2017. 6. 19 Steel (OVERWEIGHT) Iron ore supply heading up, steel down ● The world’s steel supply has been moving in tandem with demand since 2016, auguring well for prices. ● China is likely to expand fiscal spending to boost the domestic economy, given a reaffirmation of a neutral monetary stance by the central bank there and a second leadership transition slated for October. Steel demand should rebound as the Xiongan New Area development and ‘One Belt, One Road’ policy take shape. ● Iron ore price declines owe mostly to concerns over rising supply—they started after China’s iron ore production turned to growth after shrinking for two years. Yet, we expect steel spreads to stay relatively solid (vs past cases of price declines) given: 1) Chinese miners’ low cost competitiveness; 2) prospects of fiscal expansion in China; and 3) rising iron ore and correcting steel supplies. ● Company-specific issues include: 1) rising earnings at Posco’s subsidiaries; 2) auto-use steel plate price hikes at Hyundai Steel; and 3) recovering oil country tubular goods exports at Seah Steel. We choose Posco as our 2H top pick, as it should enjoy high operating leverage when the industry turns around. Meanwhile, Seah Steel deserves attention as it should benefit from a recovering US rig count. WHAT’S THE STORY? Supply moving with demand: Steel supply over 2010-2015 ballooned as capacity kept growing amid weak demand. From 2016, it started moving with demand as capacity expansions ended and China’s restructuring push hiked expectations of more production cuts. Improving supply-demand dynamics should inevitably benefit steel prices. Potential investments lift demand hopes: China’s tightened liquidity and real-estate regulations from mid-March sparked concerns over steel demand, leading global steelmakers to correct. Yet, that nation’s central bank reaffirmed it will maintain a neutral monetary stance and resumed injecting liquidity in mid-May. Also, a second leadership transition slated for October may spur the nation to opt for aggressive fiscal spending in 2H to prop up the economy, with the April designation of Xiongan as a special economic zone and a forum in May for the ‘One Belt, One Road’ policy supporting such a view. Concerns over iron ore price drops excessive: Iron ore price declines seem to be a supply side issue as they started after China’s iron ore production turned to growth after two years of declines. That said, steel spreads should stay relatively solid (vs past cases of price declines) given: 1) Chinese miners’ low cost competitiveness; 2) prospects of China’s fiscal expansion in 2H; and 3) rising iron ore and correcting steel supplies. Meanwhile, slowing growth in China’s iron ore imports and production is positive. Posco-our top pick for 2H: Company-specific issues include: 1) improving earnings at Posco’s subsidiaries; 2) auto-use steel plate price hikes at Hyundai Steel; and 3) a recovery in oil country tubular goods exports at Seah Steel. We recommend Posco as our 2H top pick, as it should enjoy high operating leverage when the industry turns around. We believe the company’s shares are undervalued, trading at just 0.5x P/B despite an estimated 2017 ROE of 4.6% (close to 2013 when its P/B multiple was 0.7x). Meanwhile, we advise eyeing Seah Steel as it should benefit from a recovering US rig count and is trading at 0.4x P/B vs a 2018 ROE of 6%. Jaeseung Baek Analyst jaeseung.baek@samsung.com 822 2020 7794 Sector Update AT A GLANCE Posco (005490 KS, KRW274,500) Target price: KRW380,000 (38.4%) Hyundai Steel (004020 KS, KRW59,000) Target price: KRW70,000 (18.6%) SeAH Steel (003030 KS, KRW93,500) Target price: KRW130,000 (39%) Steel 2017. 6. 19 2 Supply moving with demand Supply-demand imbalance over 2010-2015 behind derating Capex by major global miners and steelmakers increased over 2000-2012 despite slowing steel demand in the wake of the global financial crisis. Capex peaked in 2012, but capacity growth did not start slowing until 2015 as it takes three to four years to build a blast furnace. Thus, global steelmakers suffered anemic earnings and share deratings over 2010-2015. Supply gluts, created by capacity expansions amid soft demand, distorted steel prices. Furthermore, steelmakers saw spreads narrow as their bargaining power was undermined by a rising combined market share of major global miners. Supply and demand moving in tandem The situation changed in 2016. Most steelmakers posted disappointing results in 4Q15 and global crude steel production in 2015 shrunk y-y, falling for the first time since 2010. Since then, news flows regarding steel capex have been lacking as: 1) steelmakers could no longer afford to ramp up capacity, noting their capex had been shrinking since 2012; and 2) the government of China seemed committed to restructuring to enhance fundamentals and reduce environmen