20150129-美银美林-Steel_Road__Risks_from_RMB_devaluation__20页_1mb

Summary of "Steel Road: Risks from RMB devaluation?"

Core Content

This report from Bank of America Merrill Lynch analyzes the potential risks to the Chinese steel sector from a RMB devaluation, exploring its impact on costs, earnings, and export margins. It also provides a global perspective on steel and iron ore valuations, supply-demand dynamics, and a scenario analysis based on a hypothetical 10% depreciation of the RMB.

Main Points

Risks from RMB Devaluation

• Negative Impact on Purchasing Power: A weaker RMB reduces the purchasing power of Chinese steel companies for USD-denominated raw materials, which account for approximately 50% of total costs. This significantly increases the cost of production in RMB terms, outweighing the benefits from USD revenue.
• FX Impact on Carry Trade: Companies that borrow in USD are negatively affected by RMB devaluation, leading to an increase in net gearing (debt-to-equity ratio) by 3-4% in RMB terms.
• EPS Impact: A 10% RMB devaluation could lead to a -12% to -88% decline in earnings per share (EPS), depending on the company's exposure to USD costs and revenues.
• Company-Specific Impact:
  • Maanshan I & S is the most affected due to its low margin base and low USD export revenue.
  • Baosteel is the least affected due to higher margin base and higher USD export revenues.
  • Hengshi Mining, an iron ore company, would benefit from a weaker RMB as it could lead to higher iron ore prices in RMB terms.

Steel Margins Deterioration

• Steelmaker margins have deteriorated significantly due to weak demand and high production costs.
• Rebar producers are currently breakeven.
• HRC profitability (Hot Rolled Coil) has declined by -70% from its peak.
• The report downgrades several Chinese steel companies, including Baosteel PO by -10% after an analyst briefing.

Global Steel Price Forecasts

• US steel prices are lowered from $625/t to $580/t due to a weaker supply-demand outlook.
• EU steel prices are raised to EUR439/t from EUR418/t, as the weaker EUR could provide benefits.
• The US-China price spread has narrowed, while the EU-China price spread has returned to parity, which is a headwind for Chinese export margins.

Global Steel Valuations (Table 1)

Global Iron Ore Valuations (Table 2)

Supply-Demand Model (Table 3)

Scenario Analysis (Table 4)

Mark to Market Model (Table 5)

Key Takeaways

• RMB Devaluation Impact: Chinese steel companies are negatively affected by RMB devaluation, especially due to USD-denominated costs and carry trade FX exposure.
• Company-Specific Impact:
  • Baosteel is the least affected due to higher margins and higher USD export revenues.
  • Maanshan is the most affected due to lower margins and low USD export revenue.
  • Hengshi Mining benefits from RMB devaluation, as iron ore prices increase in RMB terms.
• Steel Margins: Steel margins have deteriorated significantly, with rebar producers currently breakeven and HRC profitability down 70% from the peak.
• Global Steel Valuations: There are significant differences in valuations across regions, with Greater China and Asia-Pacific showing lower valuations compared to Europe and North America.
• Scenario Analysis: A 10% RMB devaluation leads to significant EPS declines for most Chinese steel companies, with Hengshi Mining being a notable exception.
• Mark to Market Model: The mark to market scenario shows declines in EBITDA and EPS for most steel companies, with Hengshi Mining also showing significant declines.
• Pricing Trends: Steel and iron ore prices are fluctuating, with US prices being lowered and EU prices being raised. The US-China price spread has narrowed, which is a headwind for Chinese steel exports.

Conclusion

The report highlights the risks of RMB devaluation to the Chinese steel sector, particularly due to USD-denominated costs and carry trade FX exposure. It also provides a global perspective on steel and iron ore valuations, showing significant differences across regions. The scenario analysis and mark to market model indicate significant negative impacts on earnings, with Hengshi Mining being a positive outlier. The steel margins have deteriorated, and the steel demand is weak. The report suggests caution for investors in the steel sector due to the potential for further declines in earnings and profitability.