Japan squeezed from home and abroad
W HILE the rest of the steel industry — particularly in the US — enjoys continued profit growth, the four behemoths of the Japanese steel industry are struggling. Despite robust sales growth, JFE Holdings, Kobe Steel and Sumitomo Metal Industries all posted falls in net profit in the 2007 financial year ( which ended March 31, 2008), under the weight of rising material costs.
Only Nippon Steel — the world’s second largest steel maker of the metal, behind Arcelor Mittal — managed to lift its profit, and even it could only eke out growth of 1.1 per cent.
The problem for the Japanese steel industry is higher input costs, with iron ore and scrap steel having doubled in price in the last year, and coking ( steel making) coal having tripled. Higher- than- expected freight rates and fuel costs are also putting pressure on the Japanese steel firms.
And the industry’s customers have their own worries, making it difficult for steel makers to pass on increasing costs. Japan’s carmakers are struggling with the rising yen, while the nation’s shipyards are being overwhelmed by competition from cheaper Chinese shipbuilders, and are begging the steelmakers to delay the introduction of higher steel prices — which they fear will worsen their falling market share.
But, feeling themselves to be held over a fire by their iron ore and coking coal suppliers in Australia and Brazil, the steel makers are doing their best to pass on the price rises in their own raw materials. In May, Nippon Steel and other big Japanese steelmakers hit carmaker Toyota Motor Corp with a 30 per cent rise in steel prices, Nippon Steel said recent spikes in iron ore, coal and other materials prices would lift its costs by 38 per cent this financial year.
In Korea, the situation is similar, with tight supply/ demand conditions allowing steel companies to pass on their higher raw material costs. But concerns about these rising costs have meant that despite the continuous steel price hikes, the prices of the Korean steel stocks have significantly lagged the market.
The biggest Korean steel makers are Pohang Iron & Steel ( POSCO), the world’s fourth- largest steel producer; Hyundai Steel, the world’s second- largest electric arc furnace ( EAF) steel maker; and Dongkuk Steel.
Their biggest customers are the shipbuilders: South Korea is home to the world’s top three shipbuilders, Hyundai Heavy Industries, Daewoo Shipbuilding and Marine Engineering and Samsung Heavy Industries.
Where their Japanese counterparts are struggling to cope with the high prices of steel plate, and Chinese competition, the Korean shipbuilders are on a roll, powered by historically high prices and order volumes for ships, particularly for very large crude oil carriers ( VLCCs) and LNG carriers and offshore engineering facilities.
Korean shipbuilders also have a very profitable sideline in making high valueadded offshore LNG facilities, worth between $ US500 million and $ 1 billion per unit.
As with all steelmakers, the stockmarket has struggled to decide whether the input cost situation for the Korean industry outweighed the price benefits. But Christina Lee, analyst at Macquarie Equities in Seoul, says the first- quarter 2008 operating results for the steel makers — especially for Hyundai Steel) appear to have provided the evidence the market was looking for — that is, that higher steel prices can cover raw material cost hikes.
Korean steel shares started to regain momentum in mid- March, and we think the sector will continue to appreciate based on strong steel prices, positive quarterly earnings momentum and consensus earnings upgrades,’’ says Lee.
Macquarie’s top pick in the Korean sector is Dongkuk Steel, given its compelling valuation and strongest momentum in steelprice increases.’’ Lee also likes Hyundai Steel, which, like Dongkuk, provides longterm growth potential with active investments in the steel business.
Although Macquarie believes that POSCO is not raising prices as much as it can’’, Lee says POSCO’s shares provide decent value at current levels.’’
In Japan, the situation is clouded by the fact that Japanese shipbuilding, for example, is losing competitiveness to the Koreans and the Chinese. Macquarie’s Japanese steel analyst, Polina Diyachkina, says it is simply more difficult for Japanese steelmakers to raise prices for domestic customers. We believe some steel users will go into the red if they accept the prices steelmakers are asking,’’ says Diyachkina.
For the 2008 financial year ( which ends in March 2009), Nippon Steel, Kobe Steel and Sumitomo Metal project sharp net profit falls due to surging raw materials costs for such materials as coking coal. Nippon Steel, for example, gave guidance for a 35 per cent fall in operating earnings. JFE, which Diyachkina describes as always upbeat’’, gave no guidance at all: she says an earnings fall for JFE looks inevitable’’: Macquarie’s estimate is for an 11 per cent decline in operating earnings, with the risk to the downside’’.
Diyachkina sees no earnings growth from Nippon Steel or JFE for at least another two years, and rates them as underperform’’. But Sumitomo has been thrown out with the bathwater’’, she believes: more than half of Sumitomo’s profit comes from its highend pipe business, whose main customers are the large oil companies.
Sustained high oil prices make more complex projects economically viable, increasing the demand for pipe. These customers are less reluctant’’ than the exportoriented manufacturers to accept large price increases, making Sumitomo the most immune’’ of the Japanese steel heavyweights to higher cost pressures. Macquarie rates Sumitomo as outperform’’, as its pipe business offsets weakness in flat steel products.
Cars: Toyota’s steel costs up 30 per cent