Sector Insights Monday, August 05, 2013 Brazil s Steel Industry: Still a Challenging Scenario Ahead Low global growth and high inventories are constraining international and domestic steel prices, limiting profit margins in the Brazilian steel sector. A high tax burden hinders the competitiveness of the sector in Brazil and brings steel imports into the country. A measure in effect since January 2013 that establishes a single rate of for the interstate Brazilian tax called ICMS on imported products is likely to reduce import incentives and boost domestic production. The devaluation of the Brazilian real is likely to be positive for the steel sector, which should also benefit from general industrial growth and faster progress on infrastructure projects. In light of this scenario, we forecast slight increases of 0. in annual crude steel production and 0.6% in annual rolled steel production for 2013. For 2014, we forecast increases of 2.3% and 2.2%, respectively. However, the risk of lower domestic activity growth in the coming quarters has increased in recent weeks, which could adversely affect the growth of the steel sector. As the Brazilian steel companies are operating at low capacity utilization (with an average capacity utilization rate of 69% this year), some investments in additional capacity are being postponed. Global oversupply continues Crude Steel Production - Main Producers Rank Coutry 2003 2012 var. 2012/03 1 China 220.1 708.8 222% 2 Japan 110.5 107.2-3% 3 USA 93.6 88.6-4 India 31.8 76.7 141% 5 Russia 62.7 70.6 13% 6 South Korea 46.3 69.3 50% 7 Germany 44.8 42.6-8 Turkey 18.2 35.9 97% 9 Brazil 31.2 34.7 11% The global steel industry faced great difficulties in 2012 due to low global growth. Excess global capacity amounted to over 500 million metric tonnes, equivalent to almost 30% of total capacity. This oversupply has continued into 2013, and looking ahead, steel plants expected to become operational in China and India in the near future will likely only add to it. According to the World Steel Association (WSA), World Total 968.3 1,548 60% Source: World Steel Association, Itaú the worldwide production of crude steel grew by 0.7% in 2012, compared with 2011, reaching a record high of 1.55 billion tonnes. In the same period, the apparent consumption of steel products (domestic production plus imports, minus exports) rose by 1.2%, reaching 1.41 billion tonnes. This year, global steel production stands at 789.01 million tonnes as of June, an increase of 2.1% compared with the same period last year. Despite concerns about oversupply and economic slowdown, China remains the largest contributor to the increase in world production and consumption of crude steel. In 2013, China s cumulative steel production reached 389.1 million tonnes as of June, up 7.7% compared with the same period in 2012. Please refer to the last page of this report for important disclosures, analyst and additional information. Itaú Unibanco or its subsidiaries may do or seek to do busines Please refer to the last page of this report for important disclosures, analyst and additional information. Itaú Unibanco or its subsidiaries may do or seek to do business with companies covered in this research report. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the single factor in making their investment decision.
In the EU, however, cumulative steel production in 2013 through June fell by 5.1% compared with the same period in 2012, to 84.3 million tonnes. Over this period, production in Italy, Germany and France fell by 14.7%, 0.9% and 4.3%, respectively, compared with 2012. In North America, production fell by 5.8% in the same comparison, to 59.1 million tonnes, with the U.S. and Canada posting drops of 6. and 9.1%, respectively. In South America, the cumulative production in the first half of the year decreased by 4.6% in 2013 compared with the first half of 2012, to 22.5 million tonnes. Given the excess idle capacity and the slowdown in the Chinese economy, the steel industry will likely not greatly increase production in the short term, instead keeping pace with consumption growth and selling inventory. On the demand side, in 2012, the apparent consumption of steel products grew by 1.9% in China, by 8. in the United States and by 2.6% in Central and South America. The EU countries, on the other hand, posted a 9.3% drop in consumption. China Now Accounts for 46% of Apparent Consumption of Steel Products World ex. China China Total 378 418 447 762 800 772 551 589 588 634 646 713 761 766 World Steel Production Surplus - 2012 2.090 Capacity surplus 542 1.548 Production surplus 139 1.409 2006 2007 2008 2009 2010 2011 2012 Source: World Steel Association Capacity Production Consumption Source: Brazilian Steel Company Usiminas International prices likely to remain low in 2013 With the downturn in world consumption, we believe that idle capacity and high inventories will continue driving international prices down, as it will probably take time for the surplus to be absorbed. Thus, worldwide, margins for steel companies are likely to be low. The price of steel will probably track the prices of raw materials such as iron ore and coal, which have been running at lower levels lately. 1200 1100 1000 900 800 700 600 500 400 Hot Rolled Coil Price from USA/Canada USD, short tonne 300 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12 Jun-13 Source: Bloomberg Page 2
Brazil: Crude steel production is likely to make a stronger recovery only in 2014 40 35 Brazil: High Inventories Should Bring Greater Recovery Only in 2014, 12-month ac. 100% 9 90% Steel industry Capacity Utilization in Brazil is Very Low World Brazil 30 8 25 80% 20 15 Crude Steel Rolled Steel 10 Jun-01 Jun-03 Jun-05 Jun-07 Jun-09 Jun-11 Jun-13 Jun-15 Source: Brazil Steel Institute - IABr, Itaú Forecast 7 70% 6 60% 2002 2005 2008 2011 fev-13 Source: Brazil Steel Institute - IABr, Worldsteel In Brazil, due to the global economic situation and its negative effects, both exports and domestic demand underperformed in 2012 and in the first half of 2013. As a result, steel mills in Brazil have been operating at low capacity (running at an average capacity utilization rate of 69% in 2013 through April, down from around 72% on average in 2012). Before the crisis in 2008, this indicator was above 8. According to data from the Brazil Steel Institute (IABr), cumulative Brazilian production of crude steel in 2013 through June fell by 2.2% from the same period in 2012, to 17 million tonnes. Cumulative production of rolled steel (flat and long) in the first half of 2013 rose by 0.9% compared with the same period of 2012. In the same comparison, production of flat steel (widely used in the automotive sector) rose by 0.7%, while production of long steel (widely used in construction, with production generally keeping pace with the consumer market) grew by 1.1%. Domestic sales of steel products in the first half of 2013 grew by 2.7% compared with the same period in the previous year, reaching 11.3 million tonnes. The apparent consumption of rolled products fell by 3. in the first half of 2013, to 12.7 million tonnes, compared with the first half of 2012. In 2012, apparent steel consumption in Brazil amounted to 25.1 million tonnes, virtually flat with the previous year. According to WSA s April 2013 estimate, accelerating investments in infrastructure along with a reduction in steel inventories by the country s consumer industries should lead to growth in Brazilian apparent steel consumption both this year and in 2014. Looking ahead, we expect the improvement in global economic activity and the depreciation of the Brazilian real, combined with reduced inventories, industry recovery and faster progress on infrastructure projects, to lead to a slight increase in domestic production of crude steel and rolled steel products in the coming months. We forecast a slight increase of 0. in the production of crude steel this year, along with a 0.6% rise in the production of rolled steel products. For 2014, we forecast increases of 2.3% and 2.2%, respectively, in these two categories. However, in recent weeks we have seen an increasing risk of lower domestic activity growth in the coming quarters, which could negatively affect the growth of the steel sector. Page 3
Since 2008, there has been a significant increase in imports of steel and steel-intensive products such as machinery and equipment Of the total volume internally produced by the Brazilian steel industry in 2012, 28.0% was exported, slightly below the industry average for Brazil of the past five years (29.2%). Brazilian Exports of Steel Products Are Falling in 2013 8.6 5.2 3.4 9.0 4.7 4.2 10.8 5.2 9.7 4.5 5.6 5.2 4.4 2009 2010 2011 2012 2013 Source: Brazil Steel Institute - IABr, Itaú Jan-Jun Jul-Dec Total High imports despite low capacity utilization in Brazil Direct Imports Indirect Imports** Total 3,6 2,2 1,7 1,9 0,5 0,8 1,2 1,4 1,7 3,9 1,6 2,3 5,9 2,7 3,2 4,9 2,3 2,6 10,1 5,9 3,8 4,2 8,8 8,5 8,6 3,8 3,4 5,0 4,7 5,2 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013* * 1º Q/13 annualized **Includes steel contained in automobiles, white goods, auto parts, machinery and equipment Source: Instituto Aço Brasil, MDIC - SECEX, Itaú In the first half of 2013, Brazilian exports of steel products amounted to 4.4 million tonnes, representing a decrease of 14. in volume compared with the same period in 2012. The share of steel products in the county s exports was approximately (US$/FOB) in this period. The main destinations were the U.S. (33%), the Netherlands (8%) and Argentina (7%). Oversupply in the global steel market has caused the Brazilian steel sector to suffer reduced margins and high import volumes, with increases concentrated in indirect steel imports (i.e., the steel contained in automobiles, white goods, auto parts, machinery and equipment). Direct imports totaled 2.1 million tonnes in the first half of this year, a drop of 4.9% from 2012. During this period, imports accounted for less than 2% of Brazilian imports (US$/FOB). The main countries of origin were China (23%) and South Korea (9%). Indirect steel imports, however, grew by 1 in the first half of this year, compared with the same period of 2012, according to the National Institute of Steel Distributors (Inda). The Brazilian market has been targeted by manufacturers from abroad, especially China, Turkey and Eastern European Export and Import Coefficients Are Rising Again in the Metallurgical Sector* 40% 3 30% 2 20% 1 10% Import Coefficient * includes Steel Industry Export Coefficient 0% 1996 1998 2000 2002 2004 2006 2008 2010 2012 Source: Brazilian Industry Confederation - CNI countries. It is worth noting that China has turned from being an importer to being a net exporter of steel products. Intense competition, subsidies granted by certain countries and structural issues in Brazil, such as a high tax burden and poor infrastructure, are hindering the competitiveness of Brazilian products. The government has been taking some measures to alleviate this problem. On January 1, 2013, Resolution 13 of the Federal Senate came into force, establishing a single rate of for the interstate ICMS tax on imported products. The measure aims to end the so-called Port War by reducing the differential import incentives that Page 4
were being granted by various Brazilian states. Our assessment is that this measure will lead to an overall reduction in steel imports to Brazil. Destination of Brazilian Steel Products Exports - 1 st half of 2013 36% USA 36% 3 Source of Brazilian Steel Products Imports - 1 st half of 2013 China 23% South Korea 9% Japan Mexico 3% China 6% Argentina 7% Source: SECEX, Itaú Netherlands 8% Russia Germany Austria Argentina 6% Taiwan Source: SECEX, Itaú USA Turkey Costs: tax burden affects Brazilian production costs The main production costs of Brazilian steel mills are, in ascending order, coal/coke, labor and iron ore. Iron ore usually accounts for to 6% of production costs, depending on whether the mill has its own mine. Thus, the current slump in iron ore international prices should benefit the steel industry (see our report Sector Insights - Mining, published on 06/28/2013), even if the savings are partly offset by the devaluation of the Brazilian real. The reduction in energy costs, also, will benefit the national steel industry, although energy costs are still quite high in Brazil compared with other countries. The Brazilian steel industry imports almost all the mineral coal it uses. International coal prices are also falling, but this drop will likely be partly offset internally by the devaluation of the Brazilian real against the dollar. On the other hand, the Brazilian tax system affects the competitiveness of domestic steel products. The cost of taxes amounts to 50% in the case of steel rods, for example. Before taxes, the Brazilian industry ranks fourth-lowest in the world in the production cost of steel rods; the inclusion of taxes pushes Brazil to the sixth position in the ranking. Steel Industry Cost Structure operating costs and expenses 7% Nonoperating expenses 6% Personnel expenses 9% Example of Cost Structure: CSN Brazilian Steel Company With Own Mine Maintenance / General Costs 20% Coal 19% Depreciation 21% Industrial services provided by third parties and Maintenance Parts and accessories Electricity and fuel consumption 2% Source: PIA - IBGE, Itaú Raw materials, auxiliary materials and components 40% 11% Iron ore Energy/ Fuels 9% Plates/Coils 2% Coke 10% Source: CSN, 2012 Metals Depreciation 11% Personnel expenses 10% Page 5
Domestic prices will probably follow the same trend as international prices Domestic steel prices are likely to follow the same trend as international prices, remaining at low levels. However, they also depend on import tariffs and the exchange rate. We forecast that the value of the Brazilian real will probably remain depressed throughout this year and 2014, compared with 2012. The steel industry started the year by announcing price adjustments to distributors. Although positive for companies, we believe that the implementation of price adjustments will be gradual and will run into strong resistance from distributors. With idle capacity, the investment outlook for Brazil s steel sector dims With excess capacity and demand reacting slowly, investments in capacity expansion in Brazil will probably stay below the levels that were initially planned by BNDES for 2013-16 (see table). We expect investment volume to be 20% below the level of the previous four-year period (2008-2011). With a less-optimistic scenario and idle capacity, the 2013-2016 investment outlook for the steel sector in Brazil has dimmed Planned investments (R$ in billions) Sectors 2008-2011 2013-2016 Change % Oil & Gas 276 405 46.7 Minning 67 57-14.9 Vehicles 42 63 50.0 Pulp and Paper 21 30 42.9 Sugar Energy 47 5-89.4 Chemical 23 30 30.4 Steel 35 28-20.0 Eletronics 22 28 27.3 Textile & Clothing 12 14 16.7 Health 10 12 20.0 Aeronautics 3 10 233.3 288 352 22.1 Total Industry 846 1,034 22.0 Infrastructure 359 489 36.2 Housing 596 770 29.1 Agriculture & Services 1,149 1,515 31.9 Total 2,951 3,807 29.0 Source: National Bank for Economic and Social Development BNDES Investment Outlook, February 2013 Page 6
Iron Ore Steel Equipment Coal Steel Construction Shipyards Packaging Automobile Chemical Products & Gas Pulp Aluminum Sector Insights Monday, August 05, 2013 APPENDIX: THE STEEL INDUSTRY The steel industry is a major component of global economic production The steel industry is a key industry in the world economy, as it serves as the foundation for several extensive production chains, including the automotive, construction and capital goods industries (together, these industries account for 80% of the consumption of steel products). The construction sector alone accounted for 46% of worldwide steel consumption in 2011, and this share is expected to exceed 50% by 2020. China is now the world s largest consumer of steel. The country s rapid growth has led to an increase in its production, consumption and exports of steel. Between 2003 and 2012, Chinese steel production rose by 222% (to 708.8 million tonnes from 220.1 million tonnes), while consumption grew by 159% over the same period. 1800 1600 1400 China has Contributed to Strong Increase in World Production of Steel World World ex. China China 1200 1000 800 600 400 200 0 2000 2002 2004 2006 2008 2010 2012 Source: Brazil Steel Institute - IABr During this period, a broad industry consolidation process took place, with the formation of large international groups aiming to achieve greater production scale and operational synergies. Yet despite this consolidation, the industry remains highly dispersed. Global Steel Industry is Still Highly Fragmented 90% 80% 6 70% 60% 30%19% 2 27% 3 48% Suppliers for the steel industry Consumers of the steel industry industries Participation of the top 5 companies on world total Source: Metal Bulletin, IABr Page 7
The Steel Production Process The basic inputs for steel production are iron ore, coal and limestone. Steel production may be divided into four stages: load preparation, reduction, refining and rolling. There is usually no seasonality in the production of steel, as the blast furnaces operate continuously. According to the Brazil Steel Institute, in the first stage, a large portion of the iron ore (fines) is agglomerated using lime and coke fines. The resulting product is called sinter. Coal is processed in the coke oven and becomes coke. During the reduction process, those raw materials, now ready, are placed in the blast furnace. During this stage the process of reducing iron ore into a liquid metal, pig iron, begins. In the refining stage, some of the carbon contained in the pig iron is removed, together with impurities. Most of the liquid steel is solidified into continuous casting equipment, to produce semi-finished products, ingots and blocks. Finally, in the rolling stage, rolling mills transform semi-finished steel products into a wide variety of (rolled) steel products. Steel mills can be classified according to their production process: Integrated mills: mills that produce steel from iron ore using coal (mineral or vegetable) as a reducing agent in blast furnaces to obtain metallic iron. It should be noted that charcoal is only used in lower-capacity blast furnaces. Integrated mills carry out the entire production process, producing finished steel. Semi-integrated mills: mills that lack the reduction stage and use steel scrap and pig iron to feed electric steel shops. Non-integrated mills: mills that have only reduction or processing units and therefore do not produce finished steel. Simplified Steel Production Flow Source: Brazil Steel Institute - IABr Page 8
The steel industry in Brazil In Brazil, the steel industry is of great importance, not only for its 2.1% share of the country s industrial GDP, 1 but also for providing basic inputs to other industries, as well as to the rest of the world. Brazil s steelmaking capacity is spread throughout ten states, with the highest concentration in the Southeast region, which accounts for 9 of steel production in the country. All six major coke-based integrated mills are located in the Southeast, as are six of the seven charcoal-based mills. Sectoral Distribution of Consumption of Steel Products in Brazil - 2012 Construction Automotive Capital Goods Housewares Pipes Packaging and Containers 6. 4. 3.1% 5.2% Source: Brazil Steel Institute (IABr) 20.7% 24.7% 35. Brazil s steel industry has 29 mills belonging to 11 corporate groups, with 14 integrated mills and 15 semi-integrated mills, and an installed production capacity of 48.4 million tonnes of crude steel per year. Steelmaking Installed Capacity in Brazil Source: Brazil Steel Institute Luzineide Sales Mariana Orsini M. de Sousa 1 Data for 2009 Page 9
Macro Research Itaú Ilan Goldfajn Chief Economist Tel: +5511 3708-2696 Click here to visit our digital research library. Relevant Information 1. This report has been prepared and issued by the Macro Research Department of Banco Itaú Unibanco S.A. ( Itaú Unibanco ). This report is not a product of the Equity Research Department of Itaú Unibanco or Itaú Corretora de Valores S.A. and should not be construed as a research report ( relatório de análise ) for the purposes of the article 1 of the CVM Instruction NR. 483, dated July 06, 2010. 2. This report aims at providing macroeconomics information, and does not constitute, and should not be construed as an offer to buy or sell, or a solicitation of an offer to buy or sell any financial instrument, or to participate in any particular trading strategy in any jurisdiction. The information herein is believed to be reliable as of the date on which this report was issued and has been obtained from public sources believed to be reliable. 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