Sharp Profitability Decline amid Demand Destruction keeps Steel Outlook Negative - Moodys
Moodys outlook for the Asia Pacific steel industry remains negative. This outlook reflects Moodys expectations for fundamental business conditions in the industry over the next 12 months. It said “Falling demand will exacerbate profitability decline. Aggregate EBlTDA-per-ton profitability of the nine rated Asia Pacific steel-makers will decline by a further 15% in the 12 months to March 2021, after falling 30% a year earlier. Deteriorating economic conditions, the coronavirus-induced demand shock and producers' inability to pass on elevated costs to customers will severely hit profitability. Absolute EBITDA will decline around 20%, steeper than the EBlTDA/ton reduction, as sales volumes fall. Input costs will remain high, keeping product spreads narrow. Prices of iron ore, the main steelmaking material, will stay high over the next 12 months. Prices of metallurgical coal, the other key raw material, are falling on weak steel demand. Still, product spreads will remain narrow and profitability low because of soft steel selling prices and the elevated iron-ore price.”
Rated steel-makers' sales volume will contract for the first time since 2015. Sales volume will fall a mid-single digit in Korea Aa2 stable, around 10% in India Baa3 negative and a midteen percentage in Japan A1 stable. Plummeting automaker demand and weakness in construction, infrastructure and shipbuilding will drive the decline. China's A1 stable demand, however, will fall marginally by a low-single-digit given government support measures for infrastructure construction. Steel supply will remain broadly stable in APAC with most steel-makers delaying expansion amid the pandemic. The pandemic will cause rated Asia Pacific steel-makers' sales volumes to shrink around 6% in the 12 months ending March 2021 from a year earlier. In comparison, steel volumes declined 5% during the last downturn in 2015. Risks to this forecast remain to the downside given the uncertainty of economic recovery regionally and globally amid the high risk of resurgence in infections.
China's (A1 stable) economic growth is slowing, following years of sustained expansion. Real GDP will grow only around 1% in 2020 and as a result the country's steel consumption will likely decline by a low-single-digit percentage during LTM March 2021. Growth in infrastructure construction, which accounts for the largest portion of the country's total steel consumption, will mostly offset weak demand from the manufacturing including auto, property and shipbuilding sectors. We expect the pace of infrastructure investments to pick up in 2020-21, underpinned by the central government's spending to spur economic growth. Since late 2018, the Chinese government has articulated policies supporting faster growth of key infrastructure investments, including railway and toll-road construction. Meanwhile, demand from the property sector, another steel-intensive industry, will be weaker in 2020 than 2019. Weaker demand takes into account sales disruptions in the beginning of the year, lower economic growth, weaker demand in some lower-tier cities and our expectation that the government will not use the property sector to stimulate economic growth. Moodys expects 2020 national sales will be modestly weaker than in 2019. Weak Chinese auto sales will dampen demand for steel products such as auto sheets. Auto unit sales in China will contract 10% in 2020 amid signs that demand is beginning to return to normal levels following a sharp Q1 decline.
India’s Baa3 negative economic growth will remain materially lower than in the past with real GDP contracting 3.0% in 2020. We assume that economic activity will begin to gradually pick up from July. However, given the possibility for second or third waves of virus infections or deeper economic costs than currently factored in, downside risk to these forecasts is significant. Moodys estimate that lower GDP growth will translate into steel consumption falling at least 10% for rated steel-makers in the 12 months to March 2021. India will remain the world's second-largest steel producer behind China after having overtaken Japan in 2018. But new capacity additions will take a back seat with weak steel consumption hurting free-cash-flow generation in the current year. We do not expect new capacity until the industry's profitability as well as cash-flow stability is restored to pre-pandemic levels. Consolidation in the Indian steel sector that began in 2018 will continue in 2020, with five stressed steel companies accounting for 20% of the country's steel-producing capacity operating under new ownership. Capacity utilization will widely vary across the industry. The strongest steel-makers will likely increase utilization rates from 50% in April to more than 80% by the end of March 2021. Industry leaders, Tata Steel Limited Ba2 negative and ISW Steel Limited Ba2 negative, have already announced reduction in their capital spending to conserve cash.
The Chinese government's stance on capacity reduction remains firm. It has urged central state-owned enterprises to complete the capacity reductions outlined in the 13th Five-Year Plan by the end of 2020. China's supply-side reform initiated in 2016-17 has materially improved supply and demand dynamics in the country, supporting steel prices at relatively high levels compared with 2015 and 2016. The government had reduced steel capacity by 150 million tons during 2016-18, ahead of original schedule. The reduced capacity accounted for around 20% of total steel capacity of around 1.13 billion tons as of year-end 2015. At the same time, the government has forced steel mills that used illegal induction furnaces to shut down, removing capacity of around 230 million tons.
Indian steel-makers Tata Steel and JSW Steel will bear the brunt of a projected 10% drop in steel consumption in the country, the first decline since the global financial crisis. Even so, their competitive cost of production, use of domestic iron ore that is cheaper than imported ore, and their brand strength in India will help them to minimize volume decline and generate above-average profitability. With India's steel consumption declining, the steel-makers will seek to divert their surpluses to relatively open export destinations, such as Southeast Asia, Middle East, parts of Southern Europe and China. However, export realizations will be lower than realizations on domestic sales, with the latter benefiting from import parity prices and anti-dumping duties. We expect EBITDA per ton for JSW's and Tata Steel's Indian operations to decline by a mid-single digit percentage in LTM March 2021, and for their debt/EBITDA leverage to remain elevated at around 6.0x-7.5x.
Source : STRATEGIC RESEARCH INSTITUTE