The steel sector is facing an uncertain future as declining demand and high debt loads place considerable stress on the sector. As it stands the top 30 steel companies have more than $150 billion in debt, while estimates place the Chinese steel sector's debt at more than $500 billion. Excess capacity, according to a new report, stands at around 700 million tonnes, with little short term outlook for market recovery as China shifts its economic focus and the world economy plods along.
Steel, an alloy of Iron and other elements, is predominantly used as a construction material in varying quantities across a range of projects. The material is versatile, strong, durable and relatively cheap, making it an ideal material for the skeleton buildings, for bridges or for the reinforcing within concrete structures. In recent decades, the material has been in increasing demand as the global economy enjoyed steady growth and China boomed.
Following the global economic crisis and the more recent transformation attempts of China from an investment led to consumption led economy, the demand for steel slowed and the price began to plummet. In a new report from EY, titled ‘Debt in the Steel Sector’, the firm considers the effects of the changing market conditions on the steel industry, as well as ways in which companies are seeking to batten down the hatches in what may become protracted stormy weather for the industry.
Falling steel prices
At the start of 2015 the price of steel began to plummet, falling in the space of months from $500 per tonne to lows of $100. While prices recovered slightly to around $170 by the start of 2016, they again fell sharply mid-ways through the year, to around $50. Over the past two months prices have recovered to around $300 per tonne. The price of iron, the main constituent material in steel, fell considerably between the start of 2014 and the start of 2016.
According to the analysis by EY on the health of the top 30 steel companies, average debt relative to EBITDA has been on the increase since the financial crisis, dipping slightly in 2014 on the back of improved margins from the reduction in iron prices. Today, the debt across the 30 top steel companies stands at $150 billion, and has continued to rise as demand falls and prices remain depressed.
Anjani Agrawal, EY Global Steel Leader, says, “The steel sector continues to face headwinds. Lower prices and weaker demand over the last year has prevented steelmakers from reaping the benefits of ongoing debt restructuring and cost and efficiency measures. As a result, debt in the sector is now sitting at a record-high and many steelmakers are in some form of distress with some teetering on the verge of bankruptcy.”
China’s seemingly never ending appetite for steel, as well as competition to secure market share, has led to large Capex investments in capacity. In China for instance, since 2000 around 1,075mt of capacity has been added, last year there was a gap of 419mt between production and capacity. Globally there is currently around 700mt in excess production capacity, with utilisation rates standing at 70%. According to the firm, this represents around $300-$350 billion in excesses capacity (15% of total) that could be closed.
The weaker global growth and transformation of the Chinese economy have resulted in decreased global demand, at -3% and -5.4% respectively. Increased historical Capex into production, mixed with recent squeezes in margins as it becomes a buyer’s market, mean that companies have begun leveraging loans to finance their operations. Recent increases in short term loans suggest, according to EY’s analysts, that companies are more and more often using loans to finance daily operation or are unable to access adequate conditions on long term finance – highlighting the stress in which the industry finds itself. Short term loans tend to make companies more vulnerable in market downturns.
The firm’s analysis also looked at where steel companies are facing the greatest stress. India, China and Brazil stand out, in each country debt levels remain high, while EBITDA has fallen significantly. In India this is the result of companies investing to capture new demand, while in China excess production continues to pressure the market. Japan and Russia stand out as countries that have managed to reduce debt significantly in recent years, largely on the back of their depreciated currencies that made exports more valuable.
EY’s study points to a mixed mid-term picture, as continued low demand from the global economy and China mean that prices may stay relatively low. Governments around the world are trying to identify ways in which to protect their domestic firms, however, according to Agrawal, “These solutions will only work if the companies in question have viable long-term business models. And while many steelmakers are focusing on productivity and working capital, there’s still a lot to be done. Alternative financing, tighter controls on costs and divesting non-strategic assets to free up capital are key tactics currently playing out in the steel sector to reduce debt and release cash.” Agrawal further adds, “Closures or bankruptcies in the steel sector can have serious impacts on the local markets and also on the broader local economies. The sector players need to undertake real strategic changes to survive current conditions and prepare to ride the next wave of growth.”