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Morningstar | Overcapacity in the steel industry will continue to weigh on Angang Steel.

Angang Steel is one of the top 10 steel producers in China, with a focus on producing flat steel products, which represent around 85% of its production. Its high exposure to the flat steel end markets--including the automotive and consumer goods sectors, which have a more stable and stronger outlook than the more cyclical construction sector--should drive demand growth for its steel products for the next few years. However, as it is more focused on the commodity steel grade, it will continue to face strong competition from its peers in the steel sector. In addition, as the steel industry remains fragmented and is affected by overcapacity issues, especially in China, steel producers such as Angang Steel will remain price-takers. We have seen Angang Steel make losses in 2011, 2012, and 2015 due to the challenging operating environment.Currently, the Chinese steel industry is undergoing consolidation and capacity closures, as required by the Chinese government. A total of 115 million tons of capacity (mainly substandard steel, or ditiaogang) was shut down in 2016 and 2017. However, the actual impact on production could be smaller, as some of this capacity was either not producing or producing at a low utilization rate. In 2018, around 30 million tons of capacity is expected to be shut down, while around 15 million-20 million tons of new capacity, predominantly electric arc furnaces, is expected to be added, resulting in minimal changes to the total capacity in China. In our view, new electric arc furnaces could be built in the future to replace some of this lost capacity, resulting in ongoing overcapacity issues in China.As have many Chinese state-owned steel producers, Angang Steel increased its leverage to fuel its capacity expansion amid China’s credit boom in 2009. Interest-servicing is now a burden for the firm, having taken up more than 50% of its operating income in most of its profitable years. On a positive note, we expect Angang Steel to generate positive free cash flow due to low capital expenditures over the next few years, and the firm’s leverage ratios should gradually improve.