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Mergers Won't Save Chinese Steel

Poor old Baosteel. It spent decades building up that rarest of creatures, a Chinese state-owned steelmaker that actually makes a profit and isn't drowning in debt. It survived, and even prospered, through a once-in-a-generation collapse in the steel market. Margins widened in the March quarter thanks to a price rebound, according to Bloomberg Intelligence's Yi Zhu.

And then the government comes along and forces it to merge with one of the also-rans.

A proposed tie-up between Baoshan Iron & Steel and Wuhan Iron & Steel -- Baosteel and Wisco -- will certainly create a force to be reckoned with. With about 61 million tons of output last year combined, it's likely to be the world's biggest steelmaker after ArcelorMittal.

Better Together

Based on 2015 production, a combined Baosteel/Wisco would be the world's second-biggest steel producer

Source: World Steel Association, https://www.worldsteel.org/statistics/top-producers.html

Wisco racked up 7.5 billion yuan ($1.1 billion) of losses last year, but appears to be turning a corner. It's one of just a handful of large Chinese steelmakers that made a modest profit in the most recent quarter, and analysts estimate it will stay in the black through 2018 -- so the alliance will hopefully do more than fritter away Baosteel's income.

There's even the prospect of synergies. Both companies have mills making flat products for automakers, appliances and other higher-value customers across a swathe of eastern and southern China, limiting their exposure to the currently hot, but more volatile and low margin, construction trade.

Wisco's home city lies upstream from Baosteel's Shanghai base on the Yangtze River, one of China's major inland freight arteries. Its operations across China's south could help consolidate Baosteel's exposure to Guangdong's humming manufacturing economy. The smaller company has even got some stakes in offshore iron-ore mines that could help integrate the group's supply chain.

So much for the positives. Unfortunately, the list of negatives is long, as well.

Wisco's revenue over the past 12 months was about a third of Baosteel's 157 billion yuan, but its 41 billion yuan in net debt is almost three-quarters of Baosteel's 56 billion yuan. Adding Wisco will lift Baosteel's debt to about 64 percent of net assets from 45 percent at present -- a substantial deterioration, even if it remains outside the danger zone. Both Moody's and S&P declared the plan a credit negative for Baosteel Tuesday.

What's more, Wisco's earnings seem contingent at best. While analysts aren't forecasting any losses for the next three years, they're barely predicting profits either -- just 1.9 billion yuan over the period, about 1 percent of the 183 billion yuan in expected revenue. It wouldn't take much of a shift in iron, coal or steel prices to push that back into the red.

Source: Bloomberg

Jul 2, 2016 13:51
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