STEEL INDUSTRY THE BANE OF CHINA IMPORTS 30 OCTOBER 2014 MALAYSIA EQUITY KINDLY REFER TO THE LAST PAGE OF THIS PUBLICATION FOR IMPORTANT DISCLOSURES

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1 KDN : PP 10744/05/2013 (033520) 30 OCTOBER 2014 MALAYSIA EQUITY STEEL INDUSTRY THE BANE OF CHINA IMPORTS OCTOBER KINDLY REFER TO THE LAST PAGE OF THIS PUBLICATION FOR IMPORTANT DISCLOSURES

2 TABLE OF CONTENTS Executive summary... 3 A. Overview and update of global steel industry i. Global steel production...4 ii. Global steel demand...4 iii. Steel price...7 B. The steel industry outlook i. China s overcapacity set to continue...10 ii. Future of the industry energy efficiency...10 C. Issues plaguing the steel industry i. Circumvention of duty/incentives, global overcapacity, economic slowdown and surge in cheap imports of steel products ii. Possibility of further hike in electricity tariffs...13 D. Trade remedies available to local steel players i. Anti-dumping measure...14 ii. Countervailing measure...14 iii. Safeguard...15 E. Petition process i. Investigation process...16 F. Suggested measures to be imposed i. Requirement of a checklist for pre-shipment quality checking...17 ii. Constant review of standards for inspection and checking...17 iii. Appointment of independent surveyor...17 iv. Regular review of qualified parties for testing and certification...18 G. Steel industry in other countries i. Indonesia has tightened imports of steel...19 ii. Indonesia to implement import license system on alloyed steel...19 iii. Posco s slowdown in sales due to lower demand from China...19 iv. U.S. approved anti-dumping probe on steel wire rods from China...19 v. Anti-dumping in Vietnam...19 vi. Thailand, Indonesia issue safeguard actions on flat products...19 H. Conclusion APPENDIX Brief highlights of stocks under coverage KINDLY REFER TO THE LAST PAGE OF THIS PUBLICATION FOR IMPORTANT DISCLOSURES 2 OCTOBER 2014

3 EXECUTIVE SUMMARY MALAYSIA EQUITY RESEARCH STEEL INDUSTRY THE BANE OF CHINA IMPORTS Like any other commodity, the price of steel will be dependent on demand and supply factors. With China s dominance as the biggest steel producer and consumer in the world, any developments in China will impact the steel industry s fundamentals. Steel exports from China hit an all-time high of 8.07 mil tonnes in May this year. In Jun 14, China s export of steel products moderated to 7.07 mil tonnes but higher than Jun 13 by 33.4%. Steel industry in China has been sluggish saddled by decelerating steel demand and production overcapacity. Chinese steel mills have exploited the loophole in China s tax structure. These mills enjoy export tax rebates of 9-13% on their exports of boron added steel (alloy steel). In addition, by declaring their exports of alloy steel with only a slight addition of boron (0.0008%) content, which satisfies the simplistic World Customs Organization (WCO) Harmonized Classification System (HS) for export/import declaration purposes, the mills avoid paying export taxes of 20% on carbon steel imposed by the Chinese Government. With an overcapacity of steel production in China, exports of the China s minimally boron added steel have surged consequently. This has led to the dumping of the cheaper steel products abroad including in Malaysia, especially in the absence of product specific standards on alloy steel, causing a rise in trading conflicts with other countries as well. We believe that it is important to curb the influx of these cheap steel products which have circumvented export taxes of 20% on carbon steel in China and at the same time enjoy export rebate on minimally boron added alloy steel. This will help to provide a level playing field in terms of fair pricing and prevent profit margins of our local steel mills from being eroded. Local steel mills have sought relief from unfair trade practices. Apart from seeking relief through trade remedies, we believe it is important for the local steel mills to restructure themselves to be more cost efficient to compete. This is particularly so when Malaysia enters into FTAs such as RCEP and TPPA. In this report, we take a look at the process of making petitions to MITI for remedies, our views on the petitions submitted by the local steel mills to MITI for remedies, suggested measures which can be implemented to ensure a level playing field in the industry and actions that other countries have taken to address the issues plaguing the steel industry in their respective countries. OCTOBER

4 A. OVERVIEW AND UPDATE OF GLOBAL STEEL INDUSTRY MALAYSIA EQUITY RESEARCH I. Global steel production For the first 4 months of this year (January to April 2014), global crude steel production continued to be high. In March and April 2014, global steel production trended above the 3 month moving average from January 2007 to April This is despite of a slowdown in the growth of global steel demand. World Steel Association (WSA) has projected that steel demand globally will moderate to 2.0% in 2014, down from 3.8% in For 2015, it expects growth of global steel demand to remain soft at 2.0%. Chart 1: Global Crude Steel Production (m tonnes) month moving average trendline Jan-07 Jun-07 Nov-07 Apr-08 Sep-08 Feb-09 Jul-09 Dec-09 May-10 Oct-10 Mar-11 Aug-11 Jan-12 Jun-12 Nov-12 Apr-13 Sep-13 Feb-14 Source: World Steel Association II. Global steel demand Table 1 below shows the global steel demand by regions from 2013 to Growth in demand by China, the world s top producer and consumer of steel is expected to taper from 6.1% in 2013 to 1.0% and 0.8% in 2014 and 2015 respectively. Table 1: Steel Demand by regions Apparent Steel Consumption (Mil Tonnes) Growth rates (%yoy) f 2015f f 2015f European Union Other Europe CIS NAFTA Central and South America Africa Middle East Asia and Oceania 1,032 1,020 1, World 1,531 1,562 1, Developed Economies Emerging and Developing Economies: 1,143 1,157 1, China BRIC MENA World excluding China OCTOBER 2014 Source: World Steel Association

5 Elsewhere, growth of Emerging and Developing economies steel demand has been projected by WSA to slowdown in Nevertheless, this will be partially offset by the higher growth of Developed economies steel demand of 4.3% in The world steel demand excluding China s growth for 2014 and 2015 is expected to be 3.0% and 3.2% respectively, up from 1.7% in Chart 2 shows the growth in steel demand of China. CAGR for China s steel demand from 1991 to 2000 was 8.0% before trending higher to 17.3% from 2001 to Growth in steel demand by the country reached a peak of 23.4% in This coincided with the implementation of global stimulus spending. Thereafter, there was a slowdown in China s steel demand. For 2014 and 2015, it is likely for the growth in China s steel demand to decline as the economy enters a phase of soft landing with a slowdown in economic activities. Chart 2: Growth in China s Steel Demand (%) Source: World Steel Association Chart 3 and Table 2 showed a moderation in China s GDP growth to 7.5% in 2Q 2014 as compared to a growth of 7.7% in 4Q Construction activity remains a significant contributor to China s GDP. Growth in the floor space of buildings and residential buildings under construction have slowed down to 11.3%yoy and 8.3%yoy in 2Q 2014 from 16.1%yoy and 13.4%yoy respectively in 4Q This was in line with the weaker property market in China and the decline in property prices in the country. Hence, China s steel demand has been projected to grow at a slower rate in 2014 and Chart 3: Trend of China s GDP growth and floor space of buildings and residential buildings under construction (YoY%) Floor space of buildings under construction 15 Floor space of residential buildings 10 under construction China's GDP growth by quarters 5 Mar-10 Aug-10 Jan-11 Jun-11 Nov-11 Apr-12 Sep-12 Feb-13 Jul-13 Dec-13 May Source: Bloomberg OCTOBER

6 Table 2: China s GDP Growth and floor space for buildings under construction by quarters Quarter China s GDP Growth (%yoy) Floor space of buildings under construction (% chg yoy) Floor space of residential buildings under construction (% chg yoy) 1Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Source: Bloomberg Chart 4 showed China s growth in investment in Railways and Fixed Asset Investment. We deemed this to be a proxy of the country s investment in infrastructure development. In 2008 and 2009, the global recession led to an unprecedented stimulus packages being implemented by countries worldwide. With lower stimulus spending unveiled by the China s government recently, the growth in the country s investment in railways cum fixed assets investments has declined compared to the period in between the 4Q 2008 and 2Q The peak in China s investments was in Jan OCTOBER 2014 Chart 4: Growth in China s Railways cum Fixed Asset Investment Jun-06 Mar-07 Dec-07 Sep-08 Jun-09 Source: Bloomberg, China s Ministry of Railway Mar-10 Dec-10 Sep-11 Jun-12 Mar-13 Dec-13

7 Chart 5 shows the breakdown of the world s steel demand by regional share from 2000 to From the historical trend up until 2013, China s share of global steel demand has been steadily rising vis-à-vis the demand by Emerging & Developed Economies as well as that of the Developed Economies. Its global share of steel demand was 47.4% in 2013 as compared to 16.4% in While China s economic growth has slowed down, slower momentum has been seen on its IPI, money supply as well as the aggregate financing as authorities Chart 5: World Steel Demand by Regional Share (%) 80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% China 10.0% Emerging & Developing Economies Developed Economies 0.0% Source: World Steel Association move to rein in shadow banking. For China, we expect a sub-par growth but no hard landing for the economy. Looking ahead, China as the largest steel producer and consumer in the world will continue to affect the steel industry s fundamentals. III. Steel Price Chart 6 below shows that the World Capacity Utilization Rate reached a low of 75% in December 2013 but has since increased to a circa 79% in the previous three months (February to May 2014). Mapping it against China s Steel Bar prices for exports, there appears to be a strong correlation between the two. It was only in early 2012, that the divergence of trend occurred where Steel Bar prices continued its downward trend momentum while the World Capacity Utilization Rate continued to hover around the 70-80% mark. Chart 6: Divergence in World Capacity Utilization rate (%) and export price of China s Steel Bar (USD) Chart 7: Export price of China s Wire Rods (Shanghai Price) converted to USD Jan-08 May-09 Sep-10 Jan-12 May-13 China's Steel Bar price for export (USD) World Steel Capacity Utilisation Rate (%) Source: Bloomberg and World Steel Association Jan-08 Feb-09 Mar-10 Apr-11 May-12 Jun-13 Source: Bloomberg and World Steel Association OCTOBER

8 Chart 8 shows the decline of China s Steel Bar and Wire Rod prices. Also showing a declining trend is Billets based on Shanghai prices (see Chart 9). On raw materials, Chart 10 shows the declining price trend of iron ore while the price of scraps has been steadier comparatively. Chart 8: Domestic prices of China s Steel Bars and Wire Rods (Shanghai Price) converted to USD Source: Bloomberg and World Steel Association Steel bar Steel wire rod Chart 9: Billet price (Shanghai Price) converted to USD Source: Bloomberg Chart 10: Iron Ore and Scrap prices (in USD) Mar-10 Aug-10 Jan-11 Jun-11 Nov-11 Apr-12 Sep-12 Feb-13 Jul-13 Dec-13 May-14 Iron Ore (in USD) Turkey Scrap (in USD) Source: Bloomberg 8 OCTOBER 2014

9 Charts 11, 12 and 13 below show the spreads between billet and scrap, steel bar and scrap and steel bar and billet prices respectively. The billet and steel prices were based on China (Shanghai prices converted into USD) while the scrap prices were based on Turkey scrap prices in USD. All 3 charts showed declining trends in spreads which reflected weak steel prices. The lower spreads between billet and scrap as well as steel bar and scrap reflect that billet and steel bar prices have been weak. With the weaker demand and oversupply situation in China, Chinese mills were unable to take advantage of the decline in raw material prices. We understand that China s key leaders have intended to reduce the industry s overproduction which led to pollution and wasteful investment. Nevertheless, local officials have resisted the rush for capacity reduction on fears of loss of jobs and local business interest. Chart 11: Spread between Billet and Scrap prices (USD) Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Source: Bloomberg Chart 12: Spread between Steel Bar and Scrap prices (USD) Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Source: Bloomberg Chart 13: Spread between Steel Bar and Billet prices (USD) Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Source: Bloomberg OCTOBER

10 B. THE STEEL INDUSTRY OUTLOOK MALAYSIA EQUITY RESEARCH i. China s overcapacity set to continue China s steel companies are facing operational difficulties on the back of a decelerating steel demand and production overcapacity. Demand for steel has been weak. Thus far, slowdown in outputs was unable to match the weaker demand. Even though faced with high inventory and financing cost, steel production continued to be high against a backdrop a moderate growth in steel demand. The oversupply situation is likely to persist and continue through the remaining periods of China s government has accelerated efforts to reduce the excess production capacity. This was due to pressures of environmental protection as well as the need to eliminate backward steel production capacities. The country has been saddled with overcapacity in steel production for years. This has resulted in its mills achieving very thin margins and faced with high debts due to vast expansions in plant capacities in the previous years. While efforts have been taken to ban new projects in steel, cement, electrolytic aluminum, flat glass and shipbuilding industries before 2017 as well as removing existing projects which are below standards in production output, the overcapacity plaguing China is not likely to be resolved in the near term. The country is now faced with the need to digest production gluts from an investment boom and generous subsidies in the past few years which expanded producers capacity at a fast pace without much consideration to the future prospects of real market demand. Overall, China is now faced with overcapacity issues, weaker property sector and high country debt levels. Chart 14: China s Crude Steel Production (in mil tonnes) Jan-00 Nov-01 Sep-03 Jul-05 May-07 Mar-09 Jan-11 Nov-12 Source: CEIC 3 month moving average trendline ii. Future of the industry energy efficiency The higher natural gas price and the hike in electricity tariff have put pressure on the operational cost of steel players in addition to the margin pressures from low selling prices. Effective 1st May this year, natural gas tariffs to the non-power sector was revised upwards by an average of 20%, or RM3.25, from RM16.07 per million metric British thermal unit (mmbtu) to RM19.32/mmbtu. Electricity accounts for 8-10% while natural gas accounts for 1-3% respectively of steel companies production cost. Potential tariff revisions ahead could continue to impact margins if companies do not operate in a leaner cost structure. We believe that it will not easy for steel producers to switch to alternative sources of energy because of cost factors. There are alternative fuel sources that are more cost-effective which some steel manufacturers can look at. However, the switch in the immediate or medium term is envisaged to be difficult. This is due to the substantial capital investments in equipment and machinery required to make the change. Hence, switching to alternative sources of energy is unlikely in the near term. Going forward, steel manufacturers need to adopt efficient cost structures for the production of steel products to stay competitive in the industry. 10 OCTOBER 2014

11 C. ISSUES PLAGUING THE STEEL INDUSTRY MALAYSIA EQUITY RESEARCH i. Circumvention of duty/incentives, global overcapacity, economic slowdown and surge in cheap imports of steel products On the regional and global scene, Chinese contribution and global exports of steel products with particular attention to wire rods and steel bars show an increasing trend by China compared to the other major producers. Table 3: Breakdown of steel export by China in 2013 by products Long Flat Source: SEAISI Products Total exported in 2013 Volume exported to ASEAN market in 2013 Steel Bar 9 mil tonnes +48.0%yoy 2.7 mil tonnes +59.0%yoy Wire Rod 8 mil tonnes %yoy 3.6 mil tonnes +51.0%yoy Hot Rolled Coil 6.7 mil tonnes +7.0%yoy 1.87 mil tonnes +3.0%yoy Cold Rolled Coil 4.4 mil tonnes -1.7%yoy 0.79 mil tonnes +1.2%yoy Table 3 above shows the total exports of long and flat steel products by China in Substantial portion of the steel products exported are long steel. The volume of steel bar and wire rods exported the ASEAN market in 2013 had significant increase of 59.0%yoy and 51%yoy to 2.7 mil tonnes and 3.6 mil tonnes respectively. This was higher than the volume of flat products (hot rolled and cold rolled coil) exported to the ASEAN market. The export tonnage of hot rolled coil and cold rolled coil grew by 3.0%yoy and 1.2%yoy to 1.87 mil tonnes and 0.79 mil tonnes respectively. Charts 15 & 16 showed that China s exports of Steel Bar and Wire Rods have been on a rising trend. China s exports of steel products as shown in Chart 17 continued to be rise while imports of steel products have been flat. Chart 18 shows the trend of exports of iron and steel products by major producers (China, Japan, US and Europe). In recent months of 2014, exports of iron and steel products by China continued to be high while the production by Japan, US and Europe appeared to be sluggish. Carbon steel has reached the peak production in China. Also, manufacturing of carbon steel has been discouraged in China due to the utilization of outdated production technologies which has caused environmental pollution. Arising from this, it is has been understood that China has imposed a 20% export duty on carbon steel products. To encourage value adding, from carbon steel to alloy steel, the Chinese Government is said to provide export rebates of 9-13%. Overall, the circumvention of duties Chart 15: Exports of Steel Bars by China (Mil Tonnes) Jan-04 Jul-06 Jan-09 Jul-11 Source: CEIC Chart 16: Exports of Wire Rods by China (Mil Tonnes) Jan-01 Jul-03 Jan-06 Jul-08 Jan-11 Jul-13 Source: CEIC OCTOBER

12 provided opportunities to export steel at cheaper prices, consequently hurting the domestic industry in Malaysia and other countries. Chart 17: Exports and Imports of steel products by.china (in thousand mt) 9,000 As for the Malaysian situation on wire rods and steel bars, we gather that there are still steel mills in China that found a loophole in China s tax structure and circumvented the system by declaring their exports into Malaysia as alloy instead of carbon steel at the Chinese end. With a mere % addition of boron, steel exported out of China mills were claimed to have declared as alloy steel by these mills to avoid paying export taxes of 20% on carbon steel imposed by China s government and at the same time enjoying a rebate of 9-13% on alloy steel exports. The recourse to curbing imports causing 8,000 Import 7,000 Export 6,000 5,000 4,000 3,000 2,000 1,000 0 Jan-10 Nov-10 Sep-11 Jul-12 May-13 Mar-14 Source: Bloomberg or threatening to cause material through unfair practice of dumping (selling at a price cheaper in the foreign market compared to selling price in its own domestic market) or subsidized imports (through government support not in line with the WTO Subsidies and Countervailing Measures Agreement); and serious injury through a sudden surge in large volumes of fairly traded imports is provided for under the WTO trade remedies. Malaysian domestic industry faced with influx of cheap or surge in imports, have taken recourse to trade remedies, mainly through anti-dumping and safeguard measures depending on the case of the situation. For wire rods (carbon steel), in February 2013, MITI imposed antidumping duties ranging from 9.04% to 25.2% for Chinese Taipei, Indonesia from %, Republic of Korea, 3.03%-25.2%, Republic of China from 0-25% and Turkey nil duty. Despite this effort, the Malaysian Domestic Industry is still being hurt by the imports particularly by producers from China with nil duty and the Domestic Industry has made a submission for the review of these nil duty imposed. On seven wires pre-stressed concrete strand, antidumping duties were imposed on imports from China on 5 January 2014 ranging from 5.93% to 8.71%. Chart 18: Exports of Iron and Steel Products by Countries (in thousand mt) 9,000 9,000 8,000 7,000 Japan China US Europe 8,000 7,000 6,000 6,000 5,000 5,000 4,000 4,000 3,000 3,000 2,000 2,000 1,000 1,000 0 Jan-10 Jun-10 Nov-10 Apr-11 Sep-11 Feb-12 Jul-12 Dec-12 May-13 Oct-13 Mar-14 0 Source: Bloomberg 12 OCTOBER 2014

13 As for steel rebars, with the support of the Domestic Industry, an application to initiate antidumping investigation has been submitted in June 2014 to the International Trade and Industry Ministry (MITI), Malaysia for taking anti-dumping measure against China s and Korea s steel mills. In contrast, the flat steel products, with effective from 1st February 2013, import duty exemptions of 18 grades of Hot-Rolled Coils (HRC) into the local market have been removed by MITI. Since 1st February, imports of all 18 commercial grades of HRC have been subjected to full import duties of 20%. This has benefited HRC producer, Megasteel. These 18 grades are as in Table 4. On 16 October 2014, MITI announced the imposition of provisional anti-dumping duties ranging from 3.15% to 29.17% on imports of HRC originating from China, Indonesia and Korea. The provisional antidumping duties will be effective for not more than 120 days from 17 October 2014 and will be subject to the outcome of final investigations. HRC producers have been enjoying protection from the Government in previous years and are seeking further protection by recommending to impose 30% import duty on the imports of all types flat steel products for at least a 6-year period. This protectionist request is likely to encounter resistance from the downstream steel manufacturers as this will have an impact on the downstream players on their competitiveness both domestically and globally. Besides this, on 20th May 2014, MITI received a petition from a domestic producer alleging that imports of Hot Rolled Coil (HRC), chequered coils and picked and oiled (P & O) coils that originated and exported from China, Indonesia and Korea have been dumped in the domestic market at prices much lower than that of the alleged countries. MITI has initiated the case and is currently in the process of making a preliminary determination on the alleged dumping, whether the local industry is indeed materially injured and whether it is indeed the dumped imports that are causing the injury and not due to other factors. A safeguard measure has also been requested against the imports of HR Plates, the public notice was issued on 18 August MITI has initiated the investigation and is currently evaluating the petition to determine if the there is merit on the request and if so, on the need to impose Preliminary Safeguard Measure before concluding with a Final Determination within 200 days from the Preliminary Determination. Table 4: Import duty exemptions of 18 grades of Hot-Rolled Coils (HRC) products removed JIS G SPHT 1 JIS G 3132 SPHT 2 JIS G 3132 SPHT 3 JIS G SPHT 4 JIS G 3101 SS400 JIS G31010 SS490 JIS G3101 SS 540 JIS G3106 SM 490 BS EN S355JR BS EN S355J0 BS EN S355J2 BS EN DD11 AS/NZS 1594 HA 350 AS/NZS 1594 HA 250 JIS G 3131 SPHC Cheq JIS G 3101 SS400 Cheq ASTM A 36 Cheq BS EN S275 JR Cheq Source: MITI ii. Possibility OF further hike in electricity and gas tariffs TNB has plans to review electricity tariff every 6 months. A 2nd hike in electricity tariff is imminent, after an earlier 15% rise, which was affected on 1st January this year. With that, it is likely for further hikes in the electricity tariffs to be implemented moving forward. This will lead to more pressures on margins of steel companies which do not operate efficiently with lean cost structures. OCTOBER

14 D. TRADE REMEDIES AVAILABLE MALAYSIA EQUITY TO LOCAL RESEARCH STEEL PLAYERS Actions available for domestic steel players There are three main types of trade remedies available under WTO which have been transposed into Malaysian legislations, to domestic industries including the local steel players. These trade remedy provisions can be invoked by the domestic industry. The most common form being antidumping measures to defend against any unfair competition by foreign mills which dump, meaning selling products at lower prices in the Malaysian market than in their own domestic market (by comparing prices at the same level of trade), thus affecting steel prices in the local market. Besides antidumping measures against unfair pricing by foreign companies, there are also two other forms of trade remedies which include countervailing and safeguard measures. All trade remedies are legal actions and thus will need to be substantiated with evidence in order for the trade remedy action to be taken and, the process and procedures strictly adhered to as provided in the domestic law that has incorporated provisions from the WTO trade remedy agreements i. Anti-dumping measure The anti-dumping measure generally results in the imposition of specific additional import duty (antidumping duty) on specific foreign exporters/producers that had cooperated in an antidumping investigation and, as for those who had not cooperated/participated an antidumping duty will be imposed under others category for these companies. In the antidumping investigating process, first there is a need to establish the existence of material injury to the local or domestic industry where sixteen factors are evaluated to establish that the domestic injury is suffering material injury. Second, dumping margin needs to be established; that is by comparison of the comparable price difference of the products to show that the products are being sold at a lower price in the Malaysian market compared to the foreign domestic market of the exporting company; this price difference has to be more than 2% (de minimis dumping margin), otherwise there is no case of dumping. Another situation where there will no case is when the volume of the dumped imports from the exporting country is individually less than 3% (negligible volume); unless all those countries with less than 3% individually account for more than 7% of imports. Finally, there is a need to establish a causal link which requires to show that the material injury suffered by the domestic industry is due to dumped products and not due to other reasons. Anti-dumping measures can be in place for 5 years and a sunset review can be carried out to at the end of the 5 years to establish for the need to continue imposing for another 5 years or the measure be terminated. ii. Countervailing measure Countervailing measures are usually taken to prohibit or restrict trade distortive effects of subsidies given by a government that gives the subsidized products an unfair price advantage against a non-subsidised product. A countervailing measure therefore targets the incentives/programmes of a government of a country and is generally considered as sensitive. 14 OCTOBER 2014

15 The steps for a countervailing process and procedure is similar to that of the antidumping investigation establishment of material injury to the domestic industry; establishment that the companies receiving the subsidies have benefitted; and finally establishing the causal link between the material injury suffered by the domestic industry is by way of the subsidized imports and not, other factors. In the countervailing investigation, the de minimis subsidy level is not more than 2% for developing countries and less than 1% for developed countries. On negligible volume, for developing countries, it is individually 4% and collectively for those with less than 4% account for not more than 9% of total imports. The period of the application of countervailing measures and the provision for sunset review follows that of the antidumping. iii. Safeguard Safeguard measures are taken when there is a surge in import volume that is sudden, recent and sharp that was unforeseen; there is no claim of unfair trade practice however there is a need to establish serious injury to the domestic industry, that is a need to show a higher level of injury compared to material injury as in antidumping or countervailing measures. The safeguard measure is considered as a temporary measure to provide some breathing space for the domestic industry to restructure itself to become more competitive. Developing countries can be exempted from the safeguard measure if the imports of individual country is less than 3% and collectively account for not more than 9% of import volume. The safeguard measure can be in the form of uplift of import duties or tariff above the MFN bound tariff rates or through the imposition of quantitative restriction. These are applied for an 8-year period with a mid-term review; as for the developing countries this can be reviewed to be extended for another 2 years. In the case the tariffs are uplifted these will have to be scheduled to bring down each year during the imposition of the safeguard measure and the domestic industry will also need to submit its adjustment plan to improve its competitiveness for the duration of the safeguard measure. OCTOBER

16 E. PETITIONS PROCESS MALAYSIA EQUITY RESEARCH i. Investigation Process Investigations will only be carried out by the Investigating Authority (IA) based on a fully substantiated petition claiming injury due to the imports. This involves four phases as follows: a. 1st phase (Pre-lodgment phase) Under this phase, petitioners prepare submissions for trade remedies after determining which of the recourse they intend to take depending on imports, whether they are being dumped, subsidized by the foreign governments or just a sudden surge in imports. The Petitioners will need to obtain evidence of dumping in the case of antidumping, that the foreign government is providing subsidies that gives unfair advantage for countervailing measure and surge in imports in the case of safeguards measure. Generally the petitioners consult with the Trade Practice Section of MITI to get advice whether the petition meets the standard to merit acceptance. b. 2nd phase (Filing of petition) Once the petition is filed the IA will determine to see if it has provided all the prima facie evidence and check for adequacy and accuracy to support its claim on injury by way of the imports. The IA then has to make a decision whether to accept or reject the petition within 30 days of receiving the petition. The IA will have to do two notifications one, on receipt of petition and two, whether the IA is rejecting the petition or accepting the petition and initiating the investigations. c. 3rd phase (Initiation and preliminary determination) In this phase, MITI will send out questionnaires to all interested parties, foreign exporters/producers alleged in the petition, importers, other domestic players of the product under investigation, domestic industry associations, foreign governments of the countries alleged in the petition. Normally they will be given a month to respond to the questionnaire. In the meantime the IA will verify the information submitted by the petitioner and that submitted by the other producers to determine the claim of material injury. The IA will also verify/evaluate the information submitted by importers. Further, the IA will examine information submitted by cooperating foreign exporters/producers to see if dumping margin can be established based on their submission. The IA has 120 days to come with the Preliminary Determination which can be extended by 30 days if needed. In the event of an Affirmative Preliminary Determination of dumping and injury to the local industry, a temporary duty is generally imposed on the importation of steel products unless it is established that there is only a threat of injury where the investigation will continue without the imposition of any temporary antidumping duties. When an antidumping duty has been imposed, the Customs will collect the antidumping duty in the form of a bank guarantee or bank drafts. There will not be any cash collection of antidumping duties based on Preliminary Determination. The Preliminary Duty imposition is an interim measure to protect the domestic industry against continued influx of cheap steel products while the investigation is being conducted till the Final Determination. Usually, provisional measures shall be applied no sooner than 60 days of the date of initiation of the investigation. The validity of such measure shall run up to 4 months and can be extended by a further 30 days. d. 4th phase (Final determination) Within 120 days from publicly notifying the Preliminary Determination, the IA will have to come up with a Final Determination. During this phase, an onsite verification visit may be conducted by the authority to verify the accuracy the data submitted by the alleged foreign exporters/producers who have cooperated by submitting the foreign producer s questionnaire. This stage of investigation involves further verification and refinement of the dumping margin, establishment of causal link to justify the imposition of final definitive duty. Upon reaching an Affirmative Final Determination, a definitive antidumping duty will be imposed and this will be valid for up to 5 years from the date the final determination is published. 16 OCTOBER 2014

17 F. SUGGESTED MEASURES TO BE IMPOSED MALAYSIA EQUITY RESEARCH While provisional anti-dumping/counter veiling duties may be imposed to stop the influx of the cheap steel products in the country, there are also additional measures which can be imposed. These are to ensure a level playing field while allowing Malaysia to exercise its international rights and obligations governed by its relationship in World Trade Organisation (WTO) and the WTO Agreements on Anti-Dumping and Subsidies & Countervailing measures. We suggest that the following additional measures be introduced. These measures are based on our findings from our conversation with industry players: -- To provide checklist for pre-shipment quality checking to the appointed certified bodies and laboratories before SIRIM/CIDB issues the Certificate of Approval (COA) to allow importation of the steel products; -- To review standards for inspection and checking from time to time; -- Appointment of independent surveyor and -- Constant review of the list of qualified bodies and laboratories for testing and certification. i. Requirement of a checklist for pre-shipment quality checking Effective 21 February 2013, Malaysian Government has ceased issuing Temporary Certificate of Approval (TCOA) for the importation of steel. Arising from this, a fast track clearance facility has been provided to existing users of TCOA for 6 months until 22 August From now on, all companies intending to import steel products will be required to apply for COAs using streamlined methods of SIRIM/CIDB. SIRIM is a regulatory rather than a testing and inspection body. Hence, we believe that a checklist for testing needs to be detailed out for quality and compliance to mandatory standards checking before SIRIM/CIDB issues COA for importation of steel products. With a checklist for testing, this will allow the appointed certified bodies and laboratories to undertake more stringent checking to ensure that steel products are of quality and fit for construction purposes before allowed to be imported into the country. ii. Constant review of standards for inspection and checking Review of the existing standards may be necessary to be current with the developments taking place in the industry to enable SIRIM/CIDB to require the appointed laboratories/inspection body to carry out necessary testing. This will ensure that the products produced locally and abroad comply with safety requirements. Product specific standards may be necessary. iii. Appoint independent surveyor Another measure which can be undertaken will be the appointment of internationally recognised independent surveyor. The surveyor will check through the document of title (bill of lading). Preference will be for the authorities to appoint internationally recognised surveyors with representative offices worldwide. Prior to the export of steel products, it is proposed that the bill of landing be endorsed by the appointed surveyor on a mandatory basis. Upon arrival of the goods at the importing country, these goods will be verified by the said surveyor s representative offices. This way, the bill of lading for the shipped steel products will be not switched with another document, consequently deterring dumping of cheap steel products locally. The areas for verification by the independent surveyor could include: -- Quantity and quality of the steel products and - - Verifying the value of the products to the normal prices. In cases where accuracy of the declared value is in doubt, further information can be requested for review from the importer and/or exporter. OCTOBER

18 iv. Regular review of qualified parties for testing and certification Quality of the testing work by the certification bodies and laboratories may need to be evaluated from time to time. This will allow the retention of only qualified certification bodies and laboratories for testing and certification before COAs are issued by SIRIM/CIDB. Chart 19: Method and process for imports of steel using product laboratory testing Appoint Laboratory Testing at foreign lab (APPLAC/ILACMRA) Testing at SIRIM / accredited local lab Select accredited lab (by importer) Submit application for fit report to SIRIM Submit to SIRIM for confirmation Confirmation / Approval by SIRIM Sampling by SIRIM / Third party inspection body (TPIB) Conduct full type test Issue full type test Arrange for SIRIM sampling at country of origin/ malaysia port Conduct full type test by SIRIM / accredited local lab Issue full type test report Shipment arrived at port of entry Shipment arrived at port of entry submit application for COA Submit application for COA Consignment verification at port of entry Consignment verification at port of entry Checking marking Issue COA Checking marking Source: SIRIM/CIBD 18 OCTOBER 2014

19 G. STEEL INDUSTRY IN OTHER COUNTRIES MALAYSIA EQUITY RESEARCH i. Indonesia has tightened imports of steel Recently, Indonesia has tightened the imports for boron-infused steel bars used for infrastructure. It now restricts boron-infused steel to be imported only by registered parties. This was affected after it found producers of boron infused alloy steel collaborating with importers to exploit the tariff structure loopholes in Indonesia and to secure zero tariffs. Adding to that the steel bars have been imported from China where it received subsidies (Source: SEAISI newsletter June 2014, p.3) In addition, Indonesia mills are also hurt by non-standard steel bars which had not conformed to the requirements of Indonesia s National Standard (SNI). Distributors and users are using non standard steel bars that were lower quality in terms of mechanical strength, tensile and chemical composition. Sub-standard steel bars accounted for 50% of the total bars usage in Indonesia. Producers of standard steel bars are facing stiff competition from the distribution of non-standard ones (Source: SEAISI newsletter June 2014, p.3) ii. indonesia to implement import license system on alloyed steel Commencing from 2nd July, Indonesia Government will implement a license system on imports of alloyed steel. The license system will cover alloyed steel, steel sheets and coils, plates, bars, wire rods, shapes and sections and exclude pipes, tubes and rails. Alloyed steel imported by manufacturers of automobiles, electric and electronic appliances, ships, heavy machinery and construction machinery import directly will be exempted from the system (Source: SEAISI newsletter July 2014, p.3). iii. Posco s slowdown in sales due to lower demand from China Posco s operating margin has declined amidst the weak global steel industry. Its operating margin drop to 4.8% in 2013 from a high of 17.2% in Margins have been squeezed and are unlikely to return to the levels during the pre-crisis level. China is the largest export market for the Group. Looking ahead, Posco sales is likely to decline due to lower demand from China. Growth of steel demand from China is likely to taper from 6.1% in 2013 to 3.0% in 2014 and subsequently to 2.7% in 2015 (Source: SEAISI newsletter April 2014, p.6). iv. U.S. approved anti-dumping probe on steel wire rods from China It has also been alleged that China s steel products have sold below the fair value of that in US after receiving subsidies from China s government. China faces allegations of dumping wire rods, hence causing injury to the US steel industry players. We understand that the US Department of Commerce is currently investigating on the matter and is expected to make preliminary countervailing and/or anti-dumping duties soon (Source: SEAISI newsletter Mar 2014, p.12). v. Anti-dumping in Vietnam Over in Vietnam, preliminary anti-dumping duties ranging from % have been proposed to be imposed on cold-rolled stainless steels imported into the country. This was despite of objections received from manufacturers that import stainless steel as raw materials on fear of losing competitiveness with the duties imposed (Source: SEAISI newsletter May 2014, p.10). vi. Thailand, Indonesia issue safeguard actions on flat products Indonesia and Thailand have both continued to press on for safeguard action to restrict imports of certain flat rolled steel products. In Indonesia, the Indonesian Safeguard Committee has recommended safeguard measures to be imposed against aluminum-zinc alloy coated sheets (widths 600mm, 1.2mm in thickness, <0.6% carbon). Meanwhile in Thailand, a provisional safeguard measure in the form of a tariff increase of 34.01% of the CIF price is proposed on nonalloy hot rolled coil, sheet and plate imports of thickness mm and 600-3,048mm wide (Source: SEAISI newsletter June 2014, p.9). OCTOBER

20 H. CONCLUSION MALAYSIA EQUITY RESEARCH Exports of Steel Products by China remained high as shown in Charts 15,16 & 17. This has been a consequence of a still high production of steel in China as depicted by Chart 14. As a result of oversupply while demand has been subdued, prices of steel products are likely to remain weak. The oversupply situation has also resulted in the dumping of steel products into the domestic market. We opine that preliminary determination of an interim anti-dumping duty and/or countervailing duty is likely to be affirmative given that evidence of incentives such as tax rebates enjoyed by China mills has already been established. Indonesia for example has already taken action on the similar issue faced by the country. This is to cease the influx of cheaper steel products into the country which took advantage of the loopholes in tariff structures and to prevent further injury to the local steel companies. In Indonesia, the trade ministry recently issued a new regulation to raise the level of supervision on imported alloy steel. This was after Indonesia s government found indications that certain importers exploited loopholes in the country s tariff structure. Earlier, the Indonesian Iron and Steel Industry Association (IISIA) lodged a formal complaint with the industry ministry on the sudden rise in imports of alloy steel infused with boron. The complaint was lodged after suspecting that the surge in imports was due to several importers trying to exploit the loophole in Indonesia s tariff structure that exempted boron-infused steel from import tariffs. In addition, most of the steel were imported from China where the steel industry was subsidized and received incentives, thus making Indonesian steel less competitive. In early 2014, Government has imposed the requirement of import permits (approved permits) for the importation of alloy steel products (bars, wire rods, hot rolled, in particularly wound coils, of other alloy steels) to be subjected to licensing with effective 1st January Alloy steel products under H.S code will be subjected to APs to ensure the quality and standards of the imported products. With the world trade agreements signed and the ASEAN Economic Community 2015 (AEC) just around the corner, it is understandable that the members of Malaysian Iron and Steel Federation (MISIF) members will not be seeking additional duty protection but to seek trade remedies for a level playing field with the foreign steel mills. This is to ensure a fair trade practice and competition in the steel industry that is not subjected to exploitation of any loopholes. With the ASEAN Economic Community (AEC), regional economic integration is targeted to be achieved by AEC aims to achieve i) a single market and production base, ii) a highly competitive economic region, ii) a region of equitable economic development, and iv) a region fully integrated into the global economy. The purpose of AEC is to transform ASEAN into a region with free movement of goods, services, investment, skilled labour, and freer flow of capital. Hence, the various areas of co-operation are targeted to ensure a regional economic integration without any actions of unfair play. 20 OCTOBER 2014

21 APPENDIX Ann Joo Resources All eyes on the potential implementation of trade remedies NEUTRAL Target Price: RM3.61 Investment highlights Ann Joo Group has one blast furnace (BF) with a production capacity of 500,000 mt. It also has 1 unit of 90 tonne direct current (DC) electric arc furnace (EAF) with ladle furnace that has a production capacity of 820,000 mt. For rolling billets into steel bars, wire rods and sections, the Group has mills in Penang and Shah Alam with rolling capacity totaling 710,000 mt. Selling prices of steel products continued to be impacted by the dumping of cheap steel products from China s mills. Imports of cheap steel bars and wire rods continue to rise and this has impacted margins of AJR and other local steel mills. Hence, all eyes are now on anti-dumping duties to be imposed by the Government to cease the influx of the cheap steel products. Currently, investigations are in progress on the dumping of cheap steel products from China. Pending the implementation of anti-dumping duties or other trade remedy, margins of AJR will continue to be negatively impacted. AJR s net gearing ratio stands at 1.28x as at 30 June The Group has been reducing its gearing. It is of the local steel mills with a more efficient cost structure. This is in view of that it has both EOF and BF for manufacturing long steel products. The Group completed its 1st phase of its BF project with an expenditure of RM600m. Phase 2 of the project has yet to commence and has been delayed due to the weaker operating environment of the steel industry. Valuation We value AJR at RM1.25 pegged FY14 BVPS of 0.6x. Moving forward, rerating catalyst on the stock will be when MITI announces the imposition of preliminary anti-dumping duties on steel bars to stop the influx of cheap steel bars from China. Petitions for trade remedies against the dumping of cheap steels bars as well as wire rods from Jiangsu Shagang International Trade Co Ltd and Jiangsu Yonggang Group Co Ltd which were excluded from the earlier anti-dumping duties imposed on imports of wire rods are currently under investigation. Price Chart Stock Info Bursa / Bloomberg 6556 / AJR MK Board / Sector Main / Industrial Shariah Compliant No Issued shares (mil) Par Value (RM) 1.00 Market cap. (RM m) Price over NA 0.54x 52-wk price Range RM RM1.49 Beta (against KLCI) mth Avg Daily Vol 0.43m 3-mth Avg Daily Value RM0.58m Major Shareholders (%) Ann Joo Corp 36.6 Lim Seng Chee & Sons S/B 13.9 Financial Statistics FYE Dec FY13 FY14F Revenue (RM m) 2, ,268.5 EBIT (RM m) Pre-tax Profit (RM m) Net Profit (RM m) EPS (sen) EPS growth (%) PER(x) Net Dividend (sen) Net Dividend Yield (%) Source: Company, MIDFR Forecast OCTOBER