Retail numbers in the US are plummeting, factories are closing and a joke making the rounds names Iceland’s capital as "US$3.50." These are the dramatic and well-documented indicators of a faltering global economy. The troubles of China’s steel sector might suggest that the worst is yet to come.
Where once investors could seek solace in the likes of Angang Steel (0347.HK) – which makes higher value-added steels and is therefore perceived as being lower risk – now, it seems, no producer is safe.
"There’s no such thing as an invulnerable steel," said Thomas Wrigglesworth, head of regional metals and mining for Citi Investment Research in Hong Kong.
Some steels are more vulnerable than others. Weakening demand for property has hit makers of "long" steel, a category including construction-oriented products like rebar. Domestic long steel production fell by 1.9% in September from the previous month, and was down 7.8% year-on-year, according to a report by research house Steel Business Briefing.
As a producer of "flat" steels – a category that includes sheet and plate steels for automobiles, appliances and ships – Angang may not be as directly affected by a soft property market. However, the indirect effects are significant.
"Property drives [demand for] finished goods," said Scott Laprise, who tracks steel and automobiles for CLSA in Shanghai. "In China, everything’s naked. You get an apartment, you buy brand new appliances … You buy a new house and it comes with a parking space, so you buy a car. It is a major driver for the sector."
Furthermore, weakening overseas demand hurts companies, like Angang, that export their own steel. Flat steel output fell 4.5% in September from the previous month, and was down 9.3% year-on-year.
The scale of demand destruction means that increasing government spending on infrastructure won’t significantly help steelmakers. Despite Beijing’s recently announced fiscal stimulus package, government infrastructure investment still accounts for only 11% of the total long steel market, Laprise said.
Citi’s Wrigglesworth notes that post-earthquake rebuilding efforts in Sichuan province, widely seen as an opportunity for heavy infrastructure spending, will also have a limited effect as the tonage pales in comparison to nationwide steel consumption.
Furthermore, the market has already factored these increases in spending into steel prices, which have fallen more than 36% from their peak in June. This was bad news for the China Iron and Steel Association (CISA), which earlier agreed to significant price hikes on iron ore imports from foreign miners in the expectation that steel prices would continue to rise.
Now, as steelmakers are forced to cut the prices of their products, those earlier contracts are proving painful. In October, spot-market prices of iron ore in China had fallen to around US$100 per ton, below the negotiated contract prices. In March, spot prices had hovered around US$200.
"It’s very difficult for large steel mills," said Steel Business Briefing. "They have high levels of inventory, they bought [raw materials] at a very high price and it’s difficult for them to cut production."
According to a market source, who asked to remain anonymous, 89 million tons of contract iron ore is currently sitting at China’s ports as steelmakers work through their inventories.
Unfortunately for Angang, it has further concerns beyond those facing its industry as a whole. A recent Citi report noted that low steel prices would hurt the ramp-up of a recently opened plant in Bayuquan, Liaoning province, and warned of higher-than-expected costs in preparing the plant for full production.
Moreover, Angang sources most of its iron ore from its parent company, with prices lagging domestic prices by six months. That poses ongoing dangers as ore prices continue to fall. Although third-quarter profit was up 29% year-on-year to US$332.9 million, this represented a 36% drop from the previous quarter.
Well aware of the difficulties ahead, Angang has announced it will be cutting production by 10% to around 16 million tons from 18 million tons.
"There’s still more threat than opportunity [in steel]," said Citi’s Wrigglesworth. Where last year steelmakers were planning expansion and growth on the back of rising demand and steel prices, a grim market means few have such plans any more, he said.
"Now, it’s about weathering the storm."