China Pulse Check: Steel Sector

Apr 11, 2018 Equity Research | Sector Watch

This is a summary of a report originally written in Chinese. Please contact us for more information of the original report. The Chinese version shall prevail in the event of any discrepancy between the two versions.

Demand should rebound significantly in April, profitability set to improve

Ou Yafei SFC CE No. BFN410 oyf@gf.com.cn +86 20 8757 3009 GF Securities (Hong Kong) Brokerage Limited 29-30/F, Li Po Chun Chambers 189 Des Voeux Road Central Hong Kong Contribution from the GF A-share research team: Li Sha * lisha@gf.com.cn +86 20 8757 4792 * Please note that Li Sha is not a registered licensee with the Securities and Futures Commission of Hong Kong and is not allowed to conduct regulated activities in Hong Kong.

Demand As the weather becomes warmer, migrant workers gradually move back to the

cities, downstream industrial activities resume, and demand rebounds significantly as a

result. Historical data show crude steel consumption during March-April of 2013-17 was

9.49% higher than the Jan-Feb average. Rebar inventory at dealers dropped by 91.5k,

363.6k, and 552.3k tonnes WoW in the first three weeks of March respectively. These

declines were slightly bigger than in 2015-17. Manufacturing PMI came in at 51.5% in

March, 1.2pp higher than the previous month and a peak for 1Q18, indicating business

conditions have improved significantly. We expect a rise in demand which had been

previously depressed by environmental regulations and seasonal productions cuts, and

believe the recovery may exceed market expectations.

Supply As of March 30, blast furnace utilization rates nationwide and in northern China

were 64.50% and 54.29% respectively, which represent 84.18% and 68.03% of the

average during March-Sept of 2017. Heating-season production cuts were ended on

March 15 or 31. Assuming that the national blast furnace utilization rate remains the same

as that prior to the production cuts, our estimates indicate that newly increased production

of pig iron from the removal of production restrictions could have a marginal effect on

national pig iron output of 5.36%. Tangshan and Handan have issued new plans for non-

heating-season production restrictions, which respectively impose 10-15% and 25% cuts

on production. The Hebei Department of Environmental Protection has partially

disqualified six steel mills’ licenses for pollutant discharging, while 133 steel mills were

obligated to rectify their practices within three months with 50% production cuts, and 12

steel mills were charged administrative penalties. The continued strict environmental

regulations have depressed output growth, and accelerated the removal of production

capacity. We therefore think pig iron MoM output growth after the removal of heating-

season production restrictions will be weaker than 5.36%.

Raw materials On March 30, 2018, coke inventory at 110 steel mills amounted to

4.9059m tonnes, up 0.13% MoM and still significantly higher than the peak of 4.60m

tonnes in 2017. As of this date, average inventory days of imported iron ore stood at 30

days, up 2 days MoM and 5 days more than the corresponding period in 2017. As for raw

materials supply, the utilization rate of coking ovens at 100 independent coking plants

reached 78.81%, up 1.09pp MoM and 2.17pp higher than the corresponding period in

2017. Port inventory of iron ore came in at 162.82m tonnes, a new record high and rising

MoM after the CNY holiday, indicating abundant supply. Supply exceeded demand for

upstream raw materials; we therefore expect raw material price growth to be weaker than

for finished steel products.

Considering seasonal factors in Jan-Feb and production halts during the heating season

that depressed demand, the recovery in demand this year may be marginally stronger

than the corresponding periods in previous years. The overall supply-demand situation

should improve. We expect steel prices to stabilize and increase slightly in April, while

earnings should improve significantly.

(Continued on next page…)

Apr 11, 2018

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Sector report

Steel & ore prices slipped in March, steel prices in April may remain stable with a slight

increase, ore prices set to weaken Affected by winter stockpiling at dealers and the lag in the

rebound in downstream demand, steel prices declined overall in March. In April, as the weather

becomes warmer, migrant workers gradually move back to the cities, downstream industrial

activities resume, and demand rebounds significantly as a result. We expect a rise in demand which

had been previously depressed by environmental regulations and seasonal productions cuts, and

believe the recovery may exceed market expectations. On the supply side, the blast furnace

utilization rate was lower than in the same period last year, while as production restrictions for the

heating season were ended on March 15 or 31, growth in pig iron production in the restricted regions

after the removal of the production restrictions should have a marginal effect on national pig iron

output of 5.36%. Demand may rebound marginally stronger than in the same period in previous

years and the overall supply-demand landscape may improve slightly. We expect steel prices to

stabilize and increase slightly.

In March, production restrictions related to environmental protection depressed demand from steel

mills for raw materials, while port ore inventory was high and the corrections in steel prices led both

domestic and foreign ore prices to slip. As of March 30, the utilization rate at 100 independent coking

plants reached 78.81%, up 1.09pp MoM and 2.17pp higher than the same period in 2017; port ore

inventory stood at 162.82m tonnes, hitting a new record high. As port ore inventory has risen MoM

since CNY, supply is abundant. With supply of upstream raw materials exceeding demand, we

expect raw material price growth to be weaker than finished steel products.

Overall profitability in the steel industry dropped in March, demand should rebound

significantly in April, profitability could improve In March, profitability for key steel products

declined overall; gross profit for rebar, hot-rolled and cold-rolled steels was lower than the previous

month. According to Mysteel data, in March 2018, average gross profit for rebar came in at

Rmb1,140.61/tonne, hot-rolled steel was Rmb1,142.72/tonne, and cold-rolled steel was

Rmb1,002.38/tonne. The recovery in demand in April should be stronger than in the same period in

previous years, and the overall supply-demand situation should improve. We expect steel prices to

be stable with a slight increase and profitability to improve significantly in April.

Risks A significant economic downturn; steel exports missing expectations; weaker-than-expected

enforcement of production cuts; coordinated price cuts by major iron ore producers.

Apr 11, 2018

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Sector report

Key data points

Figure 1: 2M18 cumulative FAI growth increased slightly

Sources: NBS, GF Securities Development & Research Center

Figure 2: MoM growth in cumulative ferrous metal FAI strengthened significantly in 2M18

Sources: NBS, GF Securities Development & Research Center

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固定资产投资完成额:累计值 新增固定资产投资完成额:累计值

固定资产投资完成额:累计同比 新增固定资产投资完成额:累计同比

Cumulative FAI (Rmb100m)

Cumulative newly increased fixed assets (Rmb 100m)

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固定资产投资完成额:制造业:黑色金属冶炼及压延加工业:累计同

比工业增加值:黑色金属冶炼及压延加工业:累计同比

Cumulative ferrous metal FAI (YoY)

Cumulative ferrous metal industrial value-added (YoY)

Apr 11, 2018

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Sector report

Figure 3: Feb daily average crude steel output grew significantly MoM

Figure 4: Feb crude steel output up strongly YoY

Sources: NBS, GF Securities Development & Research Center Sources: NBS, GF Securities Development & Research Center

Figure 5: Feb crude steel apparent consumption up sharply YoY Figure 6: Cumulative crude steel apparent consumption up significantly YoY in 2M18

Sources: NBS, General Administration of Customs, GF Securities Development & Research Center

Sources: NBS, General Administration of Customs, GF Securities Development & Research Center

Figure 7: 10D interval inventory at mid/large steel companies up considerably YoY

Figure 8: Steel dealers’ inventory continued to rise in Feb (10k tonnes)

Sources: China Iron and Steel Industry Association, GF Securities Development & Research Center

Sources: www.mysteel.com, GF Securities Development & Research Center

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炼钢产能利用率

Daily avg. crude steel output (10k tonnes)

Daily avg. steel output (10k tonnes)

Steelmaking capacity utilization ratio

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生铁产量同比(%) 粗钢产量同比(%)

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Pig iron output YoY (%)

Steel output YoY (%)

Steel output YoY (%)Crude steel output YoY (%)

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Crude steel monthly apparent consumption (10k tonnes)

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Cumulative crude steel apparent consumption (10k tonnes)

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10D interval steel inventory at key steel companies (10k tonnes)

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Apr 11, 2018

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Sector report

Figure 9: Key operating data for steel-related downstream industries (12M17)

2M18 YoY Monthly YoY

2M18 12M17 Feb 2018 Dec 2017

FAI (Rmb 100m) 44626.00 7.90% 7.20% - -2.29%

Property investment (Rmb 100m)

10831.00 9.90% 7.00% - 2.38%

Property under construction (10k sqm)

632001.56 1.50% 3.00% - -5.86%

Property new starts (10k sqm)

17746.29 2.90% 7.00% - 8.64%

Property completion (10k sqm)

14184.37 -12.10% -4.40% - -13.23%

Property area sold (10k sqm)

14633.00 4.10% 7.70% - 6.14%

Property sales (Rmb 100m)

12454.00 15.30% 13.70% - 20.47%

Metal-cutting machine tool output (10k units)

8.70 -48.82% -17.90% - -15.33%

Industrial boiler output (tonnes of evaporation)

49655.10 -9.69% -5.33% - -9.30%

Locomotive output (unit)

95.00 -21.49% 16.10% - 37.56%

Auto output (unit)

439.37 -2.99% 3.19% -21.02% -0.70%

Auto sales (10k units)

452.67 1.52% 3.04% -11.43% 0.10%

Household refrigerator output (10k units)

1182.90 -11.99% -6.15% - 3.70%

Household washing machine output (10k units)

1100.60 -6.04% -1.57% - -2.50%

AC output (10k units)

2802.30 14.32% 12.40% - 21.40%

Shipbuilding completions (10k DWT)

663.00 -29.17% 20.84% - -19.77%

Civilian steel ship completions (10k DWT)

852.30 -21.69% 2.86% - 798.23%

New shipbuilding orders (10k DWT)

1229.00 456.11% 60.09% - -263.53%

Shipbuilding orders on hand (10k DWT)

9289.00 0.89% -12.43% - -46.10%

Sources: NBS, China Association of Automobile Manufactures, GF Securities Development & Research Center

Apr 11, 2018

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Sector report

Figure 10: YoY growth in cumulative property investment grew significantly in 2M18

Sources: NBS, GF Securities Development & Research Center

Figure 11: YoY growth in cumulative infrastructure investment was 11.34% in 2M18

Sources: NBS, GF Securities Development & Research Center

Figure 12: Long product price index down sharply, flat product price index slightly down

Figure 13: Both closing and settlement prices of active rebar futures contracts weakened

Sources: www.mysteel.com, GF Securities Development & Research Center Sources: Wind, GF Securities Development & Research Center

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房地产开发投资累计同比(%) 房地产开发投资当月同比(%)Cumulative property development investment YoY (%)

Monthly property development investment YoY (%)

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固定资产投资完成额:基础设施建设投资:累计同比YoY growth in cumulative infrastructure FAI (%)

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期货收盘价(活跃合约):螺纹钢

期货结算价(活跃合约):螺纹钢

Rebar futures closing price (active contracts)

Rebar futures settlement price (active contracts)

Apr 11, 2018

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Sector report

What else is in the GFS China Pulse Check?

* The GFS China Pulse Check series offers speedy updates on industry data and exclusive insights

into both short-term and longer-term trends. Its expanding coverage currently includes the following

monthly issues.

Steel sector update: Supply and demand analysis, raw material prices, steel and iron ore prices,

outlook on the coming month.

Steel trade data update: Steel product exports, iron ore imports, steel product profitability, outlook

on the coming month.

Crude steel output update: Monthly and daily crude steel/pig iron output, outlook on the coming

month.

Coal sector update: Thermal coal, coking coal and anthracite prices; supply and demand analysis;

outlook on the coming month.

Property sector update: Policy review, property transactions, land supply and sales, liquidity

supply for developers and home buyers.

Auto sector update: Auto total sales and breakdown, raw material costs.

Building materials sector update: Cement/glass output and prices, downstream industry

(property and infrastructure) sales and investment growth.

Apr 11, 2018

8

Sector report

Rating definitions Benchmark: Hong Kong Hang Seng Index Time horizon: 12 months

Company ratings

Buy Stock expected to outperform benchmark by more than 15%

Accumulate Stock expected to outperform benchmark by more than 5% but not more than 15%

Hold Expected stock relative performance ranges between -5% and 5%

Underperform Stock expected to underperform benchmark by more than 5%

Sector ratings

Positive Sector expected to outperform benchmark by more than 10%

Neutral Expected sector relative performance ranges between -10% and 10%

Cautious Sector expected to underperform benchmark by more than 10%

Analyst Certification The research analyst(s) primarily responsible for the content of this research report, in whole or in part, certifies that with respect to the company or relevant securities that the analyst(s) covered in this report: (1) all of the views expressed accurately reflect his or her personal views on the company or relevant securities mentioned herein; and (2) no part of his or her remuneration was, is, or will be, directly or indirectly, in connection with his or her specific recommendations or views expressed in this research report.

Disclosure of Interests (1) The proprietary trading division of GF Securities (Hong Kong) Brokerage Limited (“GF Securities (Hong Kong)”) and/or its affiliated or associated companies do not hold any shares of the securities mentioned in this research report. (2) GF Securities (Hong Kong) and/or its affiliated or associated companies do not have any investment banking relationship with the companies mentioned in this research report in the past 12 months. (3) Neither the analyst(s) preparing this report nor his/her associate(s) serves as an officer of the company mentioned in this report and has any financial interests or hold any shares of the securities mentioned in this report.

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