PREPARED BY NON-US BROKER-DEALER(S): BNP PARIBAS SECURITIES (ASIA) LTD THIS MATERIAL HAS BEEN APPROVED FOR U.S DISTRIBUTION. ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES CAN BE FOUND AT APPENDIX ON PAGE 32 Korea Steel Corporate Day takeaways n Weakness in iron ore price to persist, scrap unlikely to be a threat in the next 10 years in China Given the iron ore price of USD97/tonne, down 29% YTD, Mysteel’s Iron Ore Senior Analyst, who was at our recent event, believes 5-10% of domestic ore production has been suspended since end-April 2014. He expects the iron ore price to stabilise at USD90-100 in 1-2 months and sees further downside when inventories of iron ore miners reach capacity. Steel scrap is unlikely to be a threat in China in the next 10 years given: 1) the construction/auto disposal cycle; 2) 17% VAT on steel scrap since 2011; 3) high electricity tariffs; and 4) import restrictions. n P ositive outlook for auto steel for the next five years, but long-term margin decline likely We had also invited Wuhan Iron and Steel’s (600005 CH) Chief Automotive Steel engineer to our event. According to him, considering there are many auto steel projects under construction in China, most of which are due to launch by 2016, auto steel net imports will decrease and the profit margin may be squeezed. Due to the 3-5 year technology gap between Baosteel (600019 CH), Posco and Tier-2 steel mills, we believe auto steel margins in Korea and Japan can be sustained for at least 3-6 years. The replacement of steel with aluminium in SUVs is unlikely, as there is still room to increase the proportion of high strength steel and advanced high strength steel from 30% now to 50%. n S teel cos begin to see margin expansion given a large decline in raw material costs Posco and Hyundai expect margin expansion in 2Q14 due to a flattish steel price and a drop in iron ore prices. The KRW/USD rose 3.7% q-q in 2Q, likely benefiting bottom lines of both companies. Posco guided for a 2Q parent-level OP of >KRW500b (BNPe consolidated OP: KRW869b, +19% q-q; NP of KRW476m) and Hyundai for consolidated OP of >KRW300b (+20% q-q). Seah Besteel (001430 KS, NR), which also attended our event, guided 2014 revenue to rise 8% y-y with 9.2% vol. growth. It was able to protect its ASP until 2Q, despite falling scrap prices. It believes ASP also followed suit. BNPP recommendations Company BBG code Rating Share price Target price Upside/downside POSCO 005490 KS BUY 302,000 373,000 +23.5% Hyundai Steel 004020 KS BUY 73,800 81,600 +10.6% Maanshan Steel 323 HK HOLD 1.62 1.52 -6.2% Angang Steel 347 HK REDUCE 5.08 3.73 -26.6% Source: BNP Paribas estimates 28 JUNE 2014 SECTOR REPORT ASIA STEEL 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 back page. Asia Steel Rachel Cheung BNP PARIBAS 28 JUNE 2014 Investment thesis Korea’s steel market is highly concentrated. The top two producers have a combined volume market share of 77%, while in China the top two have 12%, implying better pricing power for Korea’s steel leaders. Korean steel makers focus on high-end products where prices are more defensive; profit margins widen when iron ore costs fall. Though Korean domestic demand growth is limited, producers can rely on exports (44% of domestic production is exported), whereas China’s low-quality steel tends to face anti-dumping restrictions in other countries. In 2014, we expect demand growth from the European Union and the United States to rebound faster than Asian demand. We have a positive outlook on automotive and energy steel on sustained double-digit auto demand growth in China and demand from offshore/LNG vessels (accounting for two-thirds of Korean Top 3 shipbuilders’ order books). We believe that because of this and high entry barriers, automotive and energy steel operating profit margin (OPM) can be maintained at a good 10-15% level. We prefer Korean steel makers to the Chinese ones for their 1) market concentration, 2) exposure to high-margin steel, 3) limited and visible supply growth, and 4) exports. Upside catalysts for Korea steel sector in next 9 months We believe the catalysts are: 1) some private China steel mills potentially defaulting on debt; 2) urbanisation and policies for stabilisation of the economy in China; 3) Hyundai Motor Corp (005380 KS) price hike in 2H14E; 4) new and substantial iron ore supplies from the top five suppliers in 2Q-3Q14; and 5) the end of iron ore financing in China. Key indicators to follow: China’s steel and iron ore inventory, its steel mill cash margins and default cases in the country’s steel sector. Dif