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Iron & Steel Industry Report Summary

Core Content

This report provides an analysis of the Chinese iron and steel industry, focusing on the impact of supply-side reform, changes in supply and demand dynamics, and the valuation of key players in the sector.

Main Views

• Supply-side reform has significantly reduced steel production capacity, with 1-1.5 million tonnes of crude steel capacity expected to be eliminated by 2020E. The reform has helped improve the supply-demand balance and reduce burdens on manufacturers.
• The capacity utilization rate is projected to rise from 78% to 82% in 2018-19E, indicating a more stable and sustainable profit cycle.
• Profitability has improved due to both demand recovery and supply-side reform, with GPM and NPM narrowing and overall industry ROE expected to stabilize at around 7% in 2017.
• The steel industry is currently undervalued, with P/B close to the 2011 down-cycle level, but with a more positive profit outlook than that year.
• Maanshan Iron & Steel (323 HK) is highlighted as a top pick, with a higher ROE than the sector average and a P/B that has not fully reflected its value. Its 2017-19E P/B is expected to rise to 1.1x, supporting a target price of HK$3.99.
• Angang Steel (347 HK) is considered fairly valued due to its lower ROE, which justifies its lower P/B.

Key Information

Supply and Demand Dynamics

• Steel demand is expected to grow by 1.5% in 2017E and 0.9% in 2018E and 2019E, with net exports declining slightly.
• Capacity reduction is expected to reach about 200 million tonnes by 2020E, which is 20% of the 2015 peak production.
• The construction industry remains the largest consumer of steel, followed by mechanical and auto sectors.
• Steel production has shown a moderate rebound since 2016, with a 2.2% YoY growth in 2016 and 9.8% in 2017E.

Profitability and Industry Trends

• Profitability has improved significantly, especially in the second quarter of 2016, due to the supply-side reform and demand recovery.
• The GPM & NPM of major steel companies have narrowed, reflecting improved operational efficiency.
• Industry concentration is increasing, with key enterprises taking a larger share of production, which may enhance their pricing power.
• Raw material prices are closely correlated with steel prices, with iron ore and coke being the main cost components.
• Iron ore prices are expected to decline further in the short term due to oversupply, while coke prices are likely to range-bound due to domestic supply-demand balance.

Valuation and Investment Outlook

• The sector's P/B is near the 2011 level, but with a more favorable profit outlook, it is considered undervalued.
• Maanshan Iron & Steel has a higher ROE than its peers and is expected to benefit from the growth in auto plates and train wheels.
• Angang Steel is fairly valued due to its lower ROE and P/B.
• Investment theme is centered around the dividend from supply-side reform, which is expected to be long and sustainable.

Investment Recommendations

• Maanshan Iron & Steel (323 HK) is recommended as a BUY, with a target price of HK$3.99, based on a 1.1x P/B.
• Angang Steel (347 HK) is rated NEUTRAL.
• The overall industry outlook is OVERWEIGHT, with the potential for improved profitability and a more stable demand environment.

Risk Factors

• Weakening supply-side reform could negatively impact the industry.
• Sudden economic slowdown in China might affect steel demand growth.
• Uncertainties in production costs could influence profitability.

Sector Performance

• Absolute return over 1m, 6m, and 12m periods is 2.0%, 15.9%, and 27.9%, respectively.
• Relative return compared to HSI is 1.0%, -3.2%, and 0.9% over the same periods.

Figures and Data Highlights

• Figure 1: Steel production capacity and utilization rates are expected to improve.
• Figure 2: Steel demand by industry shows a strong focus on construction, mechanical, and auto sectors.
• Figure 3: Profitability recovery is attributed to both demand and supply-side reform.
• Figure 4: GPM and NPM differences are narrowing, indicating better efficiency.
• Figure 5: Steel prices and cost fluctuations are closely correlated.
• Figure 6: P/B and ROE trends show the industry is undervalued despite improved profitability.
• Figure 7: Domestic steel sales and exports show a slight decline in net exports.
• Figure 8: M2 growth decline did not prevent steel industry growth.
• Figure 9: Capacity utilization is expected to rise from 78% to 82% by 2019E.
• Figure 10: Correlation analysis shows capacity utilization is a key factor in corporate earnings.
• Figure 11: Steel prices are influenced by raw materials and supply-demand balance.
• Figure 12: Steel prices and cost trends show a stable pattern.
• Figure 13: Corporate profitability is closely tied to capacity utilization.
• Figure 14: Steel production rebounded moderately since 2016.
• Figure 15: Operational efficiency improvements have reduced GPM & NPM differences.
• Figure 16: Key enterprises' production share has increased.
• Figure 17: GPM & NPM narrowing indicates improved efficiency.
• Figure 18: M2 growth decline did not prevent steel industry growth.
• Figure 19: Estimated steel and raw material prices show a decline in iron ore and coke.

Financial Highlights (Maanshan Iron & Steel)

• Revenue is expected to grow from RMB48,275mn in 2016 to RMB55,744mn in 2019E.
• Net profit is projected to increase from RMB1,229mn in 2016 to RMB2,285mn in 2019E.
• EPS is expected to rise from RMB0.16 in 2016 to RMB0.30 in 2019E.
• P/B is projected to decrease from 0.95x in 2016 to 0.76x in 2017E, with an expected increase to 1.1x in the long term.
• ROE is expected to be 9.8% in 2017E, 9.3% in 2018E, and 9.1% in 2019E.

Conclusion

The Chinese iron and steel industry is transitioning from a down cycle to a more sustainable profit cycle due to supply-side reform and improved demand. Maanshan Iron & Steel is seen as a top pick with strong growth potential in auto plates and train wheels, while Angang Steel is fairly valued. The sector's low P/B and high ROE suggest it is undervalued, making it an attractive investment opportunity.