Viewpoint: China’s steel mill profits may plunge

31-Dec-2018

China’s steel sector profits may shrink next year on the back of slowing demand from the real estate and automobile industries. But an expected uptick in infrastructure investment and progress in the US-China trade dispute could offer support to steel prices and profit margins.

The steel sector has been profitable since 2016 following a bleak 2015 when most mills posted sharp losses. Profits in 2017 gained by 178pc from 2016, while January-October 2018 profits were up by 64pc on the year to 355.28bn yuan ($51.5bn).

“Steel mills’ profits next year are not expected to be as good as this year. The comfortable days of the past three years are unlikely to be sustained in 2019, mostly because we are not optimistic about China’s macro-economic outlook in 2019,” said the manager of a Shanghai-based steel mill.

But most market participants are confident that mills will not slip into losses. Steel mills’ gross profits will average Yn600-800/t in 2019, said the manager of a south China-based mill, while a Beijing-based trader said profits may be in the Yn100-500/t range.

Real estate demand is key

Chinese steel mill profits have been above Yn1,000/t for most of this year until mid-November when margins slumped, with several mills now operating at breakeven or even making losses. The key driver for profitability since 2016 has been the robust real estate market, as China’s construction sector accounts for around 60pc of the country’s domestic steel consumption.

The real estate sector surprised analysts this year with a nearly 10pc growth in investments and a sharp acceleration in new project start-ups, despite Beijing’s restrictions on new home purchases in larger cities to prevent an asset bubble. Smaller cities picked up the slack, posting a sharp increase in home prices and project developments.

But the industry could be running out of steam. Real estate sales may fall by 5pc on the year in 2019 because of stricter regulatory controls on home purchases, tighter access to funding for developers and home buyers and a downturn in sentiment caused by slowing economic growth, according to an analyst report by ratings firm Moody’s. “The growth in property selling prices in second- and third-tier cities will slow because of weaker sales and price caps in cities with strong price growth,” the report stated.

Singapore-based DBS Bank has forecast a 15pc year-on-year fall in China’s real estate sales volume in 2019.

Beijing is also expected to slow the pace of its shanty-town redevelopment projects in 2019, which has added several millions of housing units in 2017 and 2018. This could affect construction sector steel demand. But the central government may step in to ease home-buying rules and financing constraints if real estate sales fall too sharply as this may derail economic growth, given that various industries such as steel, cement and machinery depend on the real estate sector for a large chunk of business.

The biggest impact of slower real estate growth will be on prices of rebar, wire rod and billet, which have posted price and profit gains during most of this year. Rebar profits and prices are likely to fall next year because of a higher base effect and continued increase in steel production, said an east China-based steel trader.

The profit margins of construction steel producers may fall very sharply and even hit zero in the first quarter of 2019 as the current slump in prices and demand during the winter months continue. Profits will recover from April, but overall profit margins in April-September may not be as high as they were during the same period this year, said a Beijing-based steel trader.

Infrastructure activity may pick up

The country’s economic growth is expected to slow next year, with the rate of slowdown dependent on how quickly the US and China resolve their trade dispute. China’s gross domestic product (GDP) growth may slow to 6pc in a bear scenario, where the US-China trade conflict continues, or it may be at 6.6pc if the dispute is satisfactorily resolved soon, said Chinese investment research firm CICC.

Higher tariffs on more Chinese products will affect flat steel demand, which is already suffering as China focuses on growing high-tech and green technology industries and shedding excess capacity in several sectors, including heavy industries such as steel and cement.

“Hot-rolled coil profits are likely to shrink further next year, with the automobile industry expected to remain sluggish,” said a northeast China-based steel trader. Among flat products, profits for steel plates may remain stable since these products are mainly used for bridge construction and shipbuilding, which are unlikely to see much downside, he added.

“I am not positive on the outlook for China’s manufacturing sector next year. I have little doubt that our mill’s profit margin in 2019 would be much lower than this year,” said the manager of a Tangshan-based mill.

Automobile sales growth in China may decrease by 5pc on the year in 2018, with the rate of decline likely to increase to 8pc year on year in 2019 unless there are policy stimulus measures such as a tax cut on automobile purchases, said analyst Victoria Li from research firm Smartkarma.com. Automobile sales have fallen by 4pc in January-November from a year earlier.

Perhaps the only positive note for steel demand in 2019 is a possible uptick in infrastructure activity. China’s infrastructure growth rate cratered in 2018, falling to around 3.7pc during January-October compared with 19pc in 2017. There is an expectation that more infrastructure projects will be rolled out next year as part of measures to stimulate the country’s economy.

“Steel demand will remain good next year, shored up by infrastructure construction, with more new projects starting up and several ongoing projects in construction stage,” said the manager of a north China-based mill.

Better utilisation of unused funds, more private-public partnership projects and the government’s comfort with raising more loans for projects will spur infrastructure activity next year, but the growth rates may still be lower than the high levels seen in previous years, according to a note by Chinese equities brokerage Northeast Securities.

Source: ARGUS MEDIA