It may sound like absurd, but the last year may qualify as successful for the Ukrainian steelmakers. In 2020, the total volume of steel production fell by only 1.1%. Who could have predicted such an outcome, for example, in early April? During the last quarter, the market saw creation of such conditions nobody could have dreamt of over the last decade. Export prices for hot rolled coil went as high as $750 per ton, for Rebar up to $670, and for billets up to $600. How come we saw such high prices during the period of crisis?
COVID-19 epidemic has created imbalances in the market. In spring, we witnessed the deepest and sharpest drop in steel consumption — by 50% in April, y-o-y. But as soon as in 6 months, demand hiked up sharply like never before.
During the spring lockdown in Europe, decline in manufacturing output appeared to be much sharper than in the construction sector. That was why prices for flat products dropped faster than the prices for long products. The lowest drop of prices for hot rolled coil was at the rate of 25% and prices kept under $400 for two months. A number of manufacturers in this very segment closed down their operations. In April, one in three blast furnaces in the EU stood idle. Material uncertainties made it impossible to take decisions on a timely start-up. That was why supply was not in place in time when demand recovered. As on January 2021, 8 furnaces with the total capacity of 11 million tons (which accounts for 5% of total capacity in the region) remained idle.
Demand, on the other hand, fully recovered in the EU from September onward and reached the levels of 2019. For that matter, shipments of rolled products by the service centers in September showed growth by 3.3%, y-o-y, and by 8.8% in November. At the fourth quarter-end, 2020, apparent steel consumption in the EU is expected to have increased by 8.8%.
These are the causes of the price rally at the end of the year. Demand has fully recovered in Europe but many production facilities are still idle, and there is deficit of domestic supply which is impossible to cover by imports because of the safeguard measures currently in place. Finally, protectionism has helped. European consumers find themselves hostage to the policy of tightening the screws on the imports. And that has resulted in a panic in the market, inability of the buyers to satisfy their needs, and hiking prices, including for raw materials. The prices for long products changed on much smaller scale and basically were preconditioned by increase in prices for raw materials.
Such rapid recovery in demand came as a complete surprise for everybody. It is especially so given that the economy is far from reaching 2019 levels. For example, Euro Area’s GDP dropped by 5.4% y-o-y in Q4. So, on the one hand, steel consumption increased by 8.8%, and on the other hand, economy shrunk by 5.4%. According to the forecasts of almost all world financial institutions, Euro Area’s GDP will return to 2019 levels only in Q2 2022.
That means that at the end of the last year, the steel market dynamics broke away from the rate of economic recovery. That fact might be preconditioned by the following causes:
1. As a result of the pandemic, the service sector suffered much more seriously than sectors consuming steel.
2. Those were sectors consuming steel that were supported under the incentive schemes.
3. Extraordinary steel demand during Q4 is temporary and will, soon, be brought in correlation with weaker GDP dynamics.
At the same time, demand in the EU will reach its full potential as early as in Q1 of this year; start-up of blast furnaces with the total capacity of 8 million tons and electric-arc furnaces with the total capacity of 2.5 million tons is planned.
That means that imbalances between demand and supply are going to be eliminated in the next two or three months. On the one hand, the demand level is in the fair way to somewhat ‘cool down’, account taken of the projected slow economic recovery in a number of regions, and risks associated with the ongoing epidemic, and expected reduction of incentives in China. On the other hand, demand is recovering.
Before long, price drop is expected: sharp one — at the end of Q1 or at the beginning of Q2, and soft landing — until the end of 2021. What concerns the price levels, the price for hot rolled coil may drop to $500 until the end of the year, or minus 30% of January baseline levels. Any further significant drop in prices for rolled products will be prevented by the iron ore price. According to the forecasts of the Australian Department of Industry, Science, Energy and Resources, average iron ore price will be above $100 in 2021. Problems involved with restoration of mining in Brazil will support the market.
We have already left behind the best period of steel industry. However, as a whole, this new year is expected to be pretty fine.
The original article was posted here.
In late September, ArcelorMittal and Cleveland-Cliffs entered into a definitive agreement according to which Cleveland-Cliffs will acquire 100% of the shares in ArcelorMittal USA. Six steel mills, eight finishing plants, two iron ore mining and pelletizing facilities and three coal and cokemaking facilities will also come under Cliffs’ control as part of this deal. The transaction is expected to close by the end of 2020, once it is approved by the regulators.
Few doubted that the 2020 year will bring a new leader in the steel industry. Last year, ArcelorMittal with its 97.3 million tons was close to losing its world leadership. Number two was the Baowu Group. The difference in their production results was as little as 1.8 million tons. As COVID-19 made ArcelorMittal idle some of its facilities worldwide, and China keeps breaking production records, Baowu is quite likely to become ‘the new king’ by the end of this year anyway. However, the sale of the US assets de facto means that ArcelorMittal is not going to struggle for retaining its top position in the world’s largest steelmakers ranking.
There was a time when the ‘number one’ status made a difference. In the mid-2000s, when the steel market was rapidly growing, companies competed for mergers to expand their influence and take the leadership. It is exactly because Lakshmi Mittal wanted to be number one, Ukraine managed to sell Kryvorizhstal at a really good profit. At that time, Arcelor and Mittal Steel jacked the price up 2.5 times, to $4.8 billion.
Times have changed. Today, the race for volumes brings no additional advantage. The market is suffering from a long-term recession and excess capacity. Corporate strategies tend to target not growth, but higher sustainability, efficiency, return per unit.
Leadership turned out to be a burden in such conditions. In 2019, number one in production volumes meant number 74 in EBITDA margin and number 42 in net debt to EBITDA (4.1) among 85 public steelmaking companies.
One could say that the company is now facing the consequences of its aggressive M&A policy in the early and mid-2000s. ArcelorMittal’s assets in the US were concentrated in the period from late 1990s to 2004. Today, these assets’ annual capacity is 20.3 million tons of steel, 90% of which is produced by the conventional BF-BOF route. These plants were built in the 1960s–1970s and need investment. According to the mass media, the Company’s assets in the US can hardly boast of high efficiency and have been losing out to more modern EAF mills. They also face difficulties in logistics in the finished products segment. The mass media also point out the great influence of trade unions on these companies’ activities, which made it difficult for them to optimize costs. ArcelorMittal USA’s capacity utilization rate in 2019 was only 60% against the industry-average 80% in the US.
The purchase of Italian bankrupt Ilva and Indian Essar hardly made ArcelorMittal any stronger. This is another proof of the fact that M&A transactions in the steel industry bring more benefit to sellers than buyers. These assets looked like a growth opportunity. But in the time of crisis, they turned out to be more of a burden. In May, the Company had to raise additional capital — a pretty expensive one. It issued shares for the amount of $0.75 billion and convertible bonds for the amount of $1.25 billion with a 5.5% coupon.
ArcelorMittal had to make a choice and sacrifice something for the sake of maintaining competitiveness and sustainability. In July, ArcelorMittal announced its business restructuring plan aimed at mitigating the consequences of the COVID-19 pandemic and raising up to $2 billion as a result of sale of its assets. That was an absolutely reasonable step.
And the Company chose to sacrifice its US assets. Importantly, according to Citibank, ArcelorMittal’s assets in Canada and Mexico are more efficient than its US business and brought the Company $95 per ton of steel in 2018–2019 compared to $60 per ton of steel in the US. According to the mass media, the Company started considering the sale of ArcelorMittal USA back a year ago.
However, ArcelorMittal actually did not just disposed of its assets, but rather exchanged them for a stock in the already integrated business in which it will get 16% of shares. The Company will get only $500 million in cash. But what is more important is that the transaction will enable it to deconsolidate (remove) a debt of $2 million off its balance sheet.
The value of the deal, including ArcelorMittal USA’s debt, will amount to about $3.3 billion. In its press release about the opportunities opened by this deal, the Company wrote that the transaction valuation for ArcelorMittal USA equates to an EV/EBITDA multiple of approximately 6x through-the-cycle, based on an average annual EBITDA from 2017 to 2019. This is higher than the industry-average 5x. And it is especially impressive in such a hard time for the industry.
But the price is not sky high at all if we look at how much Cleveland-Cliffs paid per ton of steelmaking capacities, namely $162 per ton. That is 6 times less than the cost of construction of new EAF facilities (around $1,000 per ton). While the value of the deal includes the debt, it excludes the cost of other assets covered by the deal (iron ore mining, coal mining). That means that the price paid for the mining & metals assets was even lower.
The terms of the deal seem favorable for the buyer. In addition, obsolete and inefficient assets should not be a problem for Cleveland-Cliffs. An integrated model is supposed to let the Company sufficiently utilize these assets even when the market is down. For Cleveland-Cliffs, it is important to get a stable sales market as ArcelorMittal USA was its largest client accounting for around 50% of its sales. The client’s problems are the seller’s problems too. So, it is not improbable that for Cleveland-Cliffs, it was impossible to stay aside. ArcelorMittal’s decision to sell its US assets simply left no choice for Cleveland-Cliffs.
This is the second similar M&A deal for Cleveland-Cliffs over the past 12 months. In March this year, the Company purchased another large US steelmaker, AK Steel. The reason for the deal was the same, i.e. keep a troubled large buyer that accounted for some 30% of the Company’s sales. In a word, Cleveland-Cliffs is now the second largest steel producer in the US and a happy owner of bad assets. However, an integrated model can give the Company a chance to boost sales and complete with smaller and more effective EAF mills.
The shareholders of both Companies believe that the deal is a success. The shares of both the seller and the purchaser grew by more than 10% in the first days after the deal. The only party unhappy with the deal is the creditors. Moody’s placed all ratings of Cleveland-Cliffs on review for downgrade.
Another interesting aspect is that the deal was announced right before the presidential election, which creates some risks for the purchaser. Earlier, the market players expressed their concerned about the future import duties on steel in case the Democratic candidate wins. On the other hand, the large-scale protectionism has fragmented the world market so badly that giving up this system is already virtually impossible.
In conclusion, I would like to point out that the deal is an important milestone for the whole industry. The leader is out of the running for the number one producer. Instead, efficiency is a new priority. The iron ore producer is changing its business model completely and is entering the steel market. Perhaps what we see in the US today is the future format of the steelmaking industry. Integrated mills are losing out to flexible EAF mills, especially in the context of the path towards the sustainable development goals. Integrated iron & steel companies need vertical integration as much as suppliers of iron ore the demand for which will be under pressure in the long-term perspective.
The article is also posted here.
In 2015–2019, global merges and acquisitions in the steel industry were estimated at $47 billion (around $10 billion per annum). In 2019, M&A transactions approximated $6.2 billion, 40% down from the average of the last five-year period and more than half down from 2018.
The number of transactions in the sector is small, up to 10 per annum. One or two major deals could considerably increase the overall annual ‘price list’. Without regard for ‘mega deals’ exceeding $2 billion, M&A transactions in the sector average $6-7 billion per annum. In other words, the last year does not stand out from the common pattern.
As for global M&A activity, the value of deals in the steel industry is miserable, 0.4% of the total value on average, much lower than the sector’s 0.7% share in global GDP (with regard to direct effect only).
M&A activity in the sector is historically low notwithstanding the low level of concentration. The level has remained almost unchanged since the 1970s. This is evidenced by the dynamics of the Hirschman Herfindahl Index (HHI): 1.2% in 1970 and 1.29% in 2016 against the average of 11% for all industries.
Despite a seemingly high potential for concentration, investment bankers have other preferences — high-tech sectors, pharmaceuticals.
What is the reason for low mergers and acquisitions activity in the industry?
- The steel market is stagnating.The World Steel Association’s long-term forecast for global steel consumption growth is 1% per annum. Therefore companies’ development strategies are targeted at increasing competitiveness, not growth.
- Difficulties of integrating the merger object.Given excess capacity, it makes no sense to buy competitors when the buyer has its own unutilized capacity. This of course does not cancel transactions aimed at entering new markets, expanding the range of products or deepening metal conversion, but narrows down market possibilities. Effective integration of the purchase object, according to a survey by JP Morgan, is the most important factor that determines the success of M&A. This was stated by 23% of respondents.
- Companies do not seek to take risks.Their balance sheets are full of arrears. A Net Debt to EBITDA ratio in the industry has been exceeding 4.0 for a number of years, whereas the maximum acceptable value is 3.0. Furthermore, the industry badly needs investment in the wake of the decarbonization and digitalization trends. Purchase of obsolete assets means additional investment.
- Economic uncertainty.It is economic certainty, predictability that was ranked second by importance for M&A success (19% of JP Morgan survey respondents). Yet the opposite trend has been observed over recently. The industry depends on economic cycles. The current economic cycle has been lasting for 11 years. A recession is expected every year, with a likelihood growing every year. It seems that the cycle peaked in 2018. Therefore, the uncertainty keeps growing.
- High price volatility in the markets for metal products complicates the assessment. Meanwhile, companies’ valuations seem adequate. Average EBITDA multiples are 5.0–5.5. At the same time, most M&A transactions over the past few years have been concluded with companies with troubled assets. They are from countries with large steel markets where buyers see a sales potential. Such transactions are concluded at the lowest price, often on conditions of debt repayments or investment liability. Adequacy of valuation is deemed significant by 18% of JP Morgan respondents.
- Obstacles by regulatory authorities.M&A deals in Europe are impeded by antitrust authorities. A striking example is the blocked steel merger between Tata Steel and ThyssenKrupp. ArcelorMittal had to sell three plants to receive the right to buy Ilva. Approval from trade unions is also needed for M&A deals. Liberty House had some difficulties in negotiating the purchase of ArcelorMittal’s plants.
Stimulative regulation policy is not a guarantee of M&A activity either. Mergers and acquisitions in China’s steel industry are being encouraged by the government to restructure the sector and fight excess capacity. The Chinese government set a target — the top 10 companies should hold a 60% stake of the market by 2025. Although Chinese companies concluded 40% of a total of global M&A deals in the steel industry, their number is still small. As a rule, transactions of Chinese companies were focused on domestic objects. Still, it is important to note that in the past year or two, China targeted a number of European companies: British Steel, Huta Częstochowa.
What can increase M&A activity in the industry in the coming years?
- An economic slowdown may bring a new wave of deals with companies with troubled assets.
- Protectionism may prompt companies to M&A deals to enter the market.
- Changes in technologies may encourage the creation of consortia and alliances.
- Expansion of Chinese companies.
- Response to expansion of Chinese companies.
All the aforesaid suggests that no significant change in M&A activity in the industry is anticipated. The above risks will limit companies’ appetite for concentration. In the observed difficult market conditions, the industry sets other priorities.
Alternatively, an increase in the number of deals may be due to troubled assets, but this will not affect the total number of M&A transactions. The only exception may be mega deals in China where market players seek to dominate the sector.
Initially published on Liga.Net