Highlights

Spot iron ore price rallied by ~20% to US$135/tonne since early Jun-13 (see Figure 1), spurred by: (1) Inventory replenishing by Chinese steelmakers on current low inventory level; (2) The Chinese Government’s recent stepped-up efforts to tackle the country’s steel overcapacity issue; and (3) Renewed optimism on the Chinese economy, as the South China Morning Post recently reported the Chinese government is “quietly” offering financial stimulus to key cities and provinces.

Despite the positive news flows mentioned as above, we are still holding to our cautious view on the steel sub-sector’s fortunes, as: 1. The recent run-up in the price of iron ore was partly (if not mostly) spurred by the low iron ore inventory level in China (see Figure 2), which means inventory restocking (and hence price increases) will stop once inventory level normalizes; and 2. Steel output and capacity continued to increase (see Figure 3) despite the Chinese government’s various efforts to curb the steel sector’s overcapacity since a few years ago. Notwithstanding the recent stepped-up measures to curb overcapacity, the Chinese National Development and Reform Commission (NRDC) expects steel production in China to increase further to 780m tonnes in 2013. The Chinese steel mills are reluctant to cut steel production in a bid to reaffirm their market share and to maintain active bank credit facility lines.

Nevertheless, we believe the sector will be warranted a positive re-rating once the Chinese government succeeds in curbing the sector’s overcapacity, given the low share price valuations (in terms of P/B).

Catalysts

• China decides to further stimulate its economy; 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.

Forecasts

• Maintained for now, pending results announcements later this month.

Rating

Neutral

• Negatives – Overcapacity results in volatile earnings.
• Positives – Commendable valuations (in P/B).

Sector View

• We are keeping our Neutral stance on the sector for now. For exposure in the sector, our top pick is CSC Steel (T.Buy; TP: RM1.50).

Source: Hong Leong Investment Bank Research - 14 Aug 2013