vk.com/id446425943
Sector update
Equity Research
3 December 2018
Steel EEMEA
Steel companies
Lower input costs could support margin
We maintain our cautious view on steel prices; however, we forecast declining metallurgical coal prices, which could have a favourable impact on less integrated steel producer margins, potentially offsetting falling steel prices. We believe some steel producers offer strong cash generation, despite our lower steel price forecasts, which, combined with comfortable balance sheets, could result in attractive dividends. We incorporate the most recent management guidance following Evraz’s and Severstal’s Investor Days, which results in increases to our earnings forecasts and TPs. We incorporate lower sales volumes and price realisations, which result in a cut to our ArcelorMittal South Africa (AMSA) earnings and TP. Our sector ratings remain unchanged. Our top picks are Evraz, Severstal and NLMK.
Kabelo Moshesha +27 (11) 750-1472
KMoshesha@rencap.com
Johann Pretorius +27 (11) 750-1450
JPretorius2@rencap.com
Steven Friedman +27 (11) 750-1481
SFriedman@rencap.com
Siphelele Mhlongo +27 (11) 750-1420
SMhlongo@rencap.com
Derick Deale
+27 (11) 750-1458 DDeale@rencap.com
Cautious view on steel prices
We believe elevated steel margins could incentivise an increase in utilisation rates. Management teams guide to rising sector capex, which could result in capacity growth. China’s desire to rebalance its economy from fixed asset investment-heavy to consumer-led poses a major potential demand headwind for steel, and rising supply against a muted demand growth outlook could result in oversupply.
Shifting trends may weigh on metallurgical coal prices
Metallurgical coal is a significant input into steelmaking as it accounts for around 30% of raw material costs. Metallurgical coal prices are unsustainably high, in our view; we believe prices above $180/t could incentivise new supply and we only see cost support at around $150/t. Increasing scrap availability and a changing energy mix in China could accelerate conversions to electric arc furnaces (EAF), which require significantly less metallurgical coal than blast furnaces.
Summary sector ratings and TPs (ranked by total potential 12M return, including estimated dividends)
Company |
New |
Old |
Current |
Rating |
|
TP |
TP |
price* |
|||
|
|
||||
Evraz, GBp |
680.0 |
610.0 |
464.2 |
BUY |
|
AMSA, ZAR |
5.7 |
5.9 |
3.9 |
BUY |
|
Severstal, $ |
18.9 |
17.8 |
15.0 |
BUY |
|
NLMK, $ |
27.8 |
27.8 |
24.0 |
BUY |
|
MMK, $ |
10.2 |
10.2 |
8.9 |
BUY |
*Priced at market close 30 November 2018
Source: Thomson Reuters Datastream, Renaissance Capital estimates
We remain constructive on the steel companies
We calculate attractive FCF yields of 10%, on average, for the steel producers in 2019-2020, despite our lower steel price forecasts. The declining metallurgical coal prices we forecast could have a favourable impact on less integrated steel producer margins, offsetting the impact of falling steel prices to some extent. We believe the steel companies’ balance sheets are comfortable, with average FY18E net debt/EBITDA of 0.3x. The combination of attractive FCF generation and comfortable balance sheets could translate into attractive dividends: we forecast average dividend yields of 14% over the next three years.
Key downside risks
Key downside risks to our investment stance are: 1) lower-than-forecast steel prices; 2) higher-than-forecast unit costs; 3) US sanctions against Russian steel makers or the impact of sanctions on the Russian economy; 4) steel import duties and tariffs in export markets; 5) increased government regulation, including possible requirements for social infrastructure investment, which may not attract financial returns; and 6) strong cash generation, which increases the potential for poor capital allocation through investment in value-destructive projects.
Important disclosures are found at the Disclosures Appendix. Communicated by Renaissance Securities (Cyprus) Limited, regulated by the Cyprus Securities & Exchange Commission, which together with non-US affiliates operates outside of the USA under the brand name of Renaissance Capital.
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Contents
Companies ranked by 12M return |
3 |
How to trade steel companies around met coal prices |
5 |
Cautious steel demand outlook |
6 |
Metallurgical coal a key steel input cost |
11 |
Coking coal price sensitivity |
12 |
Coking coal outlook |
18 |
Steel sector margins and capex support near-term cash |
|
generation |
27 |
Earnings revisions |
31 |
Commodity and currency assumptions |
32 |
Peer comparison per calendar year |
33 |
ArcelorMittal South Africa |
36 |
Evraz |
37 |
MMK |
38 |
NLMK |
39 |
Severstal |
40 |
Anglo American |
41 |
BHP |
42 |
Glencore |
43 |
South32 |
44 |
Vale |
45 |
Appendix |
46 |
Disclosures appendix |
48 |
Renaissance Capital
3 December 2018
Steel
2