Outlook for the global steel market
December 2015 | 10QUESTIONS | SECTOR ANALYSIS
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FW speaks with Nicholas J. Sowar, Deloitte Global Metals Sector Leader, about the outlook for the global steel market.
FW: Could you provide an overview of the state of the global steel market? What key trends are shaping the industry?
Sowar: The global steel industry is in the throes of turbulent times. Demand for steel in 2016 is likely to decline as the pace of global economic growth in major nations also slows. Steelmakers are bracing for this and are struggling to maintain profits in the face of global excess capacity and historically low prices. Global excess capacity stands around 400 to 700 million tonnes with a large amount of this lower-grade steel. Exports from China continue to penetrate markets all over the world, exerting downward pressure on the price of hot-rolled band (HRB) which is reaching prices not seen since 2002 to 2004. In this climate, steel companies will likely look to reduce debt, manage costs and implement operational improvements to weather the turbulence ahead. The industry is looking towards 2017 for signs of a recovery, but bracing for a tough year in 2016.
FW: To what extent are the 400-700 tonnes of excess capacity, the drop in steel prices, as well as China’s economic slowdown, driving distress across the industry? What other negative factors are evident?
Sowar: For many years, double-digit economic growth in China reflected the country’s deliberate effort to boost labour, capital investment and productivity. A new and much lower level of economic growth of around 6.5 percent in 2016 is more likely to be the norm going forward as the structural impacts of the years of hyper-growth settle. Slower economic growth in China is having a dramatic effect on the industry, putting downward pressure on HRB prices, primarily as a result of the sheer volume of Chinese steel products being exported all over the world. The fundamental issue continues to be the significant excess capacity in the global steel industry which has yet to be addressed and a large part of this excess resides in China. The fact that almost 70 percent of global steel production is controlled, directly or indirectly, by state-owned-entities (SOEs) results in the agendas of steel producers – and governments – often differing from free-enterprise steel producers. This is evident in areas such as the preservation of the jobs in the industry and the collection of taxes. With the SOEs being subsidised in various forms, it tends to create market imbalances and more likely extends the life of inefficient and non-competitive steel mills which may, in reality, face insolvency.
“Demand for steel in 2016 is likely to decline as the pace of global economic growth in major nations also slows.”
FW: To what extent are geopolitical tensions a factor contributing to the current state of the industry? Which regions pose the biggest threat to global steel markets?
Sowar: Geopolitical tensions are extremely high and are a major contributor to the state of the global steel industry today. The focus is very much on the global excess capacity and the strong export push by China. In 2014, China exported around 140 million tonnes of steel, which represents more than the exports of the steel producers in the North America Freed Trade Agreement (NAFTA) and European Union (EU) countries combined. Essentially, China is exporting its overcapacity to the rest of the world, adding pressure to other regions which also face overcapacity issues. The biggest short-term threat is focused on China with its excess capacity and exporting practices of selling steel below its costs. However, the enactment of tariffs and duties by other countries and regions could likely have a negative long-term impact of allowing ‘protectionism’ to become the standard, which may allow inefficient ‘free-enterprise’ steel producers to have a safe haven.
FW: What are some of the options available to steel companies struggling with shrinking global demand? Is there a need to consider operational and financial restructuring given the current circumstances?
Sowar: For a steel company to survive in these challenging times, proactive actions need to be carefully planned and implemented. These may take the form of four categories: cost reduction, balance sheet right-sizing, customer focus and strategic investments. In terms of cost reduction, steelmakers may seek to reduce structural costs and also implement operating efficiency measures such as a reliability-centred maintenance programme. Balance sheet right-sizing is another consideration which will help to unlock the value of captive assets or refinance debt and other long-term obligations to the extent possible. An unrelenting focus on customers is needed even more during these challenging times. Companies can look towards providing their customers more value-added products and services as well as ways to drive innovation in collaboration with customers and suppliers. Strategic investments also present opportunities. These may be with the view to investing and focusing on targeted growth areas of the business. Continuing to invest in talent and the development of people is highly important for steelmakers. Companies may also look to allocate capital in the highest value-added manner and also be creative in how they optimise energy management.
FW: What advice can you offer to steel companies looking to refinance existing debt? Is there an appetite among lenders to support this strategy?
Sowar: In the current economic environment, lenders are less willing to support this refinancing of debt, so steel companies may need to look at alternatives to pay down debt and free up cash. Some examples include divesting non-core assets or even positioning the company for acquisition. Steel companies should start with a solid business plan – one that is realistic and consistent with the industry view of how quickly the global steel industry may return to profitability. While a there is a lot of debt currently being refinanced due to the usual cycles of timing, not much of this activity is currently or likely to occur in the steel industry moving forward. Refinancing is best from a position of strength and is really something that should only be considered if necessary.
“For a steel company to survive in these challenging times, proactive actions need to be carefully planned and implemented.”
FW: Have you seen an increase in asset shedding and distressed M&A involving steel companies? Are stronger companies looking to take advantage by buying up smaller entities?
Sowar: While there have been some distressed assets on the market, this is no longer as prevalent. Of late, merger and acquisition (M&A) activity in the steel industry has been relatively subdued, driven by the strategic need for portfolio realignment. Asset shedding, rather than distressed M&A, has been more the norm. However, the latter may increase as pressure mounts for global steel industry players to compete in an environment of slower demand and excess supply at lower prices. Stronger companies would likely need to evaluate opportunities to buy where the asset aligns with their strategic markets and customers. Otherwise, what might be purchased is just excess capacity.
FW: To what extent are private equity firms and activists taking greater interest in the volatile steel market? What impact have they had on the fortunes and strategies of struggling companies?
Sowar: For the past few years, private equity (PE) firms have only been active in deals relating to the non-core businesses of the steel companies and the interest has generally been downstream on steel products and less upstream. These firms, however, seem to be indicating a little more interest in the steel industry, but not to a significant degree. A key reason for this is that the big deals often involve too much leverage and risk and it is usually a challenge to borrow the funds needed for such large deals in the steel industry. It will be interesting to watch if PE firms’ interests increase upon a recovery upturn, but generally other sectors tend to invite their investment attention first. While there have been a few examples in history of these firms becoming involved in the steel industry, none seem to stand out in terms of a story of improving the fortunes of struggling companies.
FW: What has been the impact of steel industry distress on the broader production supply chain? Has there been a knock-on effect for mining and energy companies, for example?
Sowar: The entire upstream supply chain has been disrupted due to excess steel capacity, including iron ore producers, coal producers and scrap providers. Furthermore, the low price of metallics, particularly iron ore, has had a dramatically negative effect on investments in alternative sources of iron like the Direct Reduction Iron (DRI) expansions. The decrease in iron ore prices is causing China to shutter high cost iron pelletising facilities in favour of cheaper iron ore imports. Iron ore producers are closing facilities throughout the world in response to the excess capacity, with iron ore prices decreasing over 64 percent since January 2014. In addition, the most significantly negative impacts of the excess steel capacity have been experienced by commodity steel producers. The global metallurgical coal industry, for example, has been roiled by the excess steel capacity, resulting in bankruptcies, plant closures and idling of production of met coal properties.
“The entire upstream supply chain has been disrupted due to excess steel capacity, including iron ore producers, coal producers and scrap providers.”
FW: In your opinion, could other industries, such as automotive, actually benefit from the current slump in the steel sector?
Sowar: The downstream consumers of steel products, such as the automotive industry, are certainly benefiting with higher margins on their product sales in light of the inexpensive steel on the market today. Coupled with the substitution of aluminium for steel in the automotive industry, further downward pressures on steel pricing is being felt by steelmakers.
FW: Going forward, what developments do you expect to see in the global steel industry over the coming months? Do you expect the oversupply problem to improve in the foreseeable future?
Sowar: Aggressive interventions with tariffs and duties are likely to increase. For example, steelmakers in the US are considering a request to invoke a Section 201 steel tariff investigation of Chinese steel imports if the US government does not act quickly on trade remedies. A Section 201 trade remedy was last put in force between March 2002 and December 2003, whereby temporary tariffs were put in effect to protect US steel producers from steel imports. Companies are indicating that if such ‘fair trade’ rulings are not enacted soon, the steel glut will continue for years and will likely only be accelerated by bankruptcies and shutdowns, resulting in major steel unemployment issues on a global basis.
Nicholas J. Sowar is the Deloitte Global Metals Sector Leader supporting the cross-functional services delivered to Deloitte member firm clients worldwide. Over his distinguished career, he has served and continues to serve as the lead client service partner or advisory partner for many leading clients in the global metals, consumer business and automotive sectors. Mr Sowar is frequently called on for his insights into trends shaping the global metals industry and regularly speaks at premier global industry events. He can be contacted on +1 (513) 784 7237 or by email: nsowar@deloitte.com.
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