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CSCI-Steel-China Steel Sector：Stay optimistic on margins amid the winter production plan - 20171009

Stay optimistic on margins amid the winter production plan

• In spite of the 6-7% correction in the past few weeks (triggered by a rebound in inventory), steel prices are still 6-11% higher than a year ago and the correction should have not changed the industry’s improving earnings outlook, in our view.
• 2017 is the first year for China to include steel in its winter production plans. Based on production plans announced in nine cities, we expect to see a 10% reduction in nationwide daily steel production. Once becoming effective in mid-Nov, the winter production plans may lead to a downtrend in steel inventory.
• We maintain positive for both Magang and Angang, with good growth prospects for the coming two years, supporting to trade at above mid-cycle valuations, thus maintain Buy on both though prefer

Reaffirming our investment logic amid the latest China steel supply policies. After experiencing a meaningful recovery, we reiterate our view that China’s steel sector will continue to undergo structural changes in its demand/supply dynamics, as well as benefit from the accelerating industry consolidation. The capacity closure and clearance of the ground steel strips targets for this year have basically been achieved. Based on industry data, over 85% of the domestic steel plants are profit making at the current steel prices, which is a substantial improvement compared to only 3% of the plants being profitable during mid-2015. Meanwhile, as the major steel producing provinces, such as Hebei, Shandong and Jiangsu, are still behind their de-capacity schedule, with new electric arc furnace capacity projects facing tighter scrutiny, suggests slower new supply this year, we believe the on-going de-capacity policy would drive earnings recovery and balance sheet improvement of industry players.

Hebei province – from cement, paper to steel – strictest ever winter production policy. For the first time this year China has implemented the winter production policy for the domestic steel industry throughout the four winter months. For cement, off-peak production scheme has been implemented in 15 northern provinces, including Hebei; and whereas for paper manufacturing, non-gas based mills in Hebei have been asked to half or suspend production until the end of the year. For steel, nine out of the “2+26” cities have pre-announced detail production plans, which should see the national daily crude steel production reduced by at least 13% when the policy is expected to be in full swing in mid-Nov. In spite of potential risks would emerge as a result of an increase in supply from non-restricted provinces and restricted plants resuming production after the expiry of the policy in mid-March, the overall supply discipline should be under control as production control is expected to remain intact amid the government’s determination to improve the air quality. Meanwhile, as we believe the recent rebound in production and inventory was a front-running of the supply reduction policies, we foresee that if the trend reverses course it would lend support for the steel price going forward.

Maintain Buy for Angang and Magang. We prefer Magang over Angang as we foresee more share price catalysts to emerge from Magang’s asset optimisation going forward. PT for Magang raised to HKD4.5 (from HKD4.0), and PT for Angang maintained unchanged at HKD8.0.