Steel is dead; long live steel. As China’s economy switches to more sustainable growth, what does this mean for the world’s often crowded and always volatile steel market?
For all its rapid growth, China makes some changes gradually. So when President Xi Jinping unveiled his vision for a more even and sustainable pattern of economic growth at last month’s 19th National Congress, commodity demand forecasts didn’t fall off a cliff. That’s understandable: industrial reform cannot be enacted overnight. Indeed, according to China’s own estimates, steel output is still on course to rise 3 per cent this year, and by another 0.7 per cent in 2018.
China’s steel market might not be a perfect proxy for economic growth or ambition, but it provides a useful window into several big economic shifts that carry implications for a raft of UK stocks. So what can we expect?
A new environment
Despite (and in part owing to) an environmental clampdown, Chinese demand in 2017 has been extraordinarily strong. The world’s largest consumer of steel – and the country that has accounted for basically all of the growth in global steel demand since the start of the century – is on course to chew up 12.4 per cent more finished steel products in 2017 than last year, according to the World Steel Association. This metric is critical for anyone keen to understand the general rise in base metals prices this year, or the 25 per cent year-to-date total return of the MSCI Global Metals & Mining index.
Tied to this are two important trends within China’s own steel production, also the largest of any individual nation. The first is a gradual increase in higher-quality products such as galvanised steel, which has boosted demand for metals including zinc and nickel, in turn benefiting miners such as Glencore (GLEN). Alongside this has been an uptick in the production of and demand for stainless steel, a development that has been broadly positive for Tharisa (THS), the London-listed South African platinum miner whose secondary source of chrome concentrate output contributed to a threefold surge in operating profit in the year to 30 September.
The second development is undoubtedly more profound. Amid intolerable levels of smog, Chinese environmental authorities have been closing heavily polluting steel mills that sinter iron ore (a process that converts fines into lumps). In turn, the measures have driven demand for high-quality iron ore and pushed up mill margins. Rio Tinto iron ore chief executive Chris Salisbury cited each of these factors as “clear evidence” of a structural change in the iron ore market at an investor seminar this week. Looking (and planning) ahead, Rio believes a wider spread between higher- and lower-quality iron ore will persist.
This view echoes the thoughts of fellow iron ore giant BHP Billiton (BLT), as well as those of Fortescue Group Metals’ (ASX:FMG) Elizabeth Gaines, who was appointed chief executive of the Australian-listed iron ore miner last week with the mandate to improve the company’s product. “In the future a majority of Fortescue’s production will be [greater than] 60 per cent Fe competing head to head in the higher grade markets,” wrote chairman Andrew Forrest, announcing Ms Gaines’ appointment.
Ferrexpo (FXPO), a Ukraine-focused iron ore producer, could lay claim to being ahead of the pack. Almost all of the FTSE 250 constituent’s output is 65 per cent pelletized iron ore, a product that typically commands a premium of $20 a tonne over iron ore fines, which currently change hands for $71 (£53) a tonne. Ferrexpo also points to analysis from commodity consultancy CRU, which expects pellets to account for the vast majority of the increase in iron ore product demand until 2021 – or an average annual growth rate of 4.4 per cent. Aside from the need to limit environmental damage, demand for higher grade ore should be further supported by the rationalisation of China’s steel making capacity into fewer but larger blast furnaces.
Meet your steelmaker
Elsewhere, the steel making industry remains under intense pressure. The latest sign of this came in September, when Germany’s ThyssenKrupp and India’s Tata Steel agreed to merge their European operations in an effort to cut costs and pool efforts to face off continent-wide overcapacity and a persistent glut of cheap Chinese production. To our minds, any efforts to consolidate European steel are likely to help Severfield (SFR). Despite a robust balance sheet, decent dividend yield, and a recovering order book and client base, shares in the UK’s largest structural steel specialist have long been overlooked. With a long-term management goal to increase pre-tax profit to £26m by 2020 remaining on track, we think this is one steel group that can thrive in this challenging sector.
