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Summary of Document: Turning Cautious on China Steel Sector

Core Content

This document provides a detailed analysis of the China steel sector, highlighting a shift in outlook from positive to neutral due to expected changes in supply and demand dynamics. It discusses the implications of increased steel production, reduced steel prices, and the impact on profit margins and earnings for key companies like Angang Steel and Maanshan Iron & Steel.

Main Points

• Profit Margin Outlook: The profit margin expansion for the steel sector is expected to reverse in 2H14 due to an increase in steel supply and subdued demand, particularly in construction.
• Supply Increase: Small steel mills are resuming production, leading to a potential supply glut. New steel capacity of 30m tpa is expected to be added in 2014, which could further pressure prices.
• Demand Trends: Steel demand remains lacklustre, especially from the residential property sector, which is a key driver of demand.
• Raw Material Costs: Raw material prices, particularly iron ore and coking coal, have fallen significantly but are unlikely to drop further, limiting the upside for steel producers.
• Inventory Trends: Steel inventories are at a 12-month low, but the momentum of inventory destocking is slowing. Inventory levels at steel mills are rising, while those at traders are falling, reflecting a more physical and timely inventory situation.
• Company Performance:
  • Angang Steel (347 HK): Profit margins are expected to improve slightly, but net profits are forecasted to decline by 4–5% for 2014–2015E and 17% for 2016E. The company is downgraded to Hold from Buy.
  • Maanshan Iron & Steel (323 HK): Net profit is expected to turn negative in 2014, with significant cuts in 2015–2016E net profits. The company is downgraded to Underperform from Hold.
• Sector Rating: The overall sector rating is downgraded to Neutral, as a structural recovery is expected to take several years, and there are limited near-term catalysts for profit margin expansion.
• Valuation Adjustments: Valuation multiples for Angang and Maanshan are reduced, reflecting lower ROEs and a more cautious outlook.
• Government Measures: The government is actively working to reduce outdated steel capacity through environmental policies and capacity cuts, particularly in Hebei, Shandong, and Jiangsu provinces.

Key Information

• Steel Price Forecasts:
  • Hot-rolled coil (HRC) price forecast for 2014 is cut by 1.9%.
  • Rebar price forecast for 2014 is cut by 1.6%.
• Unit EBITDA:
  • Expected to fall from CNY322/tonne in 2Q14 to CNY264/tonne in 4Q14.
• Inventory Adjustments:
  • Total steel inventories are at a 12-month low, but the rate of decline is slowing.
  • Inventory levels at steel mills are rising, while those at traders are falling.
• Capacity Cuts:
  • The central government aims to cut 27m tonnes of crude steel capacity by the end of 2014 and 48m tpa by the end of 2014.
  • Additional capacity cuts of 15m tpa are planned for 2015 and 80m tpa for 2015–2018.
• Company-Specific Forecasts:
  • Angang Steel: 6-month target price reduced to HKD5.20 from HKD6.60.
  • Maanshan Iron & Steel: 6-month target price reduced to HKD1.60 from HKD1.66.

Key Risks

• Upside Risk: Lower-than-expected steel supply could improve profit margins.
• Downside Risk: Higher-than-expected raw material prices could further pressure margins.

Investment Recommendations

• Sector Rating: Neutral.
• Angang Steel: Hold (from Buy).
• Maanshan Iron & Steel: Underperform (from Hold).

Structural Outlook

• The steel industry is expected to consolidate over the next 3–5 years.
• Environmental concerns are a key driver of capacity reduction.
• The sector is likely to remain in a low profitability phase until over-supply issues are fully resolved.

Conclusion

The China steel sector faces a more cautious outlook in 2H14 due to increased supply and weak demand. The focus is shifting from profit margin expansion to margin compression, with a significant impact on the earnings and valuations of key players like Angang and Maanshan. The government's capacity reduction initiatives are expected to drive long-term restructuring, but near-term recovery remains uncertain.