Merg­ers driv­ing changes

The Weekend Australian - Review - - Steel Special Report - Emily Behncke Com­ment

THE Aus­tralian steel in­dus­try is cur­rently un­der­go­ing sig­nif­i­cant change, mak­ing it more ef­fi­cient and com­pet­i­tive on a global scale. Three steel pro­duc­ing com­pa­nies will be con­sol­i­dated into two, with OneS­teel ac­quir­ing Smor­gon Steel and Bluescope ac­quir­ing Smor­gon’s dis­tri­bu­tion busi­ness.

Mean­while as China moves up the qual­ity curve, im­ports are be­com­ing more of a threat. Add to the mix Aus­tralia’s Sims Group, the dom­i­nant global scrap com­pany, and the sec­tor is cer­tainly in­ter­est­ing.

On an in­ter­na­tional ba­sis, Aus­tralia is not a sig­nif­i­cant steel pro­ducer, rep­re­sent­ing just 1 per cent of world steel pro­duc­tion. How­ever, do­mes­ti­cally, met­als man­u­fac­tur­ing rep­re­sents around 2 per cent of Aus­tralian gross do­mes­tic prod­uct.

Long and flat prod­ucts dom­i­nate the steel mar­ket. While both long and flat prod­ucts are used in con­struc­tion, long prod­ucts are typ­i­cally more struc­tural in na­ture ( eg. steel beams) and flat prod­ucts in­clude roof­ing, the ex­te­rior of a shed, or the out­side of a car.

Aus­tralia does not ex­port a large num­ber of long prod­ucts, but im­ports them to com­ple­ment the ex­ist­ing range as well as to com­pete with OneS­teel and Smor­gon. Ap­prox­i­mately 650,000 tonnes — which rep­re­sents around 20 per cent of the mar­ket — of long prod­ucts were im­ported into Aus­tralia in 2006, and we be­lieve this num­ber is in­creas­ing.

Bluescope, the only flat prod­ucts pro­ducer in Aus­tralia, ex­ports ap­prox­i­mately one- third of its crude pro­duc­tion to a variety of re­gions, mainly the US and Asia. Flat prod­ucts are also im­ported ( about 700kt), which com­pete with Bluescope Steel, rep­re­sent­ing ap­prox­i­mately 20 per cent of mar­ket de­mand.

Glob­ally, the in­dus­try is also un­der­go­ing sig­nif­i­cant change as a re­sult of China’s in­creas­ing im­por­tance and in­ter­na­tional in­dus­try con­sol­i­da­tion. Re­cent ex­am­ples of mar­ket con­sol­i­da­tion in­clude Tata’s 4.3b pound takeover of Corus and Mit­tal’s 26.5b euro ac­qui­si­tion of Arcelor. We be­lieve this trend will con­tinue, and note that Lak­shmi Mit­tal, chair­man of Mit­tal, has high­lighted Mit­tal Steel will con­tinue as an in­dus­try con­sol­ida­tor.

More re­cently, the Chi­nese Gov­ern­ment has en­forced changes across the steel in­dus­try. Given sig­nif­i­cant steel pro­duc­tion in China, the Gov­ern­ment has in­ter­vened to try to limit steel pro­duc­tion by the smaller, less ef­fi­cient pro­duc­ers. Ini­tia­tives in­clude iron ore im­port li­cence re­stric­tions, and the in­tro­duc­tion of an ex­port tax on steel. Th­ese mea­sures are an at­tempt to en­cour­age the smaller high cost pro­duc­ers to exit the in­dus­try.

De­spite th­ese re­stric­tions, pro­duc­tion in China is likely to con­tinue to in­crease a fur­ther 10 per cent or 40mt in 2008 ( against 2007). About 34mt of this re­lates to hot rolled coil ( HRC) pro­duc­tion ( or flat prod­ucts), which rep­re­sents more than six times the cur­rent HRC pro­duc­tion in Aus­tralia at Bluescope’s Port Kem­bla steel­works.

How­ever, de­spite its size, the Chi­nese steel in­dus­try re­mains frag­mented with the top 20 pro­duc­ers rep­re­sent­ing ap­prox­i­mately 50 per cent of pro­duc­tion in China in 2006. China’s Na­tional De­vel­op­ment and Re­form Com­mis­sion ( NDRC) goal is for the top 10 pro­duc­ers to rep­re­sent about 50 per cent of pro­duc­tion by 2010, im­ply­ing more con­sol­i­da­tion is on the hori­zon. The main is­sue with con­sol­i­da­tion in China cur­rently is the for­eign own­er­ship re­stric­tions ( for­eign­ers are lim­ited to a non- con­trol­ling 49 per cent stake in any Chi­nese com­pany).

Fur­ther ex­pan­sion is oc­cur­ring in China in down­stream coated and painted steel prod­ucts like Color­bond, which are pro­duced by Bluescope Steel around the world ( in­clud­ing China). In 2006, pro­duc­tion of metal coated and other coated prod­ucts in­creased 44 per cent and 24 per cent, re­spec­tively, as China con­tin­ues to ex­pand. Other ma­jor pro­duc­ers of steel glob­ally in or­der in­clude Ja­pan, the US, Rus­sia and South Korea.

While steel con­sump­tion in China of 274kg per capita is sig­nif­i­cantly be­low the de­vel­oped world ( 352kg in coun­tries cur­rently part of the North Amer­i­can Free Trade Agree­ment and 663kg per capita in Ja­pan), we be­lieve this fig­ure will in­crease — po­ten­tially be­yond the cur­rent level of NAFTA. In­dia is an out­lier with con­sump­tion per capita of about 39kg.

We be­lieve world prices will re­main ro­bust in 2007. While there may be a sea­sonal de­cline in prices com­ing into the Euro­pean and US sum­mers, we be­lieve there may be mar­ginal cor­rec­tions later in the year with over­all prices in 2007 higher than 2006. The key risk to this the­sis in China is that the cur­rent do­mes­tic over­sup­ply sit­u­a­tion borne out of the changes to ex­port taxes does not worsen and start to im­pact on global prices. Emily Behncke ( nee Smith) is Vice Pres­i­dent, Eq­ui­ties Re­search An­a­lyst, at Deutsche Bank AG

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