Why Afrimat has lost its shine

When China mandated steel production cuts the effect was profound globally

The market often becomes fixated on the big stories of the day while other important news is sidelined. This was the case of events in July which, months later, had dramatic results. Let me elucidate.

In mid-year the Chinese government under President Xi Jinping decided to clamp down on the country’s technology sector. Investigations, regulations and talk of breakups were the resultant rhetoric, and prices tumbled.

In the past months, global titans Alibaba, Ant Group, Tencent and DiDi have had hundreds of billions of dollars wiped off their valuations.

Behind this there was another major story, one overlooked by the mainstream media. I’m talking about events in the iron ore and steel sectors specifically.

In July the Chinese state started to batter the domestic steel-producing sector.

China is the world’s largest steel producer, at 1.1bn tons in the past year. The country imports vast quantities of iron ore to feed its blast furnaces. This steel production has powered Chinese growth in construction and infrastructure.

But there have been consequences. Worsening air pollution was now drawing the ire of state officialdom.

The Chinese state suddenly mandated better air emission rules and ordered steel manufacturers to modernise their old, inefficient plants and reduce steel production.

The state wanted to cap 2021 steel production at 2020 levels. That would have material consequences to iron ore demand.

This all stems from a simplistic but clear scenario: the Chinese hate to be embarrassed on the world stage.

During the 2008 Beijing summer Olympics the air was foul, hazy and grey. Athletes complained, and China was deeply embarrassed at its flagship event.

Beijing is hosting the Winter Olympics in February 2022. It does not want to be embarrassed again by images of smog and dirty snow being splashed on worldwide television.

So China decided to mandate the steel production cuts, plant closures or suspensions and implement stringent air quality rules. This has also spilled over on to electricity producers with dirty coal plants. Anything that is near Beijing has been hit with air quality regulations.

These are worthy tasks for society, but I’d wager it is being done more to save face for the Chinese government than for altruistic reasons.

When the wider world woke up to this narrative, it was simply too late, and its sector investments were about to be savaged.

Iron ore had peaked at $220 a ton in mid-July. On the year, iron ore had doubled in price, a staggering surge not seen in a decade.

I saw what was going on and warned in an institutional note on July 27, when iron ore was at $215 a ton, that trouble was coming. I recommended taking profits in Afrimat at about R60.

In early August the iron ore rollover started, and the price plunged. In September iron ore hit a low of $94 a ton as the Chinese rhetoric reverberated through global markets.

As I write, iron ore is $118 a ton, a decline of 46% from its July high. This savaging had a profound impact to global iron ore stocks. It took a while for the market to realise, and for stocks to adjust.

But they did, and fast. Today, Kumba iron ore is at a new 52-week low, having dropped 40%.

Afrimat is down 20%, as it has some diversification in operating divisions to shield it from the slide in iron ore. It is a solid business; in its recent first-half trading update for 2021 it indicated a 58%-63% rise in interim headline earnings a share. That is off a low Covid-related base set in the first half of 2020. Afrimat benefited from booming iron ore prices for five of those six months.

The market waits to see where iron ore will settle and whether the current rally from recent lows is a “dead cat bounce”.

Iron ore dominates profits in Afrimat, so its second-half results — if prices remain subdued — will pare earnings growth. But there will still be some earnings growth, as the company’s cost of production is low. It will still make materially better margin as a whole than its construction and industrial units. But some of the shine has been taken off the stock.

Nkomati coal, recovering construction and industrial markets, and the investment in manganese are all great growth points for Afrimat.

I’ve been bullish about Afrimat since its price was R3.15. As I write it is R49.50 from a recent high of R61.60.

I like the stock; it has longterm prospects. But until the iron ore dust settles, I would hold back and try to pick up the stock a few bucks lower. This one is worth watching. ●

“Anything that is near Beijing has been hit with air quality regulations