20140628-法国巴黎银行-ASIA_STEEL_Korea_Steel_Corporate_Day_takeaways_36页_1mb

Korea Steel Corporate Day Summary

Core Content

• Iron Ore Market Trends: Iron ore prices in China have fallen by 29% year-to-date (YTD), with the current price at USD97/tonne. This has led to a suspension of 5-10% of domestic iron ore production since April 2014. Prices are expected to stabilize at USD90-100/tonne in the next 1-2 months, but further declines are anticipated as miners reach full inventory capacity.

• Scrap Steel Outlook: Scrap steel is unlikely to pose a significant threat to China's steel industry in the next 10 years due to:

  • The construction and auto disposal cycle.
  • A 17% VAT on steel scrap since 2011.
  • High electricity costs.
  • Import restrictions on scrap steel.

• Auto Steel Demand: Auto steel demand in China is expected to grow significantly in the next five years, driven by sustained auto demand and offshore/LNG vessel demand. The Wugang engineer estimates 2014 auto steel demand to be around 60.22 million tonnes. High-strength steel (HSS) and advanced high-strength steel (AHSS) usage is expected to rise from 30% to 50% of total auto steel demand, reducing vehicle weight and offering cost advantages over aluminium.

• Profit Margins and Cost Structure: The cost of domestic iron ore is currently around USD70-80/tonne, with a small portion (5%) exceeding USD100/tonne. Domestic production is less sensitive to price changes, but costs are rising due to increasing salary, maintenance, and administrative expenses. Tax reductions may offer some cost relief.

• Korean Steel Market: Korea's steel market is highly concentrated, with the top two producers holding 77% of the market share, giving them better pricing power. Korean steelmakers focus on high-margin, high-end products. Exports account for 44% of domestic production, providing a strong growth driver.

• Company Performance: Posco and Hyundai are expected to see margin expansion in 2Q14 due to stable steel prices and falling iron ore prices. Posco's parent-level operating profit (OP) is guided at over KRW500 billion, while Hyundai's consolidated OP is expected to exceed KRW300 billion. Seah Besteel forecasts 8% revenue growth in 2014 with 9.2% volume growth.

Investment Thesis

• Korea vs. China: Korean steel producers are preferred due to:

  1. High market concentration.
  2. Exposure to high-margin steel products.
  3. Limited and visible supply growth.
  4. Strong export performance.

• Demand Growth: Demand from the European Union and the United States is expected to rebound faster than Asian demand in 2014, supporting Korea's steel sector.

• Auto and Energy Steel: Auto and energy steel operating margins are expected to remain strong due to high demand and high entry barriers. The use of high-strength steel is likely to increase, maintaining its role in vehicle manufacturing despite the trend toward lighter materials.

Key Indicators to Monitor

• China's Steel and Iron Ore Inventory: Will indicate market supply and demand dynamics.
• Steel Mill Cash Margins: Reflect the financial health of Chinese steel producers.
• Default Cases in the Steel Sector: May signal potential market instability.

Upside Catalysts

• Potential defaults by private Chinese steel mills.
• Urbanization and economic stabilization policies in China.
• Hyundai Motor Corp's price hike in 2H14.
• New iron ore supplies from the top five suppliers in 2Q-3Q14.
• The end of iron ore financing in China.

Differences Between Posco and HSC

• Posco: Uses a diversified business model across steel, energy, trading, and construction, with operations in multiple countries (Korea, Indonesia, Thailand, India, China, etc.). This diversification is seen as the best approach for long-term profitability.

• HSC: Benefits from strong relationships with Hyundai Motor Group (HMG) and Hyundai Heavy Industries (009540 KS), giving it a competitive edge in capturing market share from domestic suppliers in the long term.

Key Data and Exhibits

• Iron Ore Price Trends: The price at Qingdao Port has been declining, with a 39% drop in scrap steel prices compared to a 45% decline in iron ore over the last three years.
• Domestic Iron Ore Capacity: Growth has slowed in recent years, but is still faster than steel production growth. New capacity is expected to come from low-cost regions like Northeast China after 2016.
• Scrap Steel Supply and Demand: Supply is expected to increase significantly in the long term due to the aging infrastructure and fast-growing auto and ship sectors. Demand is forecasted to reach 600 million tonnes by 2060, with a weaker price outlook in the short to medium term.
• Auto Steel Capacity: China's auto steel capacity is expanding, with 14.77 million tonnes of cold rolled steel expected to come online by 2016.

Summary of Key Financials

Outlook

• Iron Ore: Prices are expected to stabilize in the short term but face further pressure as inventories reach full capacity.
• Scrap Steel: Long-term growth is anticipated, but not economically viable in the short term due to high costs and environmental restrictions.
• Auto Steel: Strong growth is expected in the next five years, with a shift toward high-strength steel.
• Korean Steel: Positioned for better profitability due to market concentration, export focus, and high-margin product offerings.