Jiming Zou, Vice President Senior Analyst Asian Steel Producers Supply Glut and Low Prices Will Reduce Earnings and Keep Leverage High in 2016
Agenda 1. Declining Chinese steel demand exacerbates supply glut and price declines 2. Asian steel companies earnings will weaken in 2016 3. Debt leverage will remain high in 2016 after increasing significantly last year 4. Market consolidation will accelerate and favor large companies 2
1 Declining Chinese steel demand exacerbates supply glut and price declines 3
Chinese steel demand will continue to decline in 2016» We expect Chinese steel demand will fall another 5% in 2016 given the slow investments in real estate and infrastructure development as well as weakening domestic manufacturing activity. Real estate sector: a 14% decline in newly started construction areas in 2015 Infrastructure projects: positive growth but won t be sufficient to lift overall demand Manufacturing activities: weakening given China s PMI below 50 (49.4 in January) Chinese Steel Demand and Production Will Decline in 2016 Sources: China Iron & Steel Association, China's General Administration of Customs, Moody s Investors Service projection 4
Chinese steel exports exacerbate regional supply glut» Anti-dumping investigations and safeguard duties will limit Chinese net steel exports growth to a single-digit percentage in 2016 from about 25.5% in 2015.» The slowdown in export growth is from a high base. China s export volume of 112 million tonnes in 2015 was larger than the steel manufactured in Japan.» About two thirds of the Chinese exports were shipped to Asian countries. China s Steel Exports Will Continue Increasing as Imports Decline 5
Significant pricing pressure in the Asian steel industry» The large amount of Chinese steel exports results in significant pricing pressure in Asia.» Chinese export hot rolled coil price of $267 per tonne was much lower than India s domestic price of $400 per tonne at the end of 2015. Significant Pricing Pressure Is Spreading from China to Other Asian Countries 6
Rated Asian steel companies registered price declines» Price declines, coupled with reduced production, led to lower revenues in 2015. Baseline credit assessment/ Fundamental credit profile Outlook Change in 2015 vs. 2014 Average selling price in local currency Revenue in local currency *** Production Moody's rated Asian steel companies Final rating volume POSCO Baa2 Baa2 Negative -16.6% 0.8% -10.6% NSSM (estimated for fiscal year ending March 2016) A3 A3* Review for Downgrade -11.7% -5.3% -11.4% JFE (estimated for fiscal year ending March 2016) (P)Baa1 Baa1* Negative -13.1% -3.4% -11.2% Baoshan Iron & Steel (estimated by Moody's) A3 Baa2 Review for Downgrade -18.6% 5.1% -12.6% Baosteel Group (estimated by Moody's) A3 baa3 Review for Downgrade -20.0% -16.0% -20.0% Hyundai Steel Baa3 Ba2 Positive -6.1% 3.1% -3.8% JSW (estimated by Moody's for Apr-Dec 2015) Ba3 Ba3 Negative -21.2% -2.2% -22.3% Tata Steel (estimated by Moody's for Apr-Dec 2015) Ba3 B1 Negative -16.0% -1.4% -17.2% China Oriental (estimated by Moody's) B2 B2 Negative -31.0% 2.6% -30.0% China's large and medium steel companies ** -31.5% -2.1% -19.5% Sources: Company financial reports, China Iron & Steel Association, Moody Investors Service estimates and projections 7
2 Asian steel companies earnings will weaken in 2016 8
Asian steel production volumes will decrease in 2016» Steel production volumes will decrease primarily because of the decline in Chinese demand. China accounts for three quarters of Asian steel production.» India s demand growth won t be sufficient to prevent an overall demand decline in the region, as India accounts for only about 8% of Asian steel production. Steel Production Volume in Asia Will Trend Lower in 2016 9
Persistent oversupply will prevent price recovery» It will take time for producers to reduce capacity in response to the declining demand.» New steel capacities (see below) coming on-line in 2016 will dilute the efforts of capacity elimination. Baosteel s 9 mtpa Zhanjiang project, Wuhan Iron & Steel Company s 9 mtpa Fangchenggang project, Tata Steel s 3 mtpa greenfield Kalinganagar plant, JSW Steel s 4 mtpa brownfield expansion, Formosa s 7 mtpa Ha Tinh project in Vietnam.» The modest price increase in January 2016 was triggered by a temporary reduction in supply after many steel mills started maintenance and idled production, rather than a fundamental improvement in the supply-demand balance. 10
Asian steel companies have weak bargaining power» Asian steel companies are not able to reduce their input costs faster than the fall in steel prices due to the fragmented nature of the region s steel industry, where many producers bid for seaborne iron ore from a handful of Australian and Brazilian suppliers.» Asian steel companies bargaining power against customers is also weak given the massive oversupply. Steel Prices Have Declined Faster Than Iron Ore Prices Since March 2015 11
Production spread will remain at historical lows» Chinese production spread will remain at historical lows given the limited improvement in demand supply balance and inability to reduce input costs faster than the fall in steel prices.» Steel mills focus on cash flows to pay for employees and interest on bank loans, coupled with asset disposals and government subsidies, keep the mills running despite the deep losses. Production Spread in China Will Remain at Historical Lows 12
Market downturn depressed EBITDA per tonne» Chinese steel producers will underperform regional peers given the massive oversupply in China.» Leading Korean and Japanese steel companies (POSCO, NSSM, JFE) are more resilient thanks to their focus on quality premium products.» The ramp-up of new steel-production capacity, resumed captive iron ore production and the government s introduction of minimum import prices will help Tata Steel and JSW Steel mitigate earnings pressure in 2016. 2015 steel production (million tonne) 2015 EBITDA (USD million) 2015 EBITDA per tonne (USD) 2014 steel production (million tonne) 2014 EBITDA (USD million) 2014 EBITDA per tonne (USD) Year-onyear change in EBITDA per tonne Moody's rated Asian steel companies POSCO 38.0 4,958 130 37.7 6,490 172-24% NSSM 44.8 4,389 98 47.3 6,556 139-29% JFE 30.0 2,246 75 31.0 3,736 120-38% Baoshan Iron & Steel 22.6 2,308 102 21.5 3,247 151-32% Hyundai Steel 19.7 2,497 127 19.1 2,677 140-10% JSW Steel 13.0 856 66 13.3 1,646 124-47% Tata Steel 26.9 1,469 55 27.2 2,997 110-50% China Oriental 10.0 194 19 9.8 330 34-43% 13
3 Debt leverage will remain high in 2016 after increasing significantly last year 14
Debt leverage will remain high in 2016» We expect the rated steel companies' adjusted debt/ebitda to average 5.1x in 2016, up from 4.1x in 2014 and down from 5.7x in 2015 given corporate austerity efforts.» Interest coverage followed a similar deteriorating trend in 2015, and will improve slightly to 7.9x in 2016 but remain lower than the 2014 level of 9.6x.» Unrated steel companies are typically weaker in debt service ratios than those rated ones. EBITDA/Interest Debt/EBITDA Moody's rated Asian steel companies 2014 2015 2016e 2014 2015 2016e POSCO 7.3 6.1 6.4 4.5 5.0 4.5 NSSM 25.6 19.8 19.7 3.4 4.3 4.8 JFE 21.7 15.1 17.3 3.8 5.3 4.7 Baoshan Iron & Steel 10.6 9.2 9.1 2.7 3.8 3.9 Baosteel Group 4.8 4.4 4.1 4.6 5.4 6.1 Hyundai Steel 6.4 6.9 7.4 4.4 4.6 4.3 JSW Steel 2.9 1.4 2.1 3.8 7.7 5.0 Tata Steel 2.8 1.4 1.9 5.0 9.9 7.5 China Oriental 4.0 3.1 3.1 4.3 5.3 5.3 Average 9.6 7.5 7.9 4.1 5.7 5.1 15
Moody s took negative rating actions on most steel companies in recent weeks Asian Steel Companies Current Rating and Outlook Rating Actions POSCO Baa2 negative Outlook changed to negative from stable on 2 Feb 2016. NSSM A3 review for downgrade Rating placed under review for downgrade on 3 Feb 2016. JFE (P)Baa1 negative Outlook changed to negative from stable on 4 Feb 2016. Baoshan Iron & Steel A3 review for downgrade Rating placed under review for downgrade on 19 Feb 2016. Baosteel Group A3 review for downgrade Rating placed under review for downgrade on 19 Feb 2016. Hyundai Steel Baa3 positive No action JSW Steel Ba3 negative Rating downgraded to Ba3 from Ba1 on 3 Feb 2016. Tata Steel Ba3 negative Rating downgraded to Ba3 from Ba1 on 11 Feb 2016. China Oriental B2 negative No action 16
4 Market consolidation will accelerate and favor large companies 17
Consolidation will accelerate and favor large companies» Most rated Asian steel companies are leaders in their respective markets, and have healthier balance sheets and stronger cash flow than the industry average.» Small inefficient producers will become unviable because of their limited resources to cover business losses and cash-flow shortfalls, and to refinance their maturing debt.» The Chinese government is seeking to consolidate the domestic steel industry by rejecting applications for new steel capacity, enforcing stricter environmental regulations against polluting mills and aligning the performance evaluations of local government officials with targets for closing inefficient and polluting mills.» However, significant uncertainty about the pace of the capacity reduction and rebalancing of demand and supply in China, given the need to address unemployment and lost tax revenue resulting from facility closures, and the bad loans on the unviable producers books. 18
Moody s analysts covering Asian steel companies: Jiming Zou VP-Senior Analyst Corporate Finance Group +86.21.2057.4018 jiming.zou@moodys.com Wan Hee Yoo VP-Senior Analyst Corporate Finance Group +852.3758.1316 wanhee.yoo@moodys.com Kaustubh Chaubal VP-Senior Analyst Corporate Finance Group +65.6398.8332 kaustubh.chaubal@moodys.com Takashi Akimoto 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 19
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