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Morningstar | Angang Steel’s Prelim FY18 Slightly Below Expectations; Shares Overvalued on Overcapacity Issues

Angang Steel announced preliminary full-year 2018 earnings that were slightly below our expectations, with net profit expected to increase by around 17.5% year over year to CNY 7.8 billion versus CNY 6.6 billion in 2017 based on restated numbers after acquiring Angang Chaoyang in September 2018. This implies that for fourth-quarter 2018, Angang Steel’s net profit was around CNY 0.95 billion, which was a 66% year-over-year decline from CNY 2.8 billion during the same period last year. Management attributed the year-over-year improvement in full-year profitability to better product mix leading to a higher average selling price for steel products, cost-cutting measures, better managing the procurement of raw materials, which in our view reduced its impairment charges, and the acquisition of Angang Chaoyang.

The ongoing supply-side reform, which started since 2016 and the strong steel demand in China in 2018 resulted in a tighter steel market and higher profitability for the steel industry. As for the year-over -year decline in fourth-quarter net profit, we think that this could be largely due to weaker steel prices as a result of: the slowdown in the China autos and consumer white goods sectors; and higher-than-expected steel production. We expect to lower our fair value estimate for Angang Steel by less than 10% on this weaker-than-expected performance pending further clarity on its full-year results, which are expected to be announced in March. Our no-moat and stable moat trend ratings on the firm remain intact. Nonetheless, we still think that Angang Steel’s current share price is slightly overvalued, as we believe the steel industry is highly commoditized and will continue to suffer from overcapacity issues.

Steel production remained strong in fourth-quarter 2018 based on our estimates as winter production curtailment is decided and imposed by local governments, which is different from fourth-quarter 2017, where there was a blanket curtailment on selected cities. This, together with weaker steel demand, resulted in lower steel prices in fourth-quarter 2018. Despite a weak start in the beginning of 2019, we expect steel demand and prices to gradually recover after Chinese New Year, which falls in early February this year, as construction should pick up.

Our bearish long-term view for the steel sector remains intact. We think China is shifting toward producing steel from electric arc furnaces using steel scrap rather than the traditional blast furnace, which uses iron ore and coking coal. We continue to believe that new electric arc furnaces can be built to offset shuttered capacity helped by an increase in the availability of steel scrap in China, and this should drive ongoing overcapacity issues in China.