Steel - Asia 2017 Outlook - Weakening Production and Earnings Keep Outlook Negative Jiming Zou VP-Senior Analyst +86.21.2057.4018 jiming.zou@moodys.com Kaustubh Chaubal VP-Senior Analyst +65.6398.8332 kaustubh.chaubal@moodys.com Takashi Akimoto AVP-Analyst +81.3.5408.4208 takashi.akimoto@moodys.com Wan Hee Yoo VP-Senior Analyst +852.3758.1316 wanhee.yoo@moodys.com November 2016
Weakening Production, Lower Profitability Drag on Earnings NEGATIVE STABLE POSITIVE» Steelmakers earnings will weaken amid declining production and lower profitability» Declining Chinese demand and global trade barriers, which limit exports, will reduce Asia s overall steel production» Overcapacity will keep steel prices and profitability low» Impact of reduced supply and consolidation in China will be limited What could change outlook to stable» If we expect China s PMI to stay above 50, indicating expansionary manufacturing activity, and» EBITDA per tonne of major Asian steelmakers shows signs of improvement in the next 12 months» Both factors would stabilize steelmakers earnings What could change outlook to positive» A positive outlook is unlikely over the next 12 months given the negative outlook Note: Since outlooks represent our forward-looking view on business conditions that factor into our ratings, a negative (positive) outlook suggests that negative (positive) rating actions are more likely on average. However, the industry outlook does not represent a sum of upgrades, downgrades or ratings under review, or an average of the rating outlooks of issuers in the industry, but rather our assessment of the main direction of business fundamentals within the overall industry. 2
China Drives Demand Weakness; Business Conditions Vary by Country Key credit themes» China drives the outlook because it is the region s largest steel consumer and producer by far» Slowing demand from China s property sector will reduce overall steel demand» Increasing trade barriers, which constrain steel exports from Asia, contribute to the production decline» Steelmakers robust profitability in mid-2016 is unsustainable, and we expect EBITDA per tonne to weaken in 2017» India is the only bright spot with rising demand and protectionist measures, while currency movements will have a large influence on Japanese companies profitability 3
Asian Steelmakers Earnings Will Weaken in 2017» Weakening stems from: Declining Asian steel production given decreasing Chinese demand and slowing exports Weakened profitability because robust earnings in 2016 are unsustainable amid persistent oversupply and limited ability to pass on rising raw material costs to customers Pre-Tax Profit of Chinese Large and Medium Steel Companies Will Weaken in 2017 15,000 10,000 RMB million 5,000 0-5,000-10,000-15,000 Sources: China Iron & Steel Association, Moody s Investors Service projection 4
Asian Steel Production Volumes Will Decrease» China: Steel production will contract by a low- to mid-single-digit percentage in 2017 due to declining domestic demand and slowing exports; China accounts for about three quarters of Asian steel production» Japan, Korea, Taiwan: Increasing trade frictions will continue to curb steel exports and production; currency movements will remain a key driver of Japanese steel exports and production» India: Production will increase to meet domestic demand but won t offset the regional production decline; India accounts for only about 8% of Asian steel production Steel Production Will Decrease in Asia Despite an Increase in India 15.0% Japan China Korea Taiwan India Total Year-on-year steel production growth rate 10.0% 5.0% 0.0% -5.0% -10.0% 2013 2014 2015 Jan-Aug 2016 2017e Sources: World Steel Association, Moody s Investors Service projection 5
Profitability Will Weaken in 2017» Temporary rebound in steel profitability in mid-2016 is unsustainable because: The rebound, stemming from a rise in steel prices, will encourage steel companies to continue producing, slowing the pace of capacity reduction and driving prices back down Price pressure will also re-emerge amid slowing demand Weak bargaining power will hinder steel producers ability to pass on rising raw material costs to customers Chinese Steel Production Spread, a Measure of Asian Steel Companies Profitability, Will Weaken in 2017 from High Mid-2016 Level 6000 China's steel production spread (right axis) Iron ore 62% at Qingdao (left axis) China hot rolled steel sheet spot price (left axis) Foundry coke spot price Shanghai (left axis) 2,500 5000 2,000 RMB/tonne 4000 3000 2000 1000 0 Profitability will weaken from the level seen in mid-2016 1,500 1,000 500 - RMB/tonne Sources: Bloomberg prices, Moody s Investors Service projection 6
Steel Demand in China, Asia s Largest Market, to Decline» Chinese steel demand will decline by about a low- to mid-single-digit percentage in 2017, following flat growth in 2016 China's apparent steel demand Year-on-year demand growth 800 25% 700 20% 600 15% million tonnes 500 400 300 10% 5% growth rate 200 0% 100-5% 0 2008 2009 2010 2011 2012 2013 2014 2015 LTMSep16 2016e 2017e -10% Note: Apparent steel demand = production less net exports Sources: China Iron & Steel Association, China's General Administration of Customs, Moody s Investors Service projection 7
China s Slowing Property Sales Reduce Steel Demand» Property sales volumes will decline moderately following the tightening of regulatory measures in September and October 2016; this will curb property investment (30%-40% of steel demand) and reduce steel demand in 2017» Continued infrastructure investments (about 20% of demand) are insufficient to avert a decline in China s steel demand» China s manufacturing activities (about 45% of demand) remain vulnerable to the slowing GDP growth and are therefore unlikely to boost steel demand Property Investment Will Moderate, After an Uptick in 1H 2016 China s PMI Improved in Oct, but Remains Vulnerable to the Slowing GDP growth 35.0% 30.0% 25.0% 20.0% 15.0% Property investment growth 51.5 51 50.5 50 10.0% 5.0% 0.0% 2008 2009 2010 2011 2012 2013 2014 2015 Q12016 Jan-Sep 2016 Source: China s National Statistics Bureau 49.5 49 Source: China Federation of Logistics & Purchasing 8
Increasing Trade Frictions Constrain Asian Steel Exports» The US and EU have taken multiple actions on steel imports from Asia, which constrain exports» Chinese steel exports have slowed in the last 12 months and will flatten out in 2017, compared with 20% growth in 2015» Japan, Korea and Taiwan, which export around 40%-50% of their steel output, are also challenged by increasing anti-dumping duties million tonnes China s Steel Export Growth Is Slowing China's steel exports Year-on-year export growth 140.0 80% 120.0 100.0 80.0 60.0 40.0 20.0-112.4 115 116 116 70% 93.8 60% 50% 62.3 55.8 40% 48.9 42.6 30% 20% 10% 0% growth rate Major Asian Steel-Producing Economies Have Large Export Exposure As of 2015 million tonnes Steel exports Steel production % of total production China 112 804 14% Japan 41 105 39% South Korea 31 70 45% Taiwan 11 21 52% Sources: China's General Administration of Customs, Moody s Investors Service projection Sources: World Steel Association, Moody's Investors Service 9
Business Fundamentals Vary Across the Region» China: Steelmakers profitability will remain below regional peers amid declining domestic demand, excess supply and slowing exports Baosteel s profitability will likely weaken in 2017 after an expected improvement in 2016 due to the impact of its merger with less profitable WISCO and persistent oversupply in China; but Baosteel will increase its market share, achieve operational synergies with WISCO and continue to outperform its domestic peers» Japan and Korea: Trade barriers will hit production and earnings; Japanese steel companies profitability will be largely affected by currency movements US anti-dumping tariffs on some Korean steel products will reduce POSCO s export profit The strong yen weakens the competitiveness of NSSM and JFE Holdings because they have kept their upstream steel-manufacturing processes in Japan; both reported operating losses in the April-June 2016 quarter» India: Growing domestic demand, minimum import prices and anti-dumping duties support Indian producers As a result, Tata Steel Ltd. s Indian operations and JSW Steel will improve their earnings in 2017, with further support from the ramp-up of Tata Steel s greenfield Kalinganagar operations and JSW s brownfield expansion» Rated steel producers remain more profitable than the regional industry average; most producers are leaders in their respective countries, sell high-margin premium steel products and benefit from business integration and diversification 10
Rated Asian Steel Companies Issuer Country Rating Outlook Nippon Steel & Sumitomo Metal Corp Japan Baa1 Negative Baosteel Group Corporation China Baa1 Negative Baoshan Iron & Steel Co. Ltd. China Baa1 Negative POSCO Korea Baa2 Stable JFE Holdings Japan (P)Baa2 Negative Hyundai Steel Korea Baa2 Stable Tata Steel India Ba3 Negative JSW Steel Limited India Ba3 Negative Source: Moody s Investors Service 11
Jiming Zou Vice President - Senior Analyst Corporate Finance Group +86.21.2057.4018 jiming.zou@moodys.com Wan Hee Yoo Vice President - Senior Analyst Corporate Finance Group +852.3758.1316 wanhee.yoo@moodys.com Kaustubh Chaubal Vice President - Senior Analyst Corporate Finance Group +65.6398.8332 kaustubh.chaubal@moodys.com Takashi Akimoto Assistant Vice President - Analyst Corporate Finance Group +81.3.5408.4208 takashi.akimoto@moodys.com Chris Park Associate Managing Director Corporate Finance Group +852.3758.1366 chris.park@moodys.com 12
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