CHINA STEEL SECTOR ：Trying, but not much progress in 2014

PREPARED BY NON-US BROKER-DEALER(S):BNP PARIBAS SECURITIES (ASIA) LTD THIS MATERIAL HAS BEEN APPROVED FOR U.S DISTRIBUTION. ANALYST CERTIFICATION ANDIMPORTANTDISCLOSURES CAN BE FOUND AT APPENDIX ON PAGE 39 EQUITIES RESEARCH CHINA STEEL SECTOR Trying, but not much progress in 2014 n Achieving forced capacity closures will be difficult in 2014, although geared steel mills could be forced out by tight funding after 2015. Currently, mills have to keep generating cash flow to cover interest expenses even if they are loss-making. Given their cash reserves, we think mills can survive for a year-and-a-half to two years. Hebei and Tangshan have announced aggressive capacity closure plans, but they have no clear compensation or labour relocation plans. n Key differences between the steel and cement segments lie in fragmentation, links with financial systems, the regional nature of the market, economic impact on particular provinces, and product heterogeneity. n We recommend being long the cement sector and short the steel sector. Rachel Cheung rachel.cheung@asia.bnpparibas.com +852 2825 1824 Our research is available on Thomson One, Bloomberg, TheMarkets.com, Factset and on http://eqresearch.bnpparibas.com/index. Please contact your salesperson for authorisation. Please see the important notice on the inside back cover. 8 JANUARY 2014 China Steel Sector Rachel Cheung BNP PARIBAS 8 JANUARY 2014 To find out more about BNP Paribas Equities Research: Visit : http://eqresearch.bnpparibas.com/ For ipad users : http://appstore.apple.com/BNPP-equities/ 2 Trying, but not much progress in 2014 n Forced closures in 2014 are harsh; geared steel mills to be forced out by tight funding in 2015 To curb overcapacity and environmental problems, the State Council and provincial governments announced capacity closure targets; 60mt in Hebei (40mt in Tangshan) by 2017, 7mt in Jiangsu by 2018, and 15mt of backward capacity by 2015. The government seems more serious than five years ago, but we are less optimistic than the market and think most of the impact will be back loaded. Capacity in Hebei will be cut (actual existing capacity is unclear), but new capacity adds in Jiangsu and Anhui East China mean utilization will not improve. Heavy interest expense will keep steel mills running, even if loss-making. There is no clear funding source to compensate capacity closures in Hebei. Based on two years’ of steel trader clean-up (from 3Q11), we think mills’ cash reserves can support loss-making operations for at least two years with 2013 as the first year of losses for most steel billet producers. We expect steel mills to struggle in 2014, reaching a critical point in 2015. Our steel demand growth forecast is 3.5% and supply is 3.4% in 2014 with 78% net utilization at best. n Fundamental differences between cement and steel determine efficacy of capacity closures Similar policies to curb overcapacity have been announced in the steel and cement sectors, but the fundamental differences between them mean the impact for cement is front loaded while steel’s is back loaded. Thanks to high clinker consolidation, its regional nature, high productivity and more homogenous products in the cement sector, it is easier for cement leaders to gain market share from smaller players. Provinces rely less on cement for taxes and revenue since capacity is regionally diverse. Steel is tradable domestically and internationally. One fundamental difference from the cement sector is that smaller steel players have better cost control than large SOE steel mills due to lower environmental concerns, off-spec product quality, and more flexible raw material supply sources. Steel capacity is clustered in a few provinces and closely linked with local banking/financial systems via traders. Provinces like Hebei rely heavily on steel businesses for tax revenue and it is hard to find alternatives to replace this medium term given weak local property market outlook. n We suggest investors switch from steel to cement Angang is trading at a 24% P/BV premium to Magang, which we don’t think is sustainable given our below-market expectations for steel in 2014. As such we downgrade Angang to REDUCE from Hold and upgrade Magang to HOLD from Reduce. In the cement sector, Given the outperformance of Angang over Anhui Conch over the past six months and better cement sector fundamentals, we recommend investors BUY Anhui Conch and REDUCE Angang. BNPP recommendations Company BBG code Rating Share price Target price Upside/downside Anhui Conch Cement 914 HK BUY 26.85 34.20 +27.4% Maanshan Steel 323 HK HOLD 1.98 2.11 +6.3% Angang Steel 347 HK REDUCE 5.30 4.65 -12.4% Sources: Bloomberg; BNP Paribas estimates 8 JANUARY 2014 SECTOR REPORT CHINA STEEL SECTOR Rachel Cheung rachel.cheung@asia.bnpparibas.com +852 2825 1824 3