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Mispricing between fundamental upside vs. attractive valuation
(1) Utilization rate approaches 90% based on recently released June production
(up from 67% in October 2008), potential pricing power emerging, in our view.
(2) Channel checks indicate 1H demand strength is mainly underpinned by
existing infrastructure project acceleration, more new project starts in 3Q.
(3) One key upside surprise from our channel checks is the better-than-expected
use of flat steel (such as welded pipes) in infrastructure projects, a key reason for
the flat steel demand upside (jumping to 20% yoy in June from single-digit ytd).
(4) More importantly, property (25% of demand) new starts turn positive for the
first time in June after 11 months of negative growth, another key demand driver
that is accelerating and boosting demand sustainability further.
(5) On the supply side, our channel checks indicate that small mills in Hebei
Tangshan are operating close to full capacity, little potential for supply threats.
(6) Capex cycle is favorable at 4.6% ytd yoy growth, the lowest it has been since
early 2007. A similar reading in early 2006 led to a two-year steel upcycle.
(7) Import threat is neutralized near term until another 20% price rise. Near the
end of a deep US/Europe de-stocking cycle could drive up 2010 utilization to 77%
in Europe and 65% in the US from current 52%, after factoring in weak macro.
(8) Inventory still not excessive, about 20%-25% higher than normal per channel
check. End-user level is still 15%-20% below normal levels. Further restocking
could support the price, in our view, as long as real demand remains strong.
(9) 3Q earnings could surprise on the upside after 1H loss. 2006-2007 upcycle
experience shows sector rerating post Baosteel 3Q06 earnings upside.
(10) Flat steel equity has been lagging in both H- and A-share markets.
Fundamentals, steel price, earnings u/g; Angang and Baosteel u/g
We upgrade our sector stance to Attractive, and raise our 2010E demand forecast
to 13% yoy from 7% previously on infrastructure and property capex upside,
resulting in China becoming a small net importer of steel from a net exporter
previously. We also raise our 2010E steel (HR) price forecast by 9% to US$600/t,
up 18% yoy. We raise our 2009E-2011E earnings forecasts by 1%-56% on the back
of our higher steel price assumptions. We revise our target prices by 14%-86%.
Stock actions: more positive on flat producers. (1) u/g Baosteel to Buy on CL
from Neutral on close to trough valuations and steel cycle leverage boost from
better stainless profitability. We raise our 12-m TP to Rmb13 based on mid-cycle
EV/RPC of 180%. (2) u/g Angang (H) to Buy from Neutral due to flat steel upside
surprise, better 2H iron ore cost (down 20% hoh), and lagging (vs. Magang by
19ppt ytd) share performance. We raise our 12-m TP to HK$20. Maintain Buy on
Magang, Neutral on Wugang. Risks: extended global macro slowdown.
Table of contents
Overview: Ten drivers for “sweet spot” 2
Driver #1: Utilization is approaching a critical hurdle, pricing power is emerging 8
Driver #2: Infrastructure spending is the key reason for 1H demand strength; more to come 9
Driver #3: Key upside surprise: More flat steel is being used in infrastructure projects 11
Driver #4: The other key demand driver, property capex, starts delivering 12
Driver #5: On the supply side, small mills are already operating at high utilization rates 14
Driver #6: On the supply side, capex cycle supports a two-year upcycle 15
Driver #7: Near-term import threat is neutralized, global utilization potential further recovery 16
Driver #8: Inventory is not excessive; end-user inventory is still below normal 18
Driver #9: 3Q earnings potential upside surprise is a key catalyst 20
Driver #10: Flat steel equity is lagging the index/construction steel peers 22
Stock picks: Upgrade Baosteel to Buy (on Buy, CL) and Angang to Buy; maintain our Buy rating on Magang 23
Risks: China policy tightening or global macro 30
Summary financials 31
Disclosures 35
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