Leading Independent Investment Research, Morningstar, Inc.

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Morningstar, Inc.

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Thematic (Sector/Industry)

China Metals and mining / Thematic (Sector/Industry)

<div class="content-highlight"><p style="text-align: center;"><strong>We remain selective in the Asian steel space, as overcapacity issues are here to stay.</strong></p></div><hr><p style="text-align: left;">China's steel industry has long been affected by overcapacity issues. From 2016 to 2017, the Chinese government began to rationalize the steel industry by shutting down 115 million tonnes of steel production capacity. This is in addition to the shutdown of around 120 million-140 million tonnes of off-the-books induction furnace capacity, which produced substandard steel, or <em>ditiaogang</em>, from melting scrap. This tightened the steel market in China, leading to higher steel prices and profitability for the steelmakers. Share prices of our Asian steel coverage nearly doubled from the beginning of 2016 to peak in February 2018. However, in recent months, our Asian steel coverage has declined by around 20% from its peak. This could be partly due to: (1) trade war concerns; and (2) concerns regarding a slowdown in Chinese steel demand going forward, driven by weaker construction end demand. In the long run, we expect overcapacity issues to persist, as new electric arc furnaces are expected to be built concurrent with declining apparent steel demand. We remain selective and prefer companies that focus on highgrade steel products and have a diversified business model.</p><h2><strong>Key Takeaways</strong></h2><ul>
<li>China apparent steel demand is expected to decline by a CAGR of 0.8% from 2017 to 2027, mainly driven by weakness from construction end demand, which is partly mitigated by consumer-oriented end demand as China transitions to a consumer-driven economy from an investment-oriented economy.</li>
<li>Over the next few years, new electric arc furnaces are expected to be built with the growing availability of steel scrap, resulting in ongoing overcapacity in the China steel industry. This new supply, coupled with falling demand, could result in utilization rates declining to 75% in 2027 from 81% in 2017.</li>
<li>We see modest upside in <a href="https://www.smartkarma.com/entities/208" target="_blank" data-smartkarma-citation="entities:208:1">POSCO (005490 KS)</a> and <a href="https://www.smartkarma.com/entities/961" target="_blank" data-smartkarma-citation="entities:961:1">Nippon Steel &amp; Sumitomo Metal (5401 JP)</a>, owing to their focus on high-grade steel products, diversified business models, and prudent capital management, resulting in a more resilient earnings profile.</li>
<li>We think <a href="https://www.smartkarma.com/entities/203" target="_blank" data-smartkarma-citation="entities:203:1">Angang Steel Co Ltd (H) (347 HK)</a> and <a href="https://www.smartkarma.com/entities/962" target="_blank" data-smartkarma-citation="entities:962:1">China Steel (2002 TT)</a> are overvalued, as we expect them to face strong competition from peers in an overcapacity environment due to the commoditized nature of their steel products.</li>
</ul>

We remain selective in the Asian steel space, as overcapacity issues are here to stay.China's steel industry has long been affected by overcapacity issues. From 2016 to 2017, the Chinese government began to rationalize the steel industry by shutting down 115 million tonnes of steel production capacity. This is in addition to the shutdown of around 120 million-140 million tonnes of off-the-books induction furnace capacity, which produced substandard steel, or ditiaogang, from melting scrap. This tightened the steel market in China, leading to higher steel prices and profitability for the steelmakers. Share prices of our Asian steel coverage nearly doubled from the beginning of 2016 to peak in February 2018. However, in recent months, our Asian steel coverage has declined by around 20% from its peak. This could be partly due to: (1) trade war concerns; and (2) concerns regarding a slowdown in Chinese steel demand going forward, driven by weaker construction end demand. In the long run, we expect overcapacity issues to persist, as new electric arc furnaces are expected to be built concurrent with declining apparent steel demand. We remain selective and prefer companies that focus on highgrade steel products and have a diversified business model.Key Takeaways
China apparent steel demand is expected to decline by a CAGR of 0.8% from 2017 to 2027, mainly driven by weakness from construction end demand, which is partly mitigated by consumer-oriented end demand as China transitions to a consumer-driven economy from an investment-oriented economy.
Over the next few years, new electric arc furnaces are expected to be built with the growing availability of steel scrap, resulting in ongoing overcapacity in the China steel industry. This new supply, coupled with falling demand, could result in utilization rates declining to 75% in 2027 from 81% in 2017.
We see modest upside in POSCO (005490 KS) and Nippon Steel &amp; Sumitomo Metal (5401 JP), owing to their focus on high-grade steel products, diversified business models, and prudent capital management, resulting in a more resilient earnings profile.
We think Angang Steel Co Ltd (H) (347 HK) and China Steel (2002 TT) are overvalued, as we expect them to face strong competition from peers in an overcapacity environment due to the commoditized nature of their steel products.


China Steel Industry: Are Overcapacity Issues Resolved?