Highlights

In our previous sector report (dated 28 May 2013), we highlighted that the improved 1Q13 performance (on qoq basis) among the steel players are unlikely to sustain, and we are reaffirming our less optimistic view on the sector’s nearterm outlook.

The recent recovery in the price of iron ore fines (which rebounded 6.7% from as low as US$112.5/tonne, Figure 1) was spurred mainly by low iron ore inventory level in China (Figure 2) rather than improving steel demand sentiment, as the prices of coking coal (another key ingredient in producing steel) and scrap steel are still trending downwards (Figures 3- 4).

While some Chinese steelmakers are tentatively curbing output by starting plant maintenance, we believe the production cut arising from plant maintenance may be insufficient in supporting steel prices. According to China Iron & Steel Association’s estimates, the average daily crude steel output in early-June rose marginally to 2.16m tonnes from 2.15m tonnes in late-May. Baosteel (which usually set tone for the wider steel sector in China) recently announced another round of price cuts in Jul following its move to slash steel prices for the first time in nine months in June.

Weak demand sentiment to persist until end-3Q13. We believe the weak demand sentiment in the region will likely to persist until end-3Q, as Ramadhan season, coupled with hot summer weather will slow construction activities, hence demand for construction steel.

Local steel players will not be spared too. While the implementation of large-scale infrastructure projects locally will sustain domestic steel consumption, we believe the weak demand sentiment would still affect local steel players’ earnings, as exports account for part of the local steel players’ revenue and earnings.

Catalysts

• China loosens its economic policy further; and
• More effective measures introduced by the Chinese authority to curb steel capacity.

Risks

• Overcapacity in China remains over the longer term;
• Volatile input prices, making the sector a play on short-term potential price trend; and
• Influx of steel at cheap prices.

Forecasts

Maintained.

Rating

Neutral

Negatives – Overcapacity results in volatile earnings.

Positives – More commendable valuations.

Sector View

We are keeping our Neutral stance on the steel sub-sector, as we anticipate the weak sentiment to continue into 3Q13. For exposure in the sector, out top pick is CSC Steel (T.Buy; TP: RM1.61).

Source:Hong Leong Investment Bank Research - 24 Jun 2013