challenges for sector reforms. To

address the weak steel market, 68% of the respondents had gone through maintenance
of the plant and production lines, 27% laid off employees, and 9% closed their production
line temporarily. Only 14% of the respondents have closed lines permanently.
The survey also asked the respondents for their view on the likely impact of the latest
sector reforms. Interestingly, the majority of the respondents were quite optimistic that
the reforms would successfully reduce overcapacity. This reflects their trust in the recent
reform plans of Chinas central government. However, the biggest challenge for the
reform is local governments unwillingness to shut down steel mills that would create
large-scale unemployment in the region.
Diagram 24: No concrete restructuring measures yet
Measures taken to counter weak steel market

% of Total Steel Mill Respondents

Temporary closure of plant and production lines

9%

Permanent closure of plant and production lines

14%

Maintenance of plant and production lines

68%

Laying off employees

27%

Sales of assets/affiliates

5%

Relocation of HQ/Plant to save cost

9%
Source: DBS Bank

Diagram 25: Optimism on Chinese reforms

Classification

Will China reforms succeed in reducing overcapacity?

(1 - optimistic; 5 - pessimistic)
1

Nil
Response

Steel mill response mix

5%

41%

36%

9%

9%

0%

Trader response mix

4%

46%

19%

19%

8%

4%

Biggest obstacles to successful reform of Chinese steel market

% of Respondents

Local government willingness to shut down steel mills

73%

Large scale unemployment

73%

Lack of capital to support restructuring

44%

Rebound in steel price

35%

Yuan depreciation

15%

Increase in exports

10%

New capacity/new plants

6%
Source: DBS Bank

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Appendix A:
Global Steel Sector Value Chain
Raw material

Global Steel Sector

Iron Ore (2015)

Global (2015)

Global production: 3,320m ton (raw ore), 1,950m

ton (Fe content 63.5%)

Crude steel capacity: 1,704m ton

China: 1,380m ton (raw ore), 325m ton

(17%, Fe content 63.5%)

Crude steel production: 1,623m ton

Finished Steel apparent consumption: 1,500m ton

Australia: 824m ton (42%)

Geographical share of crude steel output (2015)

Brazil: 428 ton (22%)

China

49.5%

Coking coal (2015)

EU

10.2%

Global coking demand: 993m ton

Japan

6.5%

China: 593m ton (60%)

India

5.5%

Asia ex. China: 170m ton (17%)

US

4.9%

Steel scrap

Crude steel production by process (2014)

Global use: 585m ton

Blast oxgen furnace

73.9%

Purchase: 378m ton

Electric arc furnace

25.6%

EU28

91.3m ton

16%

China

88.3m ton

15%

USA

62m ton

11%

Major Players
Iron ore (production volume, 2015)

Major Players (2014)

m ton

share of total output

ArcelorMittal

98.1

5.9%

Nippon Steel and

Sumitomo Metal
Corporation

49.3

3.0%

Hebei Steel Group

47.1

2.8%

Vale

372m ton

19%

Rio Tinto

263m ton

13%

BHP Billiton

237m ton

12%

Baosteel Group

43.3

2.6%

Fortescue

167m ton

9%

POSCO

41.4

2.5%

Shagang Group

35.3

2.1%

Ansteel Group

34.3

2.1%

Wuhan Steel
Group

33.1

2.0%

JFE Steel
Corporation

31.4

1.9%

Shougang Group

30.8

1.8%

Tata Steel Group

26.2

1.6%

Coking coal: Seaborne volume (2014)

BMA

49%

Yancoal

10%

Anglo American

8%

Peabody

8%

Jellinbah

8%

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Finished steel products

Steel consumption by sector

Production 1,608m ton (2014)

m ton

share

Construction

50%

Long Products

837

52%

Transport

16%

Railway

12

1%

Machinery

14%

Heavy section

51

3%

Metal products

14%

Light section

64

4%

Domestic appliance

3%

Rebars

280

17%

Electrical equipment

3%

Bars

144

9%

Wire rod

205

13%

Flat Products

741

46%

Heavy plate

255

16%

HRC

380

24%

1%

Coated sheets

121

8%

Tublar products

137

9%

Tin plates

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Appendix B:
China Steel Sector Value Chain
Raw material

Steel:

Iron concentrates:

(mt)

production

246

Crude steel capacity

Import

953

Crude steel production

804

Crude steel apparent consumption

804

Demand

1,206

Coking coal:

(mt)
1,100

Finshed steel production

1,123

Finished Steel apparent consumption

1,023

Export

113

production

483

Import

48

Export

0.97

Crude steel production by process

Demand

530

Blast Furnace

756

Electric arc furnace

48

Steel Scrap:
production

nil

Import

15.5

Export

0.004

Nickel:
production

0.58

Import

0.30

Export

0.04

Demand

0.85

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Finished steel products

Production

(mt)

Long Products:

503

Railway

Heavy section

14

Light section

57

Rebars

71

Bars

204

Wire rod

148

Flat Products:

577

Heavy plate

72

HRC

246

CRC

97

Coated sheets

61

Tubes and pipes

100

Special steel products(mt)

112

Stainless steel products(mt)

22

Source: WSA, OECD, Platts, Bloomberg Finance L.P, DBS Bank

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Disclaimers and Important Notices

The information herein is published by DBS Bank Ltd
(the Company). It is based on information obtained
from sources believed to be reliable, but the Company
does not make any representation or warranty, express
or implied, as to its accuracy, completeness, timeliness
or correctness for any particular purpose. Opinions
expressed are subject to change without notice. Any
recommendation contained herein does not have
regard to the specific investment objectives, financial
situation and the particular needs of any specific
addressee.
The information herein is published for the information
of addressees only and is not to be taken in substitution
for the exercise of judgement by addressees, who
should obtain separate legal or financial advice. The
Company, or any of its related companies or any
individuals connected with the group accepts no
liability for any direct, special, indirect, consequential,
incidental damages or any other loss or damages of
any kind arising from any use of the information herein
(including any error, omission or misstatement herein,
negligent or otherwise) or further communication
thereof, even if the Company or any other person has
been advised of the possibility thereof.
The information herein is not to be construed as an offer
or a solicitation of an offer to buy or sell any securities,
futures, options or other financial instruments or
to provide any investment advice or services. The
Company and its associates, their directors, officers
and/or employees may have positions or other interests
in, and may effect transactions in securities mentioned
herein and may also perform or seek to perform
broking, investment banking and other banking or
financial services for these companies.
The information herein is not intended for distribution
to, or use by, any person or entity in any jurisdiction
or country where such distribution or use would be
contrary to law or regulation.

Living, Breathing Asia

www.dbs.com