Current Situation of China’s Iron and Steel Enterprises and Demand Analysis in the Second Half of the Year
Investigation in Tangshan District
1. Demand side is weakening at the present stage and is expected to recover in the second half of the year.
With the year-on-year increase in real estate demand from the beginning of the year to May, steel prices and steel profits have a wave of obvious expansion, but since May, steel prices and steel profits have been significantly reduced, we can see that the accumulation is caused by the periodic decline in demand. According to the intensive investigation in the past two weeks, the feedback from both the terminal and the steel mill industry shows that the core contradiction lies in the terminal demand. The main reason for this contradiction is the gradual tightening of funds since May. From the feedback of steel mill traders, whether it is real estate projects or large-scale infrastructure projects, there has been a decline in terminal repayment since May, especially for large-scale infrastructure projects. As a result, traders have slowed down the pace of supply and construction downstream.
From the data point of view, the investment in infrastructure has not been up to expectations. The cumulative growth rate of the whole year is less than 3%. Since May, there has been a slight decline, indicating that the downstream has indeed been a financial problem since May. That is the core reason why steel prices and profits have fallen since May and June.
We believe that the current weakening of demand is phased, and demand is likely to rebound in the second half of the year. From a broad perspective, real estate and capital construction are still relatively strong links in the whole industrial chain. The base of capital construction projects, real estate stock and construction area is very large. Phased problems will indeed affect the demand for threaded steel, and the recent policy of special debt also confirms the problem of tight downstream funds. The attitude of national policy is very clear. Capital construction in the second half of the year is still the key direction. According to our survey in East China, foreign trade has performed poorly this year. Combined with macro data, we believe that foreign trade has a negative impact on the overall economic structure this year, and the growth rate of consumption demand has not reached expectations. So the core of demand in the second half of the year is the investment in real estate and infrastructure. Debts do alleviate downstream financial constraints, but it will take some time to take effect, so we expect demand to pick up around the end of July to August. In terms of building materials, the inflection point of downward cycle of large demand has not yet arrived. At present, the decline of demand in May and June is only a phased one, and it will strengthen again in the second half of the year.
The new building regulations implemented in April have little impact on screw thread demand. Through multi-proof and microscopic and macroscopic investigation, if we compare the new building rules with the old ones, the new rules will certainly play a role. The consumption per unit area will be increased by about 8%, but in fact, the demand for threaded steel will not be affected so much in the end. According to our actual investigation, the new projects started by real estate enterprises after April 1 have not changed significantly in the aspects of drawing design and construction; furthermore, the feedback from steel traders shows that the old building years built in accordance with the old regulations have been long, and the existing construction standards for many buildings are much higher than the old ones, so the new regulations implemented on April 1 are against snails. The effect of grain steel is not very great.
2. The scrap addition ratio is at a high level, and the opportunity for spontaneous reduction of production is not yet available.
May and June are the traditional off-season of the steel industry, coupled with the downstream financial constraints caused by the phased decline in demand, steel mill output maintained at a high level of toughness, in addition to iron ore assistance, so the steel prices and steel profits have caused greater pressure. Overall, steel mills in North China have been basically returned to the state of balance of profits and losses. Some state-owned enterprises have lost gross profit, especially those involving hot and cold coil varieties; some private steel mills still have gross profit of 100-200 yuan.
According to our investigation last week, if we do not consider the policy-oriented factors, the time has not come for the steel mills to reduce their production spontaneously because of the lack of substantial losses. In recent years, although production has declined, the rate of decline is very slow, and a large part of it is due to the reduction of furnace start-up rate.
At present, scrap steel addition ratio is maintained at a fairly high level. At this stage, people are more concerned about the scrap addition ratio of long process. From the data point of view, scrap addition is only slightly lower than last year’s highest level. Investigation in Tangshan area shows that the average scrap addition ratio reaches 20%, the highest even reaches 30%.
The drop in steel profits is very different from that in November last year. The decline in profits in November last year was accompanied by a rapid decline in daily consumption of scrap. However, the scrap addition ratio in this wave has not declined rapidly. In recent weeks, the daily consumption of scrap has declined very slowly. According to last week’s data, the decline is less than 1%. The main reason for this is the relative cost of scrap and iron ore. Iron ore has risen significantly this year, but scrap steel has not risen significantly, so scrap steel has obvious cost-performance advantage for hot metal. We compare the price of 6-8mm scrap steel in South China with the cost of hot metal. In fact, scrap steel has always been more expensive than hot metal before, the specific price is about 1.1 times; if rough calculation, without considering matching and other raw materials, now the specific price is about 0.9. It can be said that the cost of scrap steel is much higher than before. Therefore, in the first half of the year, some steel enterprises took the action of increasing scrap ratio, and this wave of profit reduction did not show a significant reduction in scrap addition ratio. Our findings also confirm this idea. Unless the profits of the steel mill are further reduced and the cash flow is harmed, the steel mill may spontaneously reduce the scrap addition ratio and reduce production.
3. The inflection point brought by the policy of environmental protection and production restriction is ahead of schedule, and the tight balance is expected to be broken.
Short-term steel prices were weak, slightly oversupply but basically balanced before the weekend’s policy of environmental production restriction. If the current policy of environmental production restriction is strictly implemented, the balance may be broken, and the average daily production cut-off may exceed 100,000 tons. Previously, the inflection point of steel price forecast was in July and August, but under the premise that the policy implementation will be more stringent, this inflection point may come ahead of schedule. In fact, there are some signs of this environmental restriction. Last weekend, Fengrun Billet Regulating Plant in Tangshan was shut down completely. The shutdown measure was power failure. The impact was that billet prices fell sharply by 100 yuan last Monday. So in fact, the implementation of this policy began to show last week. Before the production limit of blast furnace, sintering production was limited, and the output limit was 30-50%. According to the reflection of steel mills, this strength was greater than before. Therefore, it is expected that this time the intensity of the restriction policy should be greater than before, so it will bring the inflection point ahead.
Investigation in East China
The research objects in East China are mainly downstream, and the research time is also the junction of the first half and the second half of the year. According to the June survey, the downstream performance is slightly lower than expected, but the policy of production restriction may lead to an early inflection point.
1. Demand-side industrial timber continues to weaken, and the profits of land-use-restricted Housing enterprises have declined.
In the first half of the year, the demand for infrastructure in downstream steel has been stronger, while the demand for industrial materials has continued to weaken. From the feedback of foreign trade and household appliances enterprises, this weakness will continue. Take household appliances as an example, the third-tier cities will have a greater impact, the order level will continue to decline; in foreign trade, German electromechanical prices will also interfere with domestic exports. The impact on bulk trade is not obvious at present. In addition, there has been a marginal change in the volume of domestic transit trade exports to Europe and the United States, and now the mode of transit trade has also changed. Vietnam and other countries have gradually changed to import raw materials from the domestic market, processed and re-exported. This new mode will cause certain impact on the domestic terminal and back-end manufacturing industry. Impact.
The core point of view still comes from our understanding of the real estate market. East China is typical in the first-tier, second-tier and strong third-tier cities. According to our survey, there have been some changes in the behavior pattern of Housing enterprises in East China. Every year, there is a theme of real estate. Last year, the layout of third-tier cities and the acceleration of construction ushered in the climax of completion in the third quarter of last year. But this year, the situation is different. We observed that the profits of real estate enterprises have declined to a certain extent, because where the premium rate is high, the land that real estate enterprises can use is limited. Specifically, land with a premium rate of more than 30% requires a self-sustainment rate of more than 20%. In this case, Housing enterprises are also undergoing a transformation, the traditional “land-taking-construction-pre-sale-construction-delivery” mode of investment in real estate enterprises is gradually declining, this decline will bring a relatively long-term pressure on the upstream raw material end, but this pressure is still within the dimension of the same year-on-year data, the next stage is the main stage. Consider the change of supply and demand pattern this year.
2. Supply is the core of driving steel prices and steel stocks in off-season
First of all, we believe that supply is the core of driving steel prices and steel stocks in the off-season. From now on to the beginning of August, it will be in the traditional off-season state. If there is no environmental production restriction in off-season, July will surely show a gradual accumulation, the core of which is that environmental production restriction brings about changes in the industry itself. From June 2018 to June 2018, the environmental production restriction has experienced a full year, including both heating season and non-heating season. The gradual increase in production shows that its implementation is gradually relaxed, especially from December last year to June this year, the output growth rate reached more than 10%, which is also at a higher level.
At this time, the core purpose of the policy must be profit. For enterprises, the pursuit of profit is itself, and for the government, the pursuit of economic benefits and policy chips. In the past, we used to think that environmental protection and economy could not be combined. Environmental protection would reduce the profits of steel mills and government tax revenue. But now it is more like a win-win situation. The premise of this win-win situation is that enterprises have begun to face losses. According to the results of our Tangshan survey, half of the enterprises’gross profit has returned to zero, and some enterprises in Northeast and Northwest China may have been facing losses. In this loss pattern, environmental production restriction is actually a process of resonance between enterprises and government under the guidance of the government. What is implied in the later stage of the resonance process is where the profit limit the market can tolerate.
A big difference from last October is that the tolerance for profits has been marginally weakened. At that time, the profit of the steel mill declined very obviously. The gross profit per ton of steel dropped from more than 1000 yuan to several hundred yuan. The decline was very large, but it was still much higher than the current profit level. At that time, the implementation of environmental protection and production restriction was general in the heating season. In Tangshan last week, we mainly saw the behavior of enterprises before environmental protection, and we are still waiting for it. But once the government meets certain demands of enterprises and acts on production together, the impact of production restriction will be more obvious, which is also a very important point we look forward to.
3. The Follow-up Deduction of Supply and Demand Patterns of Black Lines
(1) Two important time nodes
We divide the follow-up deduction of the supply and demand pattern of the black system into two time points: the first time point is now before the end of July, and the second time point is from August to October. The core of the division of these two time points is from the time point of production restriction on the one hand, and the characteristics of the off-peak season on the other.
The first time point, from the annual demand side performance, from May to early August showed a seasonal downward trend, in the next stage, in late July, especially when demand is weak. However, due to the impact of environmental restrictions on production, there may be a weak supply and demand pattern in the future. Because of the greater strength of the supply side, the gap between supply and demand will be gradually opened. In the process of opening, especially at the end of July, there will be a certain gap between supply and demand.
At the second time, there will be another parade from August to October. According to the last parade situation, it will affect the cycle of at least 15 days to one month. Therefore, this environmental protection policy is not an isolated policy. On the one hand, it is a gift for the National Day, which is combined with the National Day policy. From the whole dimension, environmental protection may not only be a month, but may even affect the next month.
(2) The Impact of Environmental Protection and Production Limitation on Industrial Chain
If there is no environmental restriction on production, the profit distribution pattern of coal, coke, steel and coal in the industrial chain will probably become that the profits of steel and Coke will be crowded out, and the most important profits will be concentrated in the two ports of coking coal and iron ore. At this time, the turning point of profits will appear. However, due to the impact of environmental restrictions on production, the current supply and demand pattern has begun the process of marginal growth. In this process, profits are decided by both policy and market. At present, it is a reasonable bottom state. That is to say, the inflection point of annual profits of iron and steel enterprises has basically emerged, and the margin of profits will gradually expand as they move backwards.
In the process of enlargement, the performance of steel stocks in the third quarter will be much better than that in the second quarter. But we can also see from the perspective of institutional positions, steel in the first half of the year is at the lowest level in history, as long as the market has certain expectations, its elasticity will be more obvious. Unlike consumer stocks, steel stocks don’t last very long cycles, but they are more resilient.
4. Cost side: The expansion of steel profits is difficult to achieve through the decline of raw materials.
The upstream of iron and steel is mainly coke and iron ore. According to the investigation in Tangshan, the situation of iron ore is relatively tense at present, which is mainly reflected in two aspects: on the one hand, the difficulty of ore blending is gradually increasing, and it is relatively easy to buy various grade ores before; on the other hand, the price difference between high and low grade ores is obviously convergent.
According to the current situation, the profit of coke in the black industry is still 200-300 yuan/ton, but we should also pay attention to the spread of the policy of environmental protection and production restriction. We can see that Shanxi has also made some response.
In short, the expansion of steel profits is difficult to achieve by the decline of raw materials, so steel prices will rise more likely in the future, which may lead to stronger cost-side and higher steel prices, thus expanding the profit level of the steel industry, but during this period there has been pressure of environmental protection and production restriction. According to our calculation, gross profit of threaded steel is 200 yuan/ton at present, and it is expected to recover to a reasonable level of about 600 yuan/ton after three or four months. Sure, it’s difficult to break through this April’s high, but it’s attractive enough for steel stocks.
At present, the core of iron and steel is still production restriction in off-season. On the one hand, we need to see the common demands and bottom profits of the government and enterprises brought about by the restriction of production. At the same time, we need to see that the profit inflection point of iron and steel has appeared in the future. With the continuation of the restriction of production brought by the future military parade and the expansion of demand side, the whole profit will continue to expand. In addition, there is relatively limited space for raw material prices to fall, and steel prices are still rising mainly in the latter stage, in order to expand the profit level of steel enterprises themselves.
Since April and May this year, the performance of the steel industry has been weak. Since January this year, the relative earnings of the steel industry index and the Shanghai-Shenzhen 300 index have been about 15% negative. This reflects pessimism about the forward market on the one hand, and also reflects the expectation of a decline in profits in high output on the other. We also made a very strong judgment on the next market. The profit inflection point of the steel industry has begun to appear this year. Now is the best time to invest in steel stocks all year round.
At present, PE of iron and steel stocks is on the high side and the market reaction is relatively pessimistic, but we can see the bottom of profit and the rising cycle in the future. Iron and steel stocks are good allocation means, and the determination of profit upward is higher. We mainly recommend Southern enterprise stocks, such as Fangda Special Steel (600507), Sangang Fuguang (002110), Nangang (600282).
IV. Question and Answer Links
Q: How do you think iron ore prices will rise in the third quarter, eroding the gross profit in the third quarter?
A: At present, the ore price is about 900 yuan, which is relatively high. Prior to the increase in ore prices mainly came from the reduction of overseas ore production, but recent domestic ore production has recovered. On the other hand, from the relatively high level of iron and steel production, the daily consumption level is higher. According to the current daily consumption, the inventory level is lower than that in 2007 and 2008. However, the current policy expectations are brought about by environmental protection and production restriction. We believe that the core logic will be changed in July. The increase of steel price will erode its profits, and gradually change into the improvement of steel supply and demand pattern, which will drive up steel price, while the decrease of supply will reduce iron ore demand. Therefore, we believe that iron ore is unlikely to erode steel profits in the third quarter.
Q: Understanding that Brazil’s mining areas have resumed production, with the expansion of iron ore supply, will there be a reduction in iron ore costs, rising coil prices, and then profit expansion?
A: Today, the hot roll has risen by nearly 5%. It has already responded to the policy of production restriction. In terms of relative price, the price of hot coil will certainly be stronger than that of iron ore in the future; in terms of absolute price, if the price of hot coil rises, the price of other products will rise to a certain extent because of the inherent profit distribution ratio in the industrial chain.
Q: How do we see that this year’s crude steel output growth rate of more than 10%, is it consistent with the demand situation?
A: According to the data from January to May, crude steel output has indeed increased by more than 10%. But in detail, on the one hand, there is the problem of explicit invisible output. That is, with the improvement of profits of iron and steel enterprises this year, some output has been transferred from outside to inside the table. But this conversion has not been completed last year. There are still some output that has not been reflected outside the table, and the actual growth rate will be reduced by 2-3 percentage points. On the other hand, because domestic steel prices are relatively higher than overseas, the need to subtract the part of overseas exports, accounting for about 2-3 percentage points, so this year’s real demand growth rate is about 4%.
Q: Are production restrictions expected to continue in August and September?
A: Compared with the previous military parade, the same thing is that the government will have limited production within 15 days before and after the military parade; the difference is that the government now pays more attention to environmental protection, and this year’s military parade is larger, so this year’s expected labor restriction is still stricter before the military parade. Because if production restriction is relaxed, there will be some problems: take Tangshan as an example, air quality seasonal preference from mid-late April to the end of September every year, but air quality gradually deteriorates into October. Considering the air situation, Tangshan Municipal Government will take measures to prevent the future.
Source: China Pipe Fittings Manufacturer – Yaang Pipe Industry Co., Limited (www.steeljrv.com)
(Yaang Pipe Industry is a leading manufacturer and supplier of nickel alloy and stainless steel products, including Super Duplex Stainless Steel Flanges, Stainless Steel Flanges, Stainless Steel Pipe Fittings, Stainless Steel Pipe. Yaang products are widely used in Shipbuilding, Nuclear power, Marine engineering, Petroleum, Chemical, Mining, Sewage treatment, Natural gas and Pressure vessels and other industries.)
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