ACRA Trainings on Credit Analysis

Although a favorable period in the iron & steel industry is running its course, creditworthiness of Russian producers would improve

Russian iron & steel industry 2022 outlook

  • Global ferrous metals and commodity prices grew 20% in 2017. A correction is expected in 2018-2020. Coal markets are substantially overheated by virtue of Cyclone Debbie aftermath in Australia and the U.S. coal industry’s inability to sharply increase output at enterprises shut down during the period of low commodity prices (2014-2015). A deficit in graphite electrodes used in electric steelmaking resulted in cast iron price surge. These developments supported the iron ore market. However, high-grade coking coal (with the average price of USD 168 per ton in 2017) and iron ore (with the average price of USD 84 per ton in 2017) prices would start declining and would reach USD 140-150 per ton (FOB Australia) and 63 USD per ton (CIF Qingdao) by 2022.
  • By 2022, Russian steel output will set new records reaching 74 mln tons. Lower mortgage interest rates would support the rise in the sector: new housing properties would grow from 80 mln sq. m in 2016 to 89 mln sq. m by 2022. In addition, the share of apartment buildings would grow from 60% in 2016 to 75% in 2022, which would be favorable for the steel industry as their construction requires higher utilization of rolled steel. 
  • Russian exporters supported by weak ruble and low inflation would increase commodity exports (coal and iron ore). By 2022, coking coal exports and iron-ore pellets supply to the international markets will increase to 26 mln tons and 13 mln tons (by 3 and 1 mln tons from the 2016 level, respectively). By the end of the forecast period, exports of semi-finished steel products would also slightly increase to 16 mln tons.
  • In the domestic market, a surge in rolled steel price would give way to a correction. However, owing to price levels, the companies would still be able to maintain high creditworthiness: the average FFOmargin will remain above 25%, and FCF2 margin would be consistently positive.
  • Creditworthiness of Russian ferrous metals producers would improve. For instance, the averaged leverage (total debt to FFO ratio) that equaled 2.59x last year, will drop to 2.3x and 2.15x in 2017 and 2018. As a result, the averaged creditworthiness in the industry may continue improving (from high reached last year to very high), provided that capital expenditures remain unchanged. 

1 FFO – funds from operations.
2 FCF – free cash flow.

Table 1. Russia’s iron & steel industry and world coking coal, iron ore, and hot-rolled steel coils prices: the 2017–2022 forecast

Source: reporting data by Metals and Mining Intelligence, Bloomberg, Ministry of Industry and Trade of Russia, forecast data by ACRA

Higher utilization of steel-making capacity would prevent sharp decline in steel prices despite decreasing raw material prices

With China’s share in global steel production at 49.6% in 2016, steel-making capacity cuts in the country drive global capacity utilization higher.

China accelerated surplus steel capacity cuts: 65 mln tons of steel-making capacity instead of the planned 45 mln tons have been put out of operation in 2016. In the same period, global steel consumption increased by 0.9% reaching 1,645 mln. As a result, utilization of the global steel-making capacity stood at 73%-74% in 2016-2017. 

Figure 1. Global steel-making capacity utilization

Source: OECD, Worldsteel, Bloomberg, ACRA estimates

In 2017, the global commodity markets have been hardly hit by Cyclone Debbie in Australia as well as by export issues with scrap supplies used in steel production. ACRA expects the market to revert to normal conditions in the forecast period, which would activate the original price drivers for the market detailed in the previous ACRA forecast (Commodity prices recovery to shore up Russia’s metals & mining industry, dated November 7, 2016).

The observed figures are totally in line with the forecast made by ACRA one year ago. According to the current ACRA forecast, China would cut its steel-making capacity by up to 160 mln tons in 2017-2020. Save for any large shocks in the economy, capacity utilization may climb to 76% by 2022 - the level last seen in 2014 when the industry demonstrated sustainable financial results.

In 2017, commodity markets, and primarily the coking coal market, faced the consequences of Cyclone Debbie that hit Australia: coking coal production losses stood at 13 mln tons, with spot prices climbing to USD 300 per ton. A deficit in graphite electrodes used in the electric-furnace steelmaking process boosted demand for iron ore raw materials. This deficit was caused by Chinese electrode exports reduction by half (environmental problems forced the country to apply restrictions for petroleum-based needle coke production). As a result, ore prices appreciated to USD 84 per ton, and hot-rolled coil prices in the U.S. climbed to USD 628 per ton.

In 2018-2022, ACRA expects a decline in commodity prices: coking coal and iron ore concentrate prices falling to USD 150 per ton and USD 60 per ton, respectively, which, in turn, would push down hard-rolled coil prices to USD 530 per ton. The increasing utilization of steel-making capacity would hold off the decline in rolled steel prices.

Coking coal prices to stabilize at USD 150 per ton

Coal price forecast is based on the marginal producer model whose costs determine the market price. For coking coal, US exporters are marginal producers; therefore, the higher the demand for US coal, the more expensive coal is consumed by the market pushing the price higher.

In 2016-2017, the coking coal market saw two periods of explosive growth. The first period was related to the launch of industry regulation in China (the country returned to coal mining restrictions policy by reducing the number of working days in a calendar year to 276), and the second period was caused by the Cyclone Debbie. The negative experience in regulating the industry in China and low probability of a repeated massive flood in Australia in 2018-2022 make it possible to assume that the role of fundamental factors in the pricing of coking coal would increase in the forecast period.

In 2016, such giants of the US coal industry as Peabody Energy, Arch Coal, and Alpha Resources initiated bankruptcy procedures. In 2017, corporate debt of the industry has been restructured; some mines, however, were shut down.

In its previous forecast, the Agency noted a positive correlation between global coking coal prices and its exports from the North America. In 2017, this effect was not fully pronounced (most North-American coal miners were either undergoing bankruptcy procedures or recovering their market positions after debt restructuring programs). At the same time, small-scale miners in Australia failed to increase their output: credit institutions were wary of coal industry borrowers. In ACRA’s opinion, the current price level influenced by man-made and environmental factors exceeds the fundamentally justified level. The Agency expects that growth of U.S. output and exports of coking-grade coal would be modest driving prices down to the equilibrium level of USD 145-155 per ton. 

Figure 2. Global coking coal price forecast

Source: Bloomberg, IEA, Metals and Mining Intelligence, ACRA forecast

Iron ore to stabilize around USD 60-70 per ton (CIF)

ACRA’s forecast is based on the basic model for iron ore market development where equilibrium price is formed at the level of costs of marginal producers represented by Chinese companies with high production cost. The higher the demand for expensive Chinese ore, the higher the price as only cost-intensive producers are able to close the gap. The opposite is also true: the more affordable the cheap and quality ore from Australia and Brazil, the lower the demand for the expensive ore from cost-intensive Chinese producers, which drives the price down. Therefore, declining output in China points to low demand in the market and, consequently, to lower price environment.

Lower graphite electrode exports from China (environmental deterioration in the country continues) drove iron ore prices higher in 2016-2017. This has led to reduced utilization of electric steel-making capacity globally. As a result, scrap demand dropped and demand for resources used in blast-furnace process surged.

ACRA expects that up to a third of iron ore mining enterprises in China would be shut down in 2017-2022: more economically efficient miners from Australia and Brazil would satisfy ore demand. As a result, the output of this metallurgical resource in China will decline to 240 mln tons in the above period (-121 mln tons vs 2016); and Australia and Brazil would increase their output by 240 mln tons and 300 mln tons, respectively. 

As the Chinese iron ore producers are global marginal suppliers with a great influence on iron ore prices, ACRA expects that the equilibrium price will decline to USD 60-70 per ton.

Figure 3. Global iron ore price forecast

Source: USGS, Metals and Mining Intelligence, ACRA forecast

Steel consumption in Russia to growth, with prices slightly declining

Mid last year, the expected construction volumes in 2016 in Russia was forecast at 76-78 mln sq. m

The construction industry consumes up to 80% of steel produced in Russia (including pipes and trading companies).

As expected, the 2016 performance of the construction industry – one of the key consumers of the Russian steel – dropped to 80 mln sq m versus the record-breaking 2015, when 85 mln sq m were commissioned. The reason behind the drop is mortgage interest rate cuts as predicted in ACRA’s previous forecast. Sharp inflation slowdown seen in 2017 would continue (safe for significant economic shocks) driving the interest rates lower and prompting growth of mortgage lending.

Figure 4. Construction and industrial output growth forecast

Source: Federal State Statistics Service, ACRA macroforecast 

ACRA expects higher consumption of rolled steel in Russia (from 38.4 mln tons in 2016 to 41.1 mln tons by 2022) amid forecast construction growth. At the same time, steel production will increase from 70.5 mln tons to 73.8 mln tons in 2017-2022, which will drive domestic steelmaking capacity utilization to 82%.

In 2017-2020, rolled steel prices in the domestic market (amid their expected drop elsewhere) may decline from 29,600 RUB per ton to 27,700 RUB per tonof hot-rolled steel plates. In turn, rebar prices will fall from 26,800 RUB per ton to 25,160 RUB per ton in the above period. Likewise, prices for raw resources in the iron & steel industry will go down. By 2022, iron-ore concentrate will drop to 3,650 RUB per ton (the price was 4,500 RUB per ton in 2016). In 2016-2020, a ton of Zh and GZh grade coking coal concentrate will decline by RUB 1,000 to 8,100 RUB per ton.

3 Hereinafter prices are given exclusive of VAT.

Industry’s credit quality is improving

Creditworthiness assessment performed by ACRA represents the average-weighted creditworthiness assessment of companies in the industry.

ACRA anticipates a downtrend for steel products prices. However, these levels will be favorable for companies in the industry: the major period of the investment cycle in the sector has finished in 2004-2014; hence, credit quality of the iron and steel companies will improve even amid deteriorating environment.

In its forecast, ACRA uses reporting data of public companies in the iron and steel industry. According to the Agency’s estimates, the current scenario for steel and commodity markets dynamics (excluding leverage changes) denotes a possible improvement of the average creditworthiness in the industry. This way, the averaged leverage to FFO before working capital changes and net interest payments ratio will decline from 2.59x in 2016 to 2.3x in 2017 and to 2.15x in 2018. As operating cash flow before tax and fixed charges ratio would improve, and leverage and debt servicing ratio (debt to FFO ratio) would decline, the averaged creditworthiness assessment of Russian iron & steel companies would increase from high to very high. 

Figure 5. Russian iron & steel industry: average-weighted leverage

Source: ACRA forecast

ACRA brings to the attention that creditworthiness of specific companies in the industry will be significantly different from the average-weighted figures. However, the overall risk of lending to iron & steel companies will reduce.

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