Ja­pan squeezed from home and abroad

The Weekend Australian - Review - - Steel -

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

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