EUR 850.00 For Business Accounts Only

Morningstar | Angang Steel’s Preliminary 3Q18 Beats Expectations; Shares Still Overvalued on Overcapacity Issues

Angang Steel announced preliminary third-quarter 2018 earnings that beat our expectations, with net profit expected to increase by around 41% year over year to CNY 2.42 billion versus CNY 1.72 billion during the same period last year based on restated numbers following the acquisition of Angang Chaoyang in September. We expect to raise our fair value estimate for Angang Steel on this strong performance pending further clarity on its third-quarter results which are expected to be announced later this month. That said, the magnitude should be less than 10% as we remain negative on the firm’s long-term outlook while our no-moat and stable moat trend ratings remain intact. We still think that Angang Steel’s current share price is overvalued as we believe the steel industry is highly commoditized and will continue to suffer from overcapacity issues.

Management attributed the strong performance to contribution from Angang Chaoyang, better product mix leading to a higher average selling price for steel products, cost-cutting measures and better management of its raw material procurement which in our view, reduced its impairment charges. The ongoing supply side reform which started since 2016 and the strong steel demand in China this year resulted in a tighter steel market and higher profitability for the steel industry. We continue to expect the winter production curtailment, which should last until mid-March 2019, to support steel prices for the rest of 2018. We think Angang Steel, which is not affected by the production curtailment as it has no plants in impacted areas, could increase its market share during this period.

Our bearish long-term view for the steel sector remains intact. Although a total of 115 million tons of capacity has been shut down in 2016 and 2017, the actual impact on production could be less as some of this capacity was either not producing or producing at a low utilization rate. In 2018, only around 30 million tons of capacity is expected to be shut down. However, the net impact on steel capacity in China is expected to be muted as around 15 to 20 million tons of electric arc furnace capacity are expected to be added. Based on the new policy on building new steel production capacity to replace obsolete facilities that was announced in January, we see the Chinese government is promoting electric arc furnaces over blast furnaces. For every 1.25 tons of old capacity closed, only 1 ton of new capacity can be built if it is going to be a blast furnace. However, if old capacity is being replaced with new electric arc furnaces, the ratio is 1:1. This supports our view that China is shifting towards 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 in the future to offset shuttered capacity helped by an increase in availability of steel scrap in China, and this drive ongoing overcapacity issues in China.