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Sector Update Summary: Steel/Nonferrous Metals (OVERWEIGHT)

Core Content

The steel and nonferrous metals sector is expected to benefit from rising inflationary pressure and new demand driven by infrastructure investments in the US and potential policy changes in China. The sector was at a low in 2015 due to weak commodity prices, industry conditions, and poor company performance, but 2016 saw a rebound due to supply controls and price hikes. The analyst upgrades the sector to OVERWEIGHT, anticipating a rally in 2017.

Main Views

• US Infrastructure Spending: Expected to drive global demand for steel and copper by 1.6% and 1.8%, respectively. This should increase commodity prices and improve earnings for steel and nonferrous metal firms.
• China's Role: While steel demand growth in China is likely to slow due to a high base, the country's restructuring efforts and potential implementation of the One Belt, One Road policy could create upside for the sector.
• Commodity Price Trends: The USDX and LMEX are expected to continue rising, which is favorable for Korean steel and nonferrous metal firms.
• ROE and Valuation: Posco and Hyundai Steel are highlighted for their improved ROE and P/B ratios, which could support their valuations.

Key Information

US Infrastructure Impact

• Trump's pledged USD1 trillion infrastructure investment over 10 years is expected to boost global demand for steel and copper.
• The US is likely to increase imports of nonferrous metals due to insufficient local production.
• Commodity price hikes are anticipated due to rising demand and supply constraints.

China's Steel Market

• China's steel demand is expected to contract by 2% in 2017, but supply-side reforms and restructuring could offset this.
• The government has announced plans to reduce steel production capacity by 150 million tonnes by 2020, with 45 million tonnes cut in 2016.
• Mergers such as Baosteel and Wuhan Steel are expected to reduce market competition and increase bargaining power.
• Steel restructuring is progressing slowly, with limited consolidation since the Baosteel-Wuhan merger.

Price and Spread Analysis

• Steel spreads are expected to widen to USD221/tonne from USD209/tonne due to rising demand and utilization rates.
• Posco and Hyundai Steel are projected to see their operating profits increase by 16% and 19.7%, respectively.
• ROE for Posco and Hyundai Steel is expected to rise to 4.0% and 6.1%, respectively, from 3.3% and 5.2% in 2016.

Investment Strategy

• The market should focus on US infrastructure progress in 1H17 and China's demand potential in 2H17.
• Among large caps, Posco and Korea Zinc are favored due to their strong earnings outlook and commodity price trends.
• Among small caps, the analyst suggests a focus on firms with potential for growth and improvement in operating margins.

Company Reports

Summary of Key Charts and Tables

• Chart 1-3: Highlight the steel spread, utilization rate, and commodity price trends.
• Table 1: US infrastructure investment growth from 2015 to 2016.
• Table 2: Estimated demand and spread changes from US infrastructure spending.
• Table 3: Posco and Hyundai Steel financial projections based on US investment.
• Table 4: China's steel demand and restructuring targets.
• Table 5: Summary of steel industry restructuring measures in China.
• Table 6: Details of the Baosteel-Wuhan Steel merger.
• Table 7: China's cumulative steel capacity cut targets from 2016 to 2020.

Conclusion

The steel and nonferrous metals sector is poised for a positive outlook in 2017 due to the potential for increased demand from US infrastructure projects and China's ongoing restructuring efforts. The analyst recommends monitoring US policy implementation and China's demand dynamics, with a focus on companies that can benefit from the expected rise in commodity prices and improved spreads.