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Sector Update Summary: Steel/Nonferrous Metals

Core Content

This document provides an analysis of the steel and nonferrous metals sector, highlighting opportunities for investment despite a subdued 2018 outlook. The report focuses on China's steel demand trends, the impact of domestic and global factors, and the performance of key players in the sector.

Main Views

• Steel Industry Turnaround: A steel industry restructuring begun in 2016 has laid the groundwork for a rebound. While the 2018 outlook is anemic, the low expectations create a chance to accumulate shares.
• Demand Forecast: The World Steel Association (WSA) initially forecasted a 2% contraction in China's steel demand for 2018, but the report suggests that this may be revised upwards. The actual demand growth in 2016 and 2017 has exceeded WSA estimates, indicating the potential for further growth.
• Real Estate and Infrastructure: Real estate remains the largest contributor to steel demand in China, accounting for 45.9%, followed by infrastructure (27.5%). Despite concerns about a real estate slowdown, the government appears satisfied with current conditions and is likely to maintain infrastructure investment, especially in the context of the One Belt, One Road initiative and the Xiongan special economic zone.
• Steel Price Trends: Steel prices in China are expected to remain strong due to supply control, while Korean steelmakers, such as Posco, are well-positioned to benefit from this trend. Steel purchase costs are relatively insignificant in downstream sectors, allowing for potential price increases.
• Investment Opportunities: The sector is rated OVERWEIGHT, with Posco as the top pick. The report recommends accumulating steel and nonferrous metals players due to potential demand growth and earnings improvements.

Key Information

Steel Demand Trends

• China: Steel demand grew by 1.3% in 2016 and 0.0% in 2017, surpassing WSA forecasts.
• World: Global steel demand is expected to grow by 1.1% in 2017 and 0.9% in 2018.
• Downstream Sectors: Real estate (45.9%), infrastructure (27.5%), machinery (14.9%), and automobiles (8.2%) are the main contributors to steel demand in China.
• Real Estate Performance: Real estate investment and construction start areas have remained strong, with the government satisfied with the performance and unlikely to tighten regulations further.
• Infrastructure Growth: Infrastructure investment has been solid, with continued support from the government and expectations of further growth.

Company Reports

• Posco (005490 KS): Target price of KRW415,000, with a 28.7% upside. Recommended as the top sector pick due to strong export exposure and improving operating results.
• Korea Zinc (010130 KS): Target price of KRW650,000, with a 25% upside. Expected to benefit from the sector's rebound.
• Hyundai Steel (004020 KS): Target price of KRW68,000, with a 25.9% upside. Expected to maintain steady performance despite domestic challenges.
• Poongsan (103140 KS): Target price of KRW58,000, with a 5.3% upside. Seen as a cautious buy.
• Seah Besteel (001430 KS): Target price of KRW37,000, with a 15.8% upside. Expected to benefit from the sector's recovery.

Steel Purchase Cost-to-Sales Ratio

• Posco: 5.8% in 2017, down from 5.1% in 2016.
• Kia Motors: 7.4% in 2017, down from 6.5% in 2016.
• Hyundai Heavy Industries: 46.1% in 2017, down from 40.3% in 2016.
• Hyundai Engineering & Construction: 2.8% in 2017, down from 2.2% in 2016.
• Hyundai Development Co: 2.8% in 2017, down from 2.2% in 2016.

Economic and Policy Outlook

• Xi Jinping's Leadership: The upcoming 19th National Congress of the Communist Party of China is expected to boost economic stimuli, particularly in infrastructure, during his second five-year term.
• Regulatory Environment: Beijing is unlikely to tighten real estate regulations further, as it is content with the current market conditions.
• Global Recovery: Anticipation of a global economic recovery is seen as a positive factor for steel demand.

Conclusion

The steel and nonferrous metals sector is poised for a recovery, driven by ongoing industry restructuring, solid real estate and infrastructure data, and the potential for increased economic stimuli. While 2018 demand forecasts are weak, the low expectations present an opportunity for investors to accumulate shares. Posco is highlighted as the top pick due to its strong export exposure and improved operating results, with Korea Zinc as the second recommendation. The report emphasizes the importance of monitoring real estate and infrastructure indicators and suggests that steel prices could rise in the long term, supported by global demand and supply-side control in China.