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Steel prices rising
Spot steel prices have been trending up in China since mid-2007, and have begun
another run post-Chinese New Year. To date, flats are up an average of 18% over
2007, and construction steel is up 24%. With demand typically strong after the
holidays as buying for new projects begins and some production having been lost
during the recent storms, we expect steel prices to continue to trend up. We have
revised our price assumptions slightly, expecting them to rise 15% and 5% in
2008 and 2009 from the previous 12.5% and 2.5%. Asian regional prices have also
been very strong year to date, with regional HRC up 21% and CRC up 19%..
Production growth moderating, demand robust
PRC steel production growth moderated steadily from April through yearend, even
as consumption growth remained relatively high. This was accompanied by a
steady decline in export volumes after the April peak. With FAI growth and IP
growth steady through yearend and expected to slow very slightly through 2008,
we expect demand to remain strong even as steel production growth slows. This
suggests that consumption growth will continue to support steel prices, driving
earnings at steel companies.
Earnings adjusted
We have adjusted earnings forecasts for the PRC steel companies to reflect the
65% iron ore settlement, as well as DB's forecasts of 60% increase in coking coal
(though domestic settlements have begun to come in much lower) and stronger
steel prices. Despite the hefty increase in raw materials costs, these are largely
offset by the relatively minor adjustment to steel prices. Furthermore, given how
far spot prices have run, we see substantial, potential, upside risk to earnings.
Valuations attractive, BUY Magang, BUY Angang
Magang and Angang are now down 49% and 52% from their peaks in October
2007. Magang is trading at 9.7x 2008E and 8.2x 2009E, and Angang is on 12.6x
and 8.5x 2008E and 2009E. We value these companies on a residual income
model (TP = BV * (ROE - g)/(COE - g), incorporating DB's A share market ests. for
RFR and MRP of 4.9% and 5.3%which gives us 32% and 49% upside potential.
Risks to our view: severe economic control measures, which impact the strength
of demand and steel prices (see fig 5-8 for eps sensitivities to steel prices). Slower
growth of the construction sector would affect Magang due to its reliance on long
products. Execution of new projects at Yinkou is a specific risk for Angang.