China steel bonanza falters as investors fret over demand

10-December-2018

China’s steelmakers are facing their biggest test in three years, as a murky demand outlook drives prices lower and squashes margins.

The world’s biggest steel market is cooling as the broader economy falters amid internal pressures and escalating risks from a trade conflict with the US.

Margins on many products have collapsed and that’s unlikely to turn around without more spending on infrastructure, or other easing measures from policymakers.

Moreover, winter production curbs to contain pollution may prove less exacting than last year and less supportive of prices.

“Steel demand now has some major headwinds, and it’s difficult to guarantee any positive catalyst in the next year,” said Helen Lau, an analyst at Argonaut Securities Asia in Hong Kong.

“The implication is that margins will go down, so there is no way for earnings to improve further – and no way for me to recommend buying steel stock.”

Those stocks have faded dramatically since the summer, overturning predictions that the sector should rally due to state spending and output cuts.

Baoshan Iron & Steel Co, the listed unit of the nation’s top steelmaker, has dropped to its lowest since the middle of last year in Shanghai, while another big producer, Angang Steel Co, is retesting its September lows.

The losses come against the backdrop of declines in a broader market rattled by the trade war, with Baoshan’s price-to-earnings ratio plumbing a record low.

The bearish outlook was compounded on Friday after China’s purchasing manager’s index for the steel industry in November plunged to its lowest since June 2016 as new orders collapsed.

Baoshan and Angang specialise in flat products, which have been among the worst performing types of steel. Hot-rolled coil, used in consumer goods, has slumped to its lowest since April and is down 11% this year.

It’s a big reversal. The industry had enjoyed a bumper period since bouncing back from a crisis in 2015, lifted by sweeping plant closures, targeted production curbs and relatively strong demand.

Baoshan Steel just had its best-ever third quarter profit, while member companies of the China Iron & Steel Association saw profits almost double on the year in the first nine months.

But the intensifying stand-off on trade with the US has only added to the pressures on China’s economy – including the parts that consume most steel.

The property sector, which accounts for 40% of steel demand, according to Citigroup Inc, is slowing, while auto sales are edging toward their first annual decline in at least 20 years.

“The consensus is that there will continue to be a slowdown in the property sector,” said Sandra Huang, an analyst at UOB Kay Hian Hong Kong Ltd in Shanghai.

“The market expects that a pick-up in infrastructure will offset part of that, but we can’t see any clear signs yet that the Chinese government will stimulate infrastructure.”

State intervention has rescued China’s steel sector from previous downturns. If this weekend’s meeting between Presidents Donald Trump and Xi Jinping fails to soften their trade conflict, the Chinese government will have more incentive to take action.

Steel demand next year will “hinge heavily on the scale of the potential economic stimulus package, on which we are broadly constructive given our trust in Beijing’s policy put,” Citigroup analysts including Tracy Liao wrote in a note last week.

“However, if the government does not loosen up property sales, fixed-asset investment may struggle to accelerate much, if at all, next year.”

A more serious downturn will test whether Xi’s so-called supply-side reforms of recent years have effectively transformed the industry, by making it more responsive to changes in demand and therefore better able to defend margins.

As it stands, some mills are already running at a loss, said Yu Chen, an analyst at Mysteel Research in Shanghai. Still, some relief should be around the corner as the winter curbs take effect, said Yu. More broadly, capacity cuts have slimmed the industry so that “there’s not much potential for oversupply anymore,” said Argonaut’s Lau.

That puts mills in a much better position to maintain profitability. “We now have much higher utilisation rates, and margins will still be better than they were before supply-side reforms,” she said.

Source: BLOOMBERG

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