Iron ore spot and Chinese dealer steel prices correcting, but further downside limited
While expectations for large-scale steel price hikes are dissipating, we maintain Overweight on the sector as steel shares are trading at the lowest end of the historical P/B, and 3Q19 earnings results should meet expectations.
Iron ore spot price is now moving around USD90/ton after peaking at USD118/ton in July. Price corrections began in 3Q19, a quarter earlier than expected, due to sagging Chinese imports (as a result of the country’s increased iron ore production) and worries about a potential output increase by a Brazilian mining firm Vale (VALE).
Indeed, China’s iron ore production fell 40% YoY in 2018, but has turned around since March this year after the collapse of a dam owned by Vale, and the YoY increase in July was 14%. Vale’s production activities have also started to recover, with its Brucutu mine (30mn tpa capacity) and Vargem Grande mine (5mn tpa) resuming operations in June.
Going forward, iron ore prices should remain relatively high, over USD80/ton, rather than entering a downward trajectory. In the midst of a full-fledged trade war with the US, China is unlikely to cut steel production as it would undermine its GDP growth, which suggests that iron ore demand should stay firm.
China’s steel prices are weak, with hot rolled steel trading at CNY3,700/ton in September in the market vs. CNY4,000/ton in May. The country’s crude steel production rose 9% YTD in July, but its demand has been weak (Chinese steel PMI in August 37.5pt, down from 45.8pt in the previous month and below 50pt for a fourth consecutive month). Even so, we believe Chinese steel prices will go up rather than down considering iron ore price strength and favorable seasonality.
Steel price hike is a fait accompli on higher raw material prices; stronger nickel prices to benefit STS names
Despite the drop in steel and iron ore spot prices in China, we believe Korean steelmakers have a legitimate reason to raise their prices because of rising raw material input prices. Bound by quarterly/half-yearly contracts, they were unable to raise steel prices on a meaningful scale in 1H19; if anything, raw material input prices rose more sharply than steel prices and they will probably remain high. Accordingly, we believe steel price hikes are a necessity for Korean steelmakers like POSCO (PKX) and Hyundai Steel.
Meanwhile, LME nickel prices rose sharply, which calls for attention for stainless steel (STS) companies. Nickel prices have now jumped to USD18,000/ton from USD12,000 in June, driven by demand from rechargeable battery makers and the prospect of a supply shortage as Indonesia’s nickel ore export ban will go into effect in Jan 2020, two years earlier than what was initially thought. Typically, stainless steel prices are pegged to nickel prices and a rise in nickel prices means higher earnings for STS makers.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Hyundai Motor Company is a passive shareholder in our bank.