Regional Insights SparX Regional Steel Sector ASIAN INSIGHTS VICKERS SECURITIES ed: JS / sa:JC, PY ....

ASIAN INSIGHTS VICKERS SECURITIES ed: JS / sa:JC, PY

China Supply Reform and More Optimistic Demand Outlook

• China’s supply reform to alleviate oversupply, both globally and locally

• Global business cycle and infrastructure investment to underpin resilient demand growth

• Near term earnings outlook brighter backed by margin recovery

• Top Picks : POSCO, Hyundai Steel & Angang

For real this time. In 2016, Chinese government revealed its

ambitious restructuring plan which involves the elimination of 150

million tonnes of steel capacity. In June 2017, the National

Development and Reform Commission (NDRC) announced that

China had eliminated 42.4 million tonnes of steel capacity during

January-May 2017, which accounted for 84.8% of its target for this

year. On top of that, China has eliminated Intermediate Frequency

Furnaces (IFF) capacity equivalent to c.38.5 million tonnes of steel

output contribution, according to China Iron & Steel Association

(CISA). China’s supply reform is progressing well, which should help

to alleviate oversupply of steel both globally and locally.

Long term cycle is turning up. The outlook for global steel

demand has been raised, led by a favorable business cycle with

more aggressive infrastructure investments in both developed and

emerging countries. Steel prices and profitability of steel mills

should trend upwards gradually backed by ample availability and

stable prices of raw materials. We believe we are at the turning

point of a long term cycle, which has been on a downtrend in the

last 10 years. Near term earnings are expected to be stronger

supported by a recovery in margins.

Attractive valuations; TPs raised for our top picks. The sector

has underperformed the market since April due to weak steel

prices. As a result, the valuation discount to the market has

widened. Our top picks are POSCO, Hyundai Steel and Angang

Steel, which are expected to post the strongest profitability and

earnings growth among peers in 2017. We raised our TPs on the

our top picks after revising up FY17F/FY18F earnings to reflect their

improving fundamentals

CRY Index : 171.89

Analyst Lee Eun Young +65 6682 3708 [email protected]

Addison Dai +852 2971 1931 [email protected]

World steel spread vs. China steel spread

Steel spread = HRC benchmark price – Iron ore & coking coal prices

Source: DBS Bank, Bloomberg Finance L.P.

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(US$/tonne) World Steel Spread

China Steel Spread

DBS Group Research . Equity

30 Jun 2017

Regional Insights SparX

Regional Steel Sector

Refer to important disclosures at the end of this report

STOCKS

12-mth

Price Mkt Cap Target Price Performance (%)

KRW/HKD US$m KRW/HKD 3 mth 12 mth Rating

POSCO 284,000 21,741 340,000 (0.9) 44.5 BUY

Hyundai Steel Company 60,900 7,136 70,000 4.1 35.3 BUY Angang Steel 5.59 5,191 7.35 (0.2) 62.0 BUY

Seah Besteel Corporation 27,800 875 36,000 (3.1) 11.0 BUY

Closing price as of 28 Jun 2017

Source: DBS Bank, Bloomberg Finance L.P.

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ASIAN INSIGHTS VICKERS SECURITIES

The DBS Asian Insights SparX report is a deep dive look into thematic angles impacting the longer term investment thesis for a sector, country or the region. We view this as an ongoing conversation rather than a one-off treatise on the topic, and invite feedback from our readers, and in particular welcome follow on questions worthy of closer examination.

Table of Contents

Investment Summary and Valuation 3

China’s Supply Reform to alleviate oversupply, globally and locally 3

More optimistic outlook for steel demand 4

Near term earnings intact contrary to market expectations 4

Share price underperformance makes valuations more attractive 5 China’s Supply Reforms Progress 10

Background on China’s Supply Reforms 10

Progress of Reforms Since 2016 11

Key Measure for 2017: Shutting Down Intermediate Frequency Furnaces (IFF) 12

Impact of China’s Supply Reforms on the Steel Sector 14

Shutdown of IFFs – Who Are the Key Beneficiaries? 14

Alleviating Oversupply Globally and Locally 15

Decline in China’s Steel Exports to Improve Prices and Margins in the Region 17

Impact on China’s Steel Market 18

Impact of China’s Supply Reforms on Raw Materials 20

Iron Ore: China to increase dependency on seaborne iron ore 20

Iron Ore: Strong oligopoly to buffer negatives of oversupply 20

Coking coal: speed of supply reform depends on coal prices 22

Outlook Of Global Steel Sector 24

Global Steel Demand: More Optimistic Outlook 24

Infrastructure Investment and Resilient Construction Activities to Support Steel Demand in Mid-term 26

Chinese demand outlook 29

Global Supply Surplus to Decline but Overcapacity Remains 31

Outlook for Prices of Steel and Raw Materials 32

Iron Ore Prices Likely to Remain Weak 32

Metallurgical Coal Prices to Be Stable 32

Price Outlook and Mills’ Profitability 35

Company 39

POSCO 40

Hyundai Steel 52

Angang Steel 63

Special thanks to…… Yiseul Shin

For her relentless effort to this report.




Investment Summary and Valuation China’s Supply Reform to alleviate oversupply, globally and locally Ambitious plan with concrete follow-up measures. In February 2016, the Chinese government revealed its ambitious restricting plans for the country’s steel industry, aimed at tackling overcapacity and boosting efficiency of the sector. The government plans to remove 100-150 million tonnes of steel capacity and 800 million tonnes of outdated coal capacity by 2020. At the beginning of 2017, the Chinese government announced that it successfully cut steel capacity by 65 million tonnes in 2016 and plans to reduce another 50 million tonnes of capacity in 2017. To achieve this target, the central government is tightly monitoring provincial governments’ restructuring actions. Also to facilitate the country’s supply-side reform measures, the US$5.9-billion Siyuanhe Steel Industry Restructure Fund was established on 7 April 2017 in Shanghai. Industrial concentration through M&A. For the share of China’s 10 biggest steel producers to reach 60% of the country’s total (compared to 35% in 2015), a series of mergers and acquisitions (M&As) is expected in the steel industry. For a start, Baoshan Iron & Steel has merged with Wuhan Iron & Steel, creating China’s largest and the world’s second-biggest steel mill in terms of combined crude steel production (61 million tonnes in 2015). About10 million tonnes of outdated steel capacity has been removed in the process and total of 15.4 million tonnes will be cut by 2017. The consolidation is expected to increase competitiveness, especially in value-added sectors such as the automobile market, and improve profitability through cost savings. Cornerstone of reforms. China’s central government has decided to shut down all steel production based on intermediate frequency furnaces (IFFs) by 30 June 2017. According to China’s Metallurgical Industry Planning & Research Institute (MPI), the capacity of IFFs is estimated at 80-120 million tonnes a year, with about 30-50 million tonnes produced in 2016. IFFs are estimated to account for about 10% of China’s total steel production capacity and their products are estimated to account for about 3.7% of the country’s steel goods.

Substantial progress made in 1H17. The National Development and Reform Commission (NDRC) stated on 15 June that China is on schedule to meet its 2017 reform plans, having eliminated 42.4 million tonnes of steel capacity and 97 million tonnes of coal capacity during January-May 2017, which accounted for 84.8% and 65% of the respective capacity cut targets. Also, China has eliminated c.38.5 million tonnes of IFF capacity in terms of effective steel output contribution by May 2017, according to CISA. Alleviating oversupply globally and locally. The global steel capacity would decline to 2.32 billion tonnes in 2017 from the peak of 2.37 billion tonnes in 2015, if we factor in China’s capacity cut of 65 million tonnes in 2016 as well as its targeted reduction of 50 million tonnes and closure of IFFs in 2017. As the Chinese government announced that the IFF shutdown is not part of its targeted cut this year, the real capacity cut is projected to hit a record this year. Following this, global overcapacity will decline gradually and the utilisation of the global steel industry will increase every year, assuming stagnant production growth. Also, the overcapacity in China should reduce gradually from the peak in 2015 backed by more consistent and concrete measures compared to the past. Challenges still remains. Despite these positives, the global steel sector will remain oversupplied and utilisation would not increase sharply as an estimated 650 million tonnes of overcapacity can still be deployed for production if steel prices and the market improve. In fact, the profitability recovery since last year’s increase in steel prices’ seems to be leading production growth in China. The favourable market conditions would be negative in the long term as they would likely extend the lifespan of zombie companies, which will delay the industry’s restructuring. Of note, crude steel output has increased 4% year-on-year during January to May 2017.




More optimistic outlook for steel demand Recovery in global business cycle. The global business cycle is on a recovery path. The outlook for developed markets look positive as manufacturing sector in the US, Japan and the Eurozone – as measured by the manufacturing Purchasing Managers’ Indexes (PMI) – is gaining momentum. Also, manufacturing PMI for the emerging markets is improving year-on-year and we expect the business cycle in the emerging markets to follow that in the developed markets Global steel demand to grow 1.3% in 2017. Most regions are expected to register higher demand in 2017. Those economies hit by low commodity prices and geopolitical conflicts have shown signs of stabilisation – Commonwealth of Independent States (CIS) are projected to register steel demand growth of 3.2% in 2017. Similarly, the Middle East and Africa are likely to report strong demand in 2017. The outlook for US steel demand is promising due to potential large-scale infrastructure investment although there is some vagueness over the actual execution. We expect North America to register steel demand growth of 2.2% in 2017. Steel demand from China is expected to remain stagnant but that from other Asia should grow 2.6% in 2017. All in, global steel demand is forecast to grow 1.3% in 2017 and 0.9% in 2018. Healthy medium-term steel demand underpinned by infrastructure projects. With China’s growth slowdown, emerging markets including ASEAN and India will be the next growth driver. In medium-term, we expect steel demand growth from more infrastructure projects being materialised in the emerging markets, thanks to financing secured through higher government budget allocations, increasing private-public partnerships (PPP) and the support from China’s One Belt One Road initiative. Demand from Asia excluding China is projected to account for 24% of global steel demand, up from 23% in 2016. Infrastructure investments and construction activities in developed markets have also started to recover after sluggish years after the Global Financial Crisis. China, despite the downtrend, will continue to require substantial amount of steel (expected to consume 40% of global steel demand in 2018).

Near term earnings intact contrary to market expectations Rebound in margins of steel mills, China’s May PMI hits a one-year high. The steel spread has improved month-on-month both in the global and China markets, as Hot Rolled Coil (HRC) prices have remained flattish amid plunging raw material prices. Supported by strong order inflows in May, China’s Steel PMI reached a one-year high of 54.8 despite the fall in crude steel production. We expect steel mills to maintain healthy margins backed by improved supply-demand balance going forward. Brighter earnings in 2H17 amid stable raw material prices. The improved steel spread coupled with the buoyant industry imply earnings will be resilient in 2Q17, and we believe the key players will deliver stronger results than market consensus. We expect margins in 2H17 to likely improve, backed by lower raw material cost. The input cost of iron ore and coal are projected to drop by US$50 per tonne of crude steel, while ASP is likely to decline by c.US$15/tonne in 3Q17 in light of recent price weakness. This suggest margins would be able to increase by US$35/tonne in 3Q17. Meanwhile, steel spot prices are currently stabilising and likely to rebound, which will have a positive impact on price negotiations with customers and lead to margin improvements.




Share price underperformance makes valuations more attractive Share prices have underperformed; attractive valuations. As a result of weak steel and raw material prices, share prices of steel mills have underperformed the market since April. We expect investor interest to return to this sector as China successfully eliminates capacity in line with its target cut of 50 million tonnes and the shutdown of IFF facilities, by the 30 June deadline. The sector has been trading at a discount to the market average and the gap has widened recently given that i) sector share prices have underperformed despite upward revisions to earnings, ii) valuation multiples had stretched following

strong stock market performance. Hence, we think the sector’s attractiveness in terms of valuation has been strengthened, which should support steel mills’ share prices at current levels, at the very least. Our top picks are POSCO, Hyundai and Angang Steel. POSCO is expected to register the strongest earnings growth in 2018 among peers supported by turnaround at its affiliates. Hyundai is trading at an undemanding FY17F 0.45x P/BV and earnings momentum in 2H17 should be stronger than others thanks to the recent prices hikes on autosheets. Angang’s 2Q17 earnings is expected to exceed market consensus, which will be a re-rating catalyst. Hence we retain BUY call for all counters and raise TPs following our upward earnings revisions.

Spread between China HRC prices and spot iron ore prices Steel mills’ margins vs. HRC prices and input cost

Source: Bloomberg Finance L.P., DBS Bank


Valuation indexes

HK Metal & Mining

P/E(x)

HK Metal & Mining

P/BV(x)

HK Metal & Mining

ROE(%)

HK P/E(x)

HK P/BV(x)

KOREA- Metal & Mining

P/E(x)

KOREA- Metal & Mining P/BV(x)

KOREA- Metal & Mining

ROE(%)

KOREA -P/E(x)

KOREA- P/BV

2014 11.2 1.3 -6.0 12.0 1.4 10.6 0.7 4.3 15.9 1.1 2015 10.6 1.6 16.3 12.0 1.3 17.3 0.6 3.0 13.0 1.0 2016 7.9 1.0 10.6 13.0 1.2 22.3 0.5 2.9 10.8 1.0 2017F 8.2 1.2 15.1 18.0 1.5 11.2 0.6 5.4 12.8 1.2

Source: IBES Datastream., DBS Bank

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(US$/tonne)(US$/tonne) Spread (L)HRC benchmark prices (L)China import Iron Ore Fines 62% Fe spot(R)

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1Q10 1Q11 1Q12 1Q13 1Q14 1Q15 1Q16 1Q17

(US$/ton)(US$/ton) SpreadBench mark HRC pricesInput cost of iron ore and coking coal per ton of steel




Sector Indexes MSCI World Local MSCI World Metal &

Mining MSCI EM Local MSCI EM Metal &

Mining KOSPI Index

KOSPI Basic Metallic

Index 28 June 1,466.7 210.0 54,316.4 559.4 2,382.6 4,955.8 1wk % 0.1 3.7 0.2 3.4 1.1 5.3 1month % 0.6 (0.6) 0.2 (0.8) 1.8 2.2 3month % 2.9 (4.1) 4.8 (5.6) 10.6 3.1 YTD % 8.0 1.7 13.7 2.6 18.2 6.3 1 year % 19.0 18.8 20.6 23.6 22.5 23.7


MSCI World Index vs. MSCI World Metal & Mining MSCI EM Index vs. MSCI EM Metal & Mining



KOSPI Index vs. KOSPI Basic Metallic Index World HRC price vs. POSCO share price



Rebar price vs. Hyundia Steel World HRC price vs. Angang Steel share price



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('07=100) MSCI World Metal & MiningMSCI World Local

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('07=100) MSCI EM LocalMSCI EM Metal & Mining

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(US$/tonne)(k KRW) POSCO share price (L)

Iron & Steel SteelBenchmarker Hot rolledcoil World Export Market $ per tonne

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Hyundai Steel Share price (R)

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Iron & Steel SteelBenchmarker Hot rolledcoil World Export Market $ per tonne




Earnings forecasts and valuation

Source: DBS Bank

POSCO (KRW bn) FY2013 FY2014 FY2015 FY2016 FY2017F FY2018FTotal Revenue 61,865 65,098 58,192 53,084 58,376 60,657Operating Profit 2,996 3,214 2,410 2,844 4,180 4,362EBITDA 5,682 6,452 5,628 6,058 7,365 7,581EBIT 2,996 3,214 2,410 2,844 4,180 4,362Profit Before Tax (After-EI) 1,946 1,378 181 1,433 2,507 3,041Net Profit (After-EI) 1,376 626 181 1,363 1,834 2,225EV/ EBITDA (X) 7.8 7.4 7.2 6.7 5.5 5.1Return on Average Equity (ROAE) % 6.5% 1.5% 0.4% 3.3% 4.3% 5.1%EPS (After-EI) 15,787 7,181 2,072 15,637 21,037 25,515EPS (After EI) Growth (%) (YoY) 0% -55% -71% 655% 35% 21%P/E (X) 18.0 39.5 137.1 18.2 13.5 11.1Price/ BVPS (X) 0.5 0.5 0.6 0.5 0.5 0.5

Hyundai St eel Co. (KRW bn) FY2013 FY2014 FY2015 FY2016 FY2017F FY2018FTotal Revenue 13,533 16,762 16,133 16,692 18,017 18,771Operating Profit 763 1,491 1,464 1,445 1,561 1,609EBITDA 1,700 2,672 2,569 2,806 3,041 3,065EBIT 986 1,483 1,295 1,418 1,652 1,658Profit Before Tax (After-EI) 782 1,099 927 1,130 1,383 1,409Net Profit (After-EI) 692 765 734 819 1,002 1,021EV/ EBITDA (X) 9.5 6.3 6.9 6.1 5.4 5.1Return on Average Equity (ROAE) % 6% 6% 5% 5% 6% 6%EPS (After-EI) 8,102 6,562 5,866 6,136 7,509 7,651EPS (After EI) Growth (%) (YoY) -13% -19% -11% 5% 22% 2%P/E (X) 7.5 9.3 10.4 9.9 8.1 8.0Price/ BVPS (X) 0.5 0.5 0.5 0.5 0.5 0.5

Seah Best eel Corp (KRW bn) FY2013 FY2014 FY2015 FY2016 FY2017F FY2018FTotal Revenue 2,113 2,202 2,527 2,531 2,783 2,891Operating Profit 144 175 222 143 175 188EBITDA 238 272 379 313 352 362EBIT 149 181 245 162 194 207Profit Before Tax (After-EI) 129 163 215 133 169 192Net Profit (After-EI) 104 124 151 89 128 145EV/ EBITDA (X) 6.2 4.4 5.7 6.1 5.1 4.4Return on Average Equity (ROAE) % 7.5% 8.5% 10.2% 5.5% 7.1% 7.6%EPS (After-EI) 2,900 3,444 4,208 2,473 3,565 4,048EPS (After EI) Growth (%) (YoY) -12.7% 18.8% 22.2% -41.2% 44.1% 13.6%P/E (X) 9.6 8.1 6.6 11.2 7.8 6.9Price/ BVPS (X) 0.7 0.7 0.7 0.6 0.5 0.5

Angang (RMB m) FY2013 FY2014 FY2015 FY2016 FY2017F FY2018FTotal Revenue 75,329 74,046 52,759 57,882 75,192 77,275Operating Profit 3,193 4,275 -1,053 3,871 4,655 5,779EBITDA 6,197 6,835 1,508 6,357 9,092 10,258EBIT 1,946 2,851 -2,417 2,906 5,047 6,182Profit Before Tax (After-EI) 728 1,579 -3,763 1,620 3,376 4,465Net Profit (After-EI) 770 928 -4,593 1,616 2,524 3,338EV/ EBITDA (X) 8.1 7.9 32.8 8.5 5.9 4.8Return on Average Equity (ROAE) % 1.6% 2.0% -10.1% 3.7% 5.5% 7.0%EPS (After-EI) 0.11 0.13 -0.63 0.22 0.35 0.46EPS (After EI) Growth (%) (YoY) -119.1% 20.5% -594.9% -135.2% 56.2% 32.3%P/E (X) 45.9 38.1 -7.7 21.9 14.0 10.6Price/ BVPS (X) 0.8 0.7 0.8 0.8 0.8 0.7

Maanshan (RMB m) FY2013 FY2014 FY2015 FY2016 FY2017F FY2018FTotal Revenue 29,404 36,086 44,110 55,622 67,835 73,488Operating Profit 7,643 8,591 7,984 12,330 15,771 17,085EBITDA 10,802 12,238 12,196 18,689 23,001 24,943EBIT 8,739 9,126 7,476 12,847 16,388 17,779Profit Before Tax (After-EI) 7,379 7,328 5,259 9,457 12,788 14,604Net Profit (After-EI) 5,593 5,314 3,649 6,540 8,833 10,083EV/ EBITDA (X) 5.6 5.1 6.7 5.1 4.1 3.6Return on Average Equity (ROAE) % 22.8% 18.1% 10.8% 17.0% 19.6% 19.2%EPS (After-EI) 0.95 0.89 0.58 0.91 1.23 1.41EPS (After EI) Growth (%) (YoY) 2.6% -6.4% -34.7% 57.0% 35.1% 14.1%P/E (X) 6.5 6.9 10.6 6.7 5.0 4.4Price/ BVPS (X) 1.4 1.1 1.1 1.1 0.9 0.8




Sector valuation P/BV: HSI vs KOSPI Metal & Mining Index ROE: HSI vs KOSPI Metal & Mining sector

Source: IBES, DBS Bank Source: IBES, DBS Bank

Trailing P/BV: HSI Metal & Mining index Trailing P/BV: KOSPI Basic Metal Index



Trailing PE: HSI Metal & Mining index Trailing PE: KOSPI Basic Metal Index



3.4

1.3

1.01.3

1.5

0.8 0.8

1.31.6

1.01.2

1.41.2 1.0

1.1 1.01.2

1.5

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(x)

HK Korea

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24.4

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16.3

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15.116.6 15.1

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4.43.0 2.9

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(%)

HK Korea

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2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

HONG KONG-DS Ind. Met & Mines - PRICE/BOOK RATIO

Avg

-1sd

+2sd

+1sd

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1.0

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2007 2009 2011 2013 2015 2017

KOREA-DS Ind. Met & Mines - PRICE/BOOK RATIO

Avg

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+2sd

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2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

HONG KONG -DS Ind. Met & Mines - (PE)

Avg

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0.0

5.0

10.0

15.0

20.0

25.0

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

KOREA-DS Ind. Met & Mines - (PE)

Avg

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+2sd




Peer comparison

Market

Cap (US$m)

PER PBR EV/EBITDA ROE

28 June FY17F FY18F FY19F FY17F FY18F FY19F FY17F FY18F FY19F FY17F FY18F FY19F

Korea listed players

Posco 21,719 9.3 8.8 8.3 0.5 0.5 0.5 5.5 5.4 5.3 6.0 6.0 6.1

Hyundai Steel 7,128 8.1 8.1 7.8 0.5 0.5 0.4 6.3 6.2 6.0 6.1 5.8 5.7

Seah Besteel 874 10.0 9.1 8.4 0.6 0.6 0.5 6.3 5.8 5.7 6.1 6.3 6.5

HK-listed players

Angang Steel 5,903 14.7 12.3 11.4 0.8 0.7 0.7 8.1 7.6 7.6 5.2 5.8 6.0

Maanshan Steel 3,827 10.3 9.8 9.2 1.0 0.9 0.8 7.0 6.9 6.8 9.7 9.5 9.0

China A-share listed players

Baosteel-A 21,768 11.4 9.8 9.5 1.0 1.0 1.0 7.1 6.5 6.5 9.8 9.1 8.5

Hebei Iron & Steel-A

6,587 21.3 17.5 15.9 1.0 0.9 0.9 11.9 11.2 N/A 4.6 4.9 5.5

Angang-A 5,903 16.4 14.2 12.0 0.9 0.8 0.8 7.9 7.3 6.9 5.3 5.8 6.5

Maanshan Steel-A

3,827 15.0 13.5 11.3 1.3 1.2 1.1 7.3 7.0 6.5 8.9 9.0 9.7

Asian listed players China Steel Corp.

12,919 21.0 17.8 17.8 1.2 1.2 1.2 10.3 9.6 9.8 6.1 7.1 6.8

Tata Steel 7,838 10.8 9.2 8.2 1.5 1.3 1.0 7.2 6.8 6.2 13.4 14.0 13.6

Steel authority of India

3,653 70.4 10.2 N/A 0.6 0.6 N/A 11.8 8.0 N/A (0.3) 3.9 N/A

JSW Steel 7,403 12.0 10.1 9.3 1.8 1.6 n.a. 6.8 6.3 6.2 16.0 16.4 15.9

Jindal Steel & Power

1,693 N/A 17.5 9.4 0.4 0.4 N/A 7.8 6.3 5.3 (2.6) 2.8 3.9

JFE 10,243 11.2 9.6 8.9 0.6 0.6 0.5 7.4 6.8 6.7 5.3 5.6 5.7

Nippon Steel & Sumitomo Metal

20,991 11.5 10.1 9.5 0.7 0.7 0.7 8.4 7.6 7.4 6.8 7.2 7.1

Nisshin Steel 1,175 12.0 10.1 11.2 0.6 0.6 0.6 8.3 7.7 7.8 5.4 6.0 5.3

Kobe Steel 3,587 13.5 10.2 9.4 0.6 0.6 0.5 6.4 5.8 5.6 4.5 5.5 5.7

International listed player

AK Steel 2,135 11.0 8.6 6.5 N/A 16.4 4.6 6.5 5.7 5.2 (31.0) 1,411.9 56.7 Steel Dynamics Inc 8,448 12.5 11.6 9.9 2.5 2.1 1.8 6.5 6.2 5.4 22.2 20.2 20.3

ArcelorMittal 23,085 8.4 8.6 8.1 0.7 0.7 0.6 4.7 4.7 4.7 8.1 7.3 7.6 United States Steel Corp. 3,942 28.2 11.5 7.8 1.6 1.4 1.2 6.2 4.8 4.2 4.1 13.0 19.0

Thyssenkrupp 16,587 29.5 15.2 12.9 6.8 4.9 3.8 7.6 6.8 6.5 15.9 35.7 32.2 Nucor 18,559 14.0 12.9 11.6 2.1 1.9 1.7 7.1 6.7 6.2 16.5 16.1 16.6 Severstal 11,075 7.8 9.3 9.9 3.1 2.8 2.5 5.4 6.0 6.1 42.1 31.0 29.3





China’s Supply Reforms Progress Background on China’s Supply Reforms Declining demand, excess capacity, trade conflict. China’s steel demand might have already peaked in 2013 and most industry experts believe that it is unlikely to return to the 2013 level in the long term, given that the Chinese economy is shifting its growth driver from investment, which relies heavily on steel, to private consumption, which will require less steel for the same rate of growth. Despite the fact that steel demand in other emerging countries is still robustly growing, it is too small to substantially offset the slowdown in China. China’s steel sector has been increasing exports to defend against declining domestic demand, which has resulted in aggressive trade action by importing countries against Chinese steel exports. In light of the domestic and external environment, the Chinese

steel industry faces a big challenge in remaining profitable; steel demand is expected to decline, while excess capacity will not be immediately eliminated. It is high time for the steel industry to be restructured and re-organised to achieve sustainability. Capacity control. Capacity control has long been a headache for the Chinese government. According to WSA, more than 320 steel-related policies and measures were implemented in China from 1990 to 2016, of which half were aimed at capacity control. However, these have been far from successful as the country’s crude-steel production continued to accelerate through the 1990s and 2000s, with its first decline observed only in 2015.

China’s steel sector: Change of focus of industry policies

Source: POSRI, WSA, DBS Bank

Capacity expansion quality improvement

Self-sufficiencyWas top priority

Closure of small producers

Steel became abundant, world no.1 producer

Capacity control industry access, M&A, raw materials

environment

Capacity closure, environment, M&A

Expanded too fast, too many new entrants,

emissions Boom is over…

China’s annual crude steel production

80 85 90 95 00 05 10 151) June,1997 First list of outdated technologies & facilities to be phased out

2) November, 2000 First list of small mills to be closed

3) December, 2003 Guidance for restraining over investment in steel industry

4) July, 2005 Steel Industry Development Policy

5) March, 2009 Regeneration Plan for Steel Industry

6) April, 2013 First list of qualified steelmakers

7) February, 2016 Action plan to close 100-150 mt/a




Progress of Reforms Since 2016 More ambitious. In February 2016, the Chinese government revealed its ambitious restricting plans for the country’s steel industry, aimed at tackling overcapacity and boosting efficiency of the sector. The government plans to remove 100-150 million tonnes of steel capacity and 800 million tonnes of outdated coal capacity by 2020. The restructuring plan appears to have been well followed through so far as it was announced at the 12th National People’s Congress annual meeting that China, in 2016, successfully cut steel capacity by more than 65 million tonnes and coal production capacity by 290 million tonnes, surpassing the target of 45 million tonnes and 250 million tonnes, respectively. 13th Five-Year Plan. In November 2016, The MIIT officially unveiled the 13th Five-Year Plan for China’s steel industry, which urged cuts to crude steel capacity by a net 100-150 million tonnes We have noticed that the goal has been extended to five years from the original plan of three years. However, it is acknowledged that removing capacity and deleveraging is the key focus during the 13th Five-Year Plan. China’s steel sector: 13th Five-Year Plan targets

Source: MIIT

Tight monitoring of provincial governments. Provincial governments were told to compile reports on capacity reduction for the central government. The report should contain details such as the devices removed to completion of the task. In addition, there is mandatory monthly reporting of progress in different regions by the working group – which monitors the overcapacity reduction – for better supervision and accountability.

Enhancing industrial concentration through M&A. For the share of China’s 10 biggest steel producers to reach 60% of the country’s total (compared to 35% in 2015), a series of mergers and acquisitions (M&As) is expected in the steel industry. For a start, Baoshan Iron & Steel has merged with Wuhan Iron & Steel, creating China’s largest and the world’s second-biggest steel mill in terms of combined crude steel production (61 million tonnes in 2015). About 10 million tonnes of outdated steel capacity has been removed in the process and total of 15.4 million tonnes will be cut by 2017. The consolidation is expected to increase competitiveness, especially in value-added sectors such as the automobile market, and improve profitability through cost savings. More aggressive reforms in 2017. Despite the outstanding results, China’s crude steel output showed growth (+0.6% y-o-y) to 808.4 million tonnes in 2016. This is because a large proportion of closed capacity had actually already been left idle for years. In 2017, China plans to cut another 50 million tonnes of steel-making capacity, shut down coal output by 150 million tonnes, and, at the same time, close or stop construction of coal-fired power plants with capacity of more than 50 million kilowatts in 2017. Not included in this capacity-reduction target is the closure of IFFs that produce substandard steel. Substantial progress made in 1H17. The National Development and Reform Commission (NDRC) stated on 15 June that China is on schedule to meet its 2017 reform plans, having eliminated 42.4 million tonnes of steel capacity and 97 million tonnes of coal capacity during January-May 2017, which accounted for 84.8% and 65% of the respective capacity cut targets. Complete closure of IFF facilities is also on track to meet the 30 June deadline. China’s first steel Industry restructuring fund. To facilitate the country’s supply-side reform measures, Siyuanhe Steel Industry Restructure Fund was established on 7 April 2017 in Shanghai. Among the four participants is China’s Baowu Steel, which will hold 25% (US-China Green 25%, WL Ross & Co 26%, China Merchants Finance Holdings 24%). The US$5.9-billion fund is expected to launch in June 2017.

2015 2020

China Value Added of Industry y-o-y (%) 5.4% 6.0%

Crude steel capacity (million tonnes) 1,130 1,000

Crude steel utilisation (%) 70% 80%

Concentration ratio of top 10 (%) 34% 60%




Key Measure for 2017: Shutting Down Intermediate Frequency Furnaces (IFF) Earlier measures. At the end of November 2016, the State Council’s environmental protection inspection teams visited outdated crude steel facilities in northern Jiangsu that use IFFs and ordered them to shut down (by cutting their power supply). In early December, the teams inspected Tangshan in Hebei province and also ordered the outdated crude steel facilities that use IFFs to halt output from 15 December. IFFs cause more air pollution and its steel products are of low quality. Shutdown of IFFs by June 2017. China’s central government has set 30 June as the date for the elimination of IFF-based steel production, which would be the cornerstone of its supply-side structural reforms of the industry in 2017. Earlier measures for curbing induction steel output have failed to deliver results, but this time round, the government seems to have set its mind on removing such steel-making capacity. According to China’s Metallurgical Industry Planning & Research Institute (MPI), the capacity of IFFs is estimated at 80-120 million tonnes a year, with about 30-50 million tonnes produced in 2016. We think that shutting down substandard steel players should be a key step towards achieving an effective capacity cut. IFFs are estimated to account for about 10% of China’s total steel-making capacity and its products, about 3.7% of total production. Reinforcing commitment through progress updates. In January 2017, in an update to regulations governing entry into the iron and steel scrap processing industry, the MIIT started prohibiting the sale of scrap to IFF operators, starving them of their main raw material. In February 2017, NDRC and four other top government agencies reiterated the importance of cracking down on excess capacity and IFFs churning out low-quality steel. Furthermore, banks are forbidden to lend to the targeted companies, and are told instead to support steelmakers that conform to capacity cuts and environmental regulations. IFF shutdown on track. According to CISA, China has shut down IFF capacity equivalent to 38.5 million tonnes of effective output of steel products. The figure represents 90% of the end-June 2017 elimination target, while 10% of the capacity curtailment target is still operational due to their strong relationships with the local governments. In general, we deem progress of the capacity closure is in line with market expectations.

China : Elimination of IFF (“Ditiao Steel”) capacity

Note: "Ditiao Steel" are those low-quality steel produced in intermediate frequency furance (IFF) Source: local NDRC (National Development and Reform Commission), DBS Vickers

To cut more capacity than planned. For 2017, we expect tighter environmental restraints and anticipate environmental-protection inspection of steel plants to spread across the full year. China’s likely elimination of IFF crude-steel capacity could help cut further excessive crude steel output, helped also by the capacity-mothballing targets of blast furnaces unveiled by the 13th Five-Year Plan. What is IFF steel? According to Platts, IFF steel (“ditiaogang” in Chinese, literally meaning ground bar steel) is made by melting scrap in IFFs using electricity. The process does not allow effective control over the composition and quality of the steel produced. The Chinese government has been paying attention to IFF steel producers to regulate them, but it has largely failed to control them. Operators have been astute in expanding furnace inner volumes, adding secondary processing units, and branching out into casting and rolling in order to stay ahead of closure thresholds. Often, however, those added facilities are merely a facade and are not put into operation, according to the China Iron and Steel Association (CISA). IFF operators tend not to issue invoices for their purchases and sales, and their full-time staff members are few and transient, which means that they can avoid costly social security contributions borne by legitimate steelmakers.

Provinc e

El imina te d c a pa c i ty of "Di tia o Ste e l"* (mt)

Yunnan 6.0 Liaoning 10.1 Gansu 1.9 Guizhou 1.4 Hubei 1.8 Jiangsu 12.3 Anhui 2.5 Inner Mongolia 2.6 Tota l 38.6




China: Steel-making capacity (m tonnes, 2016) China: Steel-making capacity by type

Source: CISA, DBS Bank Source: CISA, DBS Bank

Others, 15 Small Steel Mills' EAF, 45

CISA Members' EAF, 100 Intermediate

Frequency Furnace, 105

Small Steel Mills' BF/BOF,

715

845 862 855 820 780 755

75 70 6560 65 70

70 80 90 1003 0

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1,200

2013 2014 2015 2016 2017F 2018F

(m tonnes) BOFs

EAFs

Induction Furnace




Impact of China’s Supply Reforms on the Steel Sector Shutdown of IFFs – Who Are the Key Beneficiaries? Decline in long-steel products supply with IFF closure. The closure of induction steel plants will reduce the supply of steel, especially that of long-steel products such as rebar and rods. The production volumes of rebar and wire rods were 202.5 million tonnes and 141.9 million tonnes respectively in 2016, according to numbers from CEIC. The export volume of bar and rod products was 30.4 million tonnes in 2016, implying that 8.8% of production was exported, mainly to Southeast Asia and South Korea. Positive for China’s large steel mills. We believe that the early key beneficiaries of this measure will be the large state-owned steel mills in China that focus on long-steel products. In particular, Maanshan Iron & Steel Company seem to be in a better position to enjoy the benefits, as its product range is tilted towards standard products including rebars and it has a

larger exposure to the spot market than its peers. In 2Q17, China’s rebar steel spread, representing the difference between rebar selling prices and raw material input cost (including iron ore, coking coal and scrap) was RMB1,414/tonne, compared to steel spread of RMB1,171/tonne for HRC. South Korean and Southeast Asian steel mills to benefit. South Korean steel mills should also benefit as South Korea is a key market for Chinese bar and rod steel products, accounting for about 11% of exports. As the key exports of China’s steel industry are low-end HRC, rebar, and H-beam, the beneficiaries would be Hyundai Steel and Dongkuk Steel, the leading players in long-steel products. Also, steel mills in Southeast Asia, which consume about 33% of Chinese steel exports, are likely to see some positive impact. Krakatau Steel – the largest steel mill in Southeast Asia – should be a major beneficiary.

China: Bar/rod export destinations (2016)

Source: Mysteel, DBS Bank

Indonesia, 12%

South Korea, 11%

Philippines, 10%

Thailand, 9%Singapore ,

6%Malaysia , 4%

Others, 48%




China steel sector: HRC steel spread China steel sector: Rebar steel spread

Source: Custeel, Wind, DBS Vickers

Source: Custeel, Wind, DBS Vickers

Alleviating Oversupply Globally and Locally Aggravated oversupply. Excess capacity in the global steel industry has increased significantly since the global financial crisis. Despite slowing demand growth globally, there continue to be new investment projects in many parts of the world, especially China. According to the OECD, the world’s steel-making capacity reached 2.32 billion tonnes in 2014, which is more than twice the 1.06-billion-tonne capacity in 2000. Before China’s supply reforms took place, global steel-making capacity had been expected to climb another 100 million tonnes to 2.42 billion tonnes in 2017, factoring in only the projects already underway; global capacity would have reached as high as 2.72 billion tonnes upon completion. Alleviating oversupply. Global steel capacity would decline to 2.32 billion tonnes in 2017 from the peak of 2.37 billion tonnes in 2015, if we factor in China’s capacity cut of 65 million tonnes in 2016 as well as its targeted reduction of 50 million tonnes and closure of IFFs in 2017. As the Chinese

government announced that the IFF shutdown is not part of its targeted cut this year, the real capacity cut is projected to hit a record this year. Following this, global overcapacity will decline gradually and the utilisation of the global steel industry will increase every year, assuming stagnant production growth. Also, the overcapacity in China should reduce gradually from the peak in 2015. Since China started implementing restructuring plan – backed by more consistent and concrete measures compared to the past – forecasts of China’s capacity have been revised down by analysts and industry experts. Challenges could remain. Despite these positives, the global steel sector will remain oversupplied and utilisation would not increase sharply as an estimated 650 million tonnes of overcapacity can still be deployed for production if steel prices and the market improve. Also, despite China’s aggressive supply reforms, there is still doubt that the capacity cut is real and will lead to a decline in production; we have noticed that the output in China increased in 2016 despite the government having achieved its target to cut 65 million tonnes of capacity.

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(Rmb$/t)




Forecast of global steel-making capacity

Source: WSA, OECD, DBS Bank Base case: factored the capacity construction already underway, Highest case: factored all the capacity construction planned

Forecast of global crude steel production and utilisation

Source: WSA, OECD, DBS Bank

50%

55%

60%

65%

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Highest case




China: Steel-making capacity

Source: CISA, DBS Bank

Decline in China’s Steel Exports to Improve Prices and Margins in the Region China’s excess capacity has been a big burden for the regional steel market as China has been exporting surplus steel products to its neighbours. China’s steel exports increased at a compound annual growth rate (CAGR) of 29% during 2009-2015 from 24.6 million tonnes to 112.4 million tonnes in 2015, which was slightly lower than US steel consumption of 121 million tonnes. Of note, the US is the second-largest steel-consuming country in the world. Overflow of cheap steel exports from China has been dampening steel prices and profitability in some regions. Since August 2016, exports of Chinese steel products has decreased significantly, declining 18% year-on-year during August-December 2016 and 26% year-on-year in January-

April 2017. This is very positive for regional steel prices and steelmakers’ margins. In fact, the world benchmark HRC price as well as spread between HRC price and iron-ore price has increased 33% and 44%, respectively from August 2016 to May 2017. Although the export of Chinese steel products is not an absolute determinant of steel prices and profitability, it’s obvious that having less exports from China is favourable for the global and regional steel sector. Low-grade steel products to benefit. Rod and bar products account for 38% of total exports while sheet and plates contribute 44%. As most of China’s steel export is low-grade products for the construction sector, the reduction in capacity focused on low-grade facilities implies that the oversupply of steel products for the construction sector will ease going forward. This aligns with the IFF shutdown.

China: Steel exports and spread China’s steel exports by products (2016)


8992

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7572

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7377

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2001 2003 2005 2007 2009 2011 2013 2015 2017F 2019F

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Production

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2009 2010 2011 2012 2013 2014 2015 2016 2017F

(US$/tonne)(m tonnes) China steel export

Spread (HRC benmark price - iron ore price)

Rod & Bar, 38%

Angle, Shape,

Section, 5%

Sheet & Plate, 44%

Tube & Pipe, 9%

Railway Use, 0% Others, 4%





China’s steel exports by products

Source: CISA, DBS Bank 2017F is annualized figure based on Jan-Apr export statistics

Impact on China’s Steel Market Financial positions of steel companies improved slightly in 2016, still some way to go. As a result of strict environmental constraints under supply-side reforms and solid downstream demand, steel selling prices in China started rebounding at beginning of 2016 and were up nearly 90% by the end of the year. Despite the recovery in steel profitability since the beginning of 2016 to date, the leverage positions in China’s steel industry has just started to narrow. According to CISA, total debt-to-equity ratio of China’s large and medium-sized steel companies was 229% at end-2016, versus 234% at end-2015. This compares with 149% during the 2004-2011 commodity boom and 222% during the 2012-2015 commodity doom. Having said that, we are of the opinion that China steel industry’s supply-side reform measures will remain for the long term. Crude steel production and finished steel output trends are shifting. Before 2017, China’s growth in finished steel output exceeded growth in crude steel production as over-production primarily came from the operation of IFFs. This is because low-

quality steel products produced by IFFs are not included in China’s official statistics (National Bureau of Statistics of China). Taking into account the effective capacity shut-down of IFFs, growth in finished steel output has been slower than crude steel output since February 2017 (See ‘China crude steel output growth vs finished steel output growth’ chart below). Push for M&As. Besides capacity curtailment, steel industry consolidation is another way to advance the reform agenda. In August 2016, the State Council’s State-owned Assets Supervision and Administration approved the restructuring of Baosteel and Wuhan Steel, establishing the Bao-Wu Steel Group on 1 December 2016. Upon the M&A, China’s concentration ratio of its ten biggest steel companies increased marginally to 36% in 2016 compared to 34% in 2015, which is well below the target of 60% by 2020. Thus, we expect the industry consolidation to accelerate during the 13th Five-Year Plan. The M&A between state-owned enterprises could be accelerated by the central government through equity swaps, while M&A between private enterprises could be driven by the market through debt-for-equity swaps.

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(m tonnes) Rod & Bar Angle, Shape & SectionSheet & Plate Tube & PipeRailway Use OthersTotal Y-o-Y %(R)




China: total debt to equity ratio of large- and medium-sized steel mills

China crude steel output growth vs finished steel output growth

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Source: CEIC, DBS Vickers Source: National Bureau of Statistics, DBS Vickers

China’s steel sector: Concentration ratio of top ten steel companies

Source: Custeel, DBS Vickers

-4%-2%0%2%4%6%8%

10%12%14%

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Crude steel output growth (%)

Finished steel output growth (%)

(% y-o-y)

Rank Company (million tonnes) % total Rank Company (million tonnes) % total

1 Bao-Wu Steel Group 64 7.9% 1 Hebei Iron & Steel Group 48 5.9%

2 Hebei Iron & Steel Group 45 5.6% 2 Baosteel Group 35 4.3%

3 Shagang Group 33 4.1% 3 Shagang Group 34 4.3%

4 Angang Steel Group 33 4.1% 4 Angang Steel Group 32 3.9%

5 Shougang Group 27 3.3% 5 Shougang Group 29 3.6%

6 Shandong Iron & Steel Group 23 2.8% 6 Wuhan Iron & Steel Group 26 3.2%

7 Magang Group 19 2.3% 7 Shandong Iron & Steel Group 22 2.7%

8 Beijing J ianlong 16 2.0% 8 Magang Group 19 2.3%

9 Laiwu Iron & Steel Group 16 1.9% 9 Beijing J ianlong 15 1.9%

10 Hunan Hualin 15 1.9% 10 Hunan Hualin 15 1.8%

China's total 808 36.0% China's total 804 34.0%

2016 2015




Impact of China’s Supply Reforms on Raw Materials

Iron Ore Market China to increase dependency on seaborne iron ore

Dampened iron ore production. Demand for global iron ore peaked in 2014 and declined 2% in 2015 and 5% in 2016, and global pig-iron production slipped 2% and 8% in 2015 and 2016. Global iron ore production – which had outpaced demand growth during the boom period – also has declined significantly in 2015 and 2016, declining 4% each year. This is mainly attributable to plunging iron ore production in China, which declined 9% in 2015 and 7% in 2016. The fact that China’s iron ore production declined more than other regions was natural consequences as the average production cost per tonne in China is estimated to be over US$60, hence, the weak iron ore prices in 2015 and 2016 would have forced operations of high-cost mines in China to shut down.

While China is expected to reduce iron ore supply in 2017 in line with its supply-side reform plans, output had increased 10.6% year-on-year to 401 million tonnes in January-April 2017 as iron ore prices continued to be strong in 1Q17 (averaging US$85.6/tonne). Output should fall in 2H17 as iron ore prices fell below US$60/tonne at end-May. According to our channel checks, capacity utilisation of domestic iron mines is c.50% at present, compared to 52.8% in April-2017 and 53.2% at end-2016.

China’s appetite for imported iron ore. Accordingly, China’s imports of iron ore grew 2% and 7% in 2015 and 2016 to above 1 billion tonnes. In fact, China’s imports of iron ore have increased at a CAGR of 12% during the last 10 years, led by the seaborne iron ore market. This is mainly driven by China’s strong steel production during the boom; during a slowdown, domestically produced iron ore would be used. Our channel checks reveal that China’s dependence on imported iron ore could rise to 85% in 2016 from 82% in 2015. We expect China to be more reliant on imported ore going forward.

China’s iron ore imports to be sustainable. China’s steel-sector restructuring is likely to drive more consumption of imported iron ore as the Chinese steel sector will encourage large integrated steel mills to produce high-grade steel products. These steel mills, such as Baosteel, are nearly completely reliant on imported iron ore for their production. Also, the shutdown of IFFs is projected to boost demand for iron ore, given that the steel demand that had been met by IFFs should now be substituted by integrated steelmakers. Some steel companies

are trying to upgrade IFFs to electric arc furnaces to avoid facility closure; the proportion of this would be less than 10%, according to market participants. The key question would be: what is the production volume from IFFs and how much of that volume will be substitute by integrated steel plants?

Steel mills increase the use of steel scrap. Due to significant increase in iron ore prices, Chinese steel companies have raised the use of scrap steel in steel-making since late 2016. According to a survey by SMM, steel mills in China have raised input of steel scrap to converter (part of blast furnace-based crude steel-making process) to produce more crude steel since November 2016. The steel scrap input ratio per crude steel making has increased to 0.15 from 0.1. We think the ratio of using steel scrap will remain, given oversupply of scrap as a result of the country’s IFF capacity shutdown.

Strong oligopoly to buffer negatives of oversupply

Iron ore market remains oversupplied. The iron ore market is likely to see a return to oversupply conditions, no thanks to the significant production growth of the Big 4 and cooling of demand from China. Exports from Australia and Brazil will start to ramp up in 2Q17 after the monsoon season (which ends in March every year). Some of the new major projects are expected to be the key determinants of iron ore supply in 2017 – Vale’s new S11D mine in Brazil which has an annual capacityof 90 million tonnes; and Roy Hill’s new project in Australiawith a current run-rate of about 35m tonnes p.a. is expectedto achieve its full capacity run-rate of 55m tonnes per annumin March 2017. Out of the major miners (Vale, Rio Tinto, BHPBilliton, Fortescue Metals, and Roy Hill), Fortescue Metals is theonly one expected to reduce its iron ore supply in 2017. Totaladditional seaborne supply coming from the Big 4 alone isestimated to be about 70 million tonnes in 2017, while thedemand for iron ore would only grow 24 million tonnes, basedon our global steel production forecasts.

Big 4’s dominance to strengthen. The iron ore market has become a stronger oligopoly as the Big 4 are increasingly dominant. Notably, the market share of the Big 4 has increased to 80% in 2016 from 70% in 2013. At the same time, the contribution of Australian and Brazilian ore to China’s total iron ore imports has jumped to 83% in 2016 from 69% in 2013. Despite oversupply, stronger-than-expected gains in iron-ore prices may be dependent on the Big 4’s market dominance.




Iron ore production by country Iron ore consumption by country

Source: Bloomberg Finance L.P., DBS Bank Source: Bloomberg Finance L.P., DBS Bank

China’s iron ore imports from Australia and Brazil Iron ore exports by company

Source: Bloomberg Finance L.P., DBS Bank Source: Companies, Bloomberg Finance L.P., Platts, DBS Bank

China: iron ore imports China: Iron-ore production/imports/iron ore prices


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(m tonnes)Brazil Europe China Australia India

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Australia

Proportion of Australia & Brazil (R)

305.6 313.6 322.8 341.0 365.0

244.3 288.3 318.5 327.6 335.0205.7

242.2 260.7 261.1 270.099.4152.8

166.8 171.4 167.522.6

55.0

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(m tonnes)Roy Hill Fortescue BHP Billiton Rio Tinto Vale

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(m ton) China's import of iron ore & concentrates

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2004 2006 2008 2010 2012 2014 2016

(US$/tonne)(m tonnes) China ProductionChina ImportImported Iron Ore Price (R)




Coking Coal Market – speed of supply reform depends on coal prices

Short-term shortage in 2H16. China’s supply-reform measures for the coal sector were effective in 2016, as the government announced at the 12th National People’s Congress annual meeting that it successfully removed 290 million tonnes of coal capacity in 2016 (against its target of 250 million tonnes). Its total coal production was also down about 9% year-on-year to 3.4 billion tonnes from 3.7 billion tonnes in 2015. One of the most notable measures taken was limiting the maximum number of working days at coal mines to 276 (versus 330 pre-regulation) from April to November 2016 to restrict production. The tight supply caused coking coal prices to soar, with both domestic spot coke and imported coking coal rising about 270% in 2016.

Reforms to maintain principal but adjust speed. In 2017, China plans to stop construction of coal-fired power plants with capacity of more than 50 million kilowatts (kW) and shut down at least 150 million tonnes of capacity, almost half of the 290m removed in 2016. China’s intention to go easier on coal sector reform is also visible from its target coal output for 2020 that was raised to 3.9 billion tonnes, from the 3.75 billion tonnes set in 2015, due to expected rise in consumption to 4.1 billion tonnes in 2020. Under its restructuring plan, the NDRC will cut 800 million tons of outdated and inefficient coal capacity by 2020, while adding 500 million tonnes of “advanced” capacity. The reductions will be concentrated among smaller mines in the north-east while big producers in the west, such as Inner Mongolia and Xinjiang, will boost supplies.

At the same time, China is looking to impose stricter environmental protection measures. Of note, the Hebei Environmental Protection Department published a notice on 27 February that industrial companies, including coking coal producers, are required to reduce air pollution emissions (i.e. production) by 30%. To follow up, China’s Ministry of Environmental Protection had carried out inspections across Beijing-Tianjin-Hebei region over April-May 2017 and has promised to ensure that environmental laws and regulations are met by all companies.

Stable prices. Contrary to the market expectations, China did not reintroduce the 276-day rule for 2017. Coking coal has already surrendered all of the unexpected price gains from Cyclone Debbie in April. We expect coking coal prices to be stable, supported by China’s flexible policy in adjusting the supply of coal.

Reducing coal consumption over time. Surging coking coal prices in the second half of 2016 placed upward pressure on steel mills’ costs of coke. To defend their profitability, steel mills have been increasingly switching to iron ore with higher Fe content, which would boost production while reducing the ratio of coke. In 2016, sinter as a proportion of total steel mills’ iron ore consumption decreased about 0.2% while the average Fe content increased about 0.4%. Albeit small, the change hints at the possible shrinking need for coking coal going forward. Furthermore, the ongoing supply reform plan and burgeoning pressure on environmental regulations will contribute to lower coal consumption.




Contribution to seaborne coking coal market Coking coal exports


Global coking coal demand


Australia, 61.6%Canada,

9.9%

US, 12.2%

Mongolia, 8.6%

China, 0.4%

Others, 7.3%

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30

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(m tonnes) Global Coking Coal Exports

Australian Coking Coal Exports

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(m tonnes) ChinaEx ChinaEx China y-o-y growth(R)




Outlook Of Global Steel Sector

Global Steel Demand: More Optimistic Outlook

Better-than-expected demand in 2016. Global steel demand increased 1.3% year-on-year in 2016, exceeding our previous forecast of flattish growth in December 2016, which was in line with the World Steel Association’s (WSA) forecast. The key contributors to the higher consumption were buoyant construction activity and restocking demand in China, which led to 1.8% higher demand in 2016. Also, demand from North America increased 0.7% in 2016.

Recovery of global business cycle. We reckon that the global business cycle is on a recovery path. The outlook for developed markets look positive as manufacturing in the US, Japan and the Eurozone – as measured by the manufacturing PMI indexes – is gaining momentum. Mills in Europe and the US continueto push for higher prices behind tariff walls on the back ofimproving economic activity. On top of that, manufacturingPMI index for the emerging markets is also improving year-on-year. As such, we expect the business cycle in the emergingmarkets to follow that in the developed markets.

Global Manufacturing PMI Emerging markets Manufacturing PMI


US Manufacturing PMI EU Manufacturing PMI


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US: Steel shipments US: Inventory


China’s steel sector recovered in May. The purchasing managers’ index (PMI) for the Chinese steel sector hit a one-year high of 54.8 points in May, turning around from the declines in March and April. The recovery was driven by strong order inflows as indicated by a 10-point rise in the new orders index. Along with it, Chinese HRC prices rose 6.7% to US$396/tonne in May, and further increased to US$404/tonne in mid-June, which indicates that steel activities continue to be healthy in June. China will remain as the biggest steel consuming country while demand is expected to remain flat in 2017.

Global steel demand to grow 1.3% in 2017. Most regions are expected to register higher demand in 2017, especially as emerging and developing economies register strong growth

after escaping demand contraction in 2016. Those economies hit by low commodity prices and geopolitical conflicts have shown signs of stabilisation – countries that make up the Commonwealth of Independent States (CIS) are projected to register steel demand growth of 3.2% in 2017 and 3.4% in 2018. Similarly, the Middle East, where major infrastructure projects worth US$200 billion are on-going in preparation for 2022 World Cup in Qatar, and Africa are likely to report strong demand in 2017. The outlook for US steel demand is promising due to potential large-scale infrastructure investments although there is some vagueness over the actual execution. We expect North America to register steel demand growth of 2.2% in 2017. All in, global steel demand is forecast to grow 1.3% in 2017 and 0.9% in 2018.

China: Manufacturing PMI SA China: Steel PMI

Source: Bloomberg Finance L.P., DBS Bank Source: CFLP, Bloomberg Finance L.P., DBS Bank

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Forecast of global steel demand (by country/region)

Crude steel equivalent consumption. Source: WSA, DBS Bank

Infrastructure Investment and Resilient Construction Activities to Support Steel Demand in Mid-term

Strong infrastructure demand to underpin steel demand in emerging markets. With the China’s growth slowing down, emerging markets including ASEAN and India will be the next growth drivers, albeit much smaller in absolute size. Refering to the steel intensity chart below, these emerging countries are concentrated near the bottom-left corner where steel consumption and GDP are both at the lower end of the range. As economic progress is made, they should move along the top-right direction where steel consumption should rise along with GDP. In the medium-term, we expect to see continuous steel demand growth arising from more infrastructure projects in the emerging markets, thanks to financing secured through higher government budget allocations, increasingly popular use of private-public partnerships (PPP), and support from China’s One Belt One Road initiative. We note that, among ASEAN countries, the Philippines has seen the largest investment growth and is expected to step up further as its new administration has dedicated more than 5% of GDP to infrastructure spending in 2017, for the first time in 30 years (vs. average of 2.9% during the previous administration). Also, India has allocated a 22% higher budget of US$18bn for railways in 2017. The strong boost for infrastructure investment will translate into higher demand for steel. Demand from Asia excluding China, is projected to grow 3.3% in 2018, and its contribution to the global steel demand will expand to 24%, up from 23% in 2016.

Developed markets to increase infrastructure spending led by economic recovery. Infrastructure investments and construction activities which were sluggish in developed countries following the Global Financial Crisis, have recently started to recover. President Trump is launching a US$1 trillion infrastructure modernisation project over a 10-year period, focused on building bridges and roads, and US’s total construction spending has risen by 5.8% year-on-year for January-April 2017. Also, EU construction & engineering PMI as well as Eurozone building permits index have mostly been outperforming the previous years’ levels, indicating a recovery. Given that construction accounts for 36% of total steel demand in developed countries, we expect steel demand to remain solid from developed markets even in the medium term. Steel demand from the EU and North America are expected to grow 1.4% and 2.4%, respectively, in 2018.

Medium-term steel demand to be healthy. Shrinking steel demand from China is inevitable as its economy shifts to a consumption-driven one. Nevertheless, we expect global steel demand to be resilient in the medium-term. Despite the downtrend, China will continue to require substantial amounts of steel (expected to consume 40% of global steel demand in 2018), and the growing presence of emerging markets and increasing infrastructure spending from developed markets will make up for the decline.

(m tonnes) Y o Y %2013 2014 2015 2016 2017F 2018F 2016 2017F 2018F

China 715.6 700.6 657.9 669.7 669.7 656.3 1.8% 0.0% -2.0%Other Asia 350.5 362.0 367.5 377.0 387.0 399.6 2.6% 2.6% 3.3%EU 157.2 160.7 163.3 165.9 166.7 169.1 1.6% 0.5% 1.4%North Americaa 134.5 146.6 137.8 138.7 141.8 145.2 0.7% 2.2% 2.4%Middle East 66.8 72.4 74.6 76.1 78.5 81.4 2.0% 3.1% 3.7%Latin America 52.7 53.8 51.3 45.7 47.3 49.5 -10.9% 3.5% 4.7%CIS 48.6 46.7 42.0 41.6 42.9 44.4 -1.0% 3.2% 3.4%Africa 42.4 42.6 43.9 43.0 43.6 45.4 -2.1% 1.5% 4.1%Other Europe 36.6 35.7 34.3 34.8 35.7 37.0 1.5% 2.6% 3.5%Australia & New Zealand 7.6 7.5 7.3 7.3 7.3 7.3 0.0% 0.0% 0.0%World tota l 1,612.6 1,628.6 1,579.9 1,599.7 1,620.5 1,635.1 1.3% 1.3% 0.9%




Steel Intensity to GDP and consumption by country

Source: WSA, Custeel, DBS Bank

China: Steel demand breakdown (2015) Developed countries: Steel demand breakdown (2015)

Source: WSA, DBS Bank Source: WSA, DBS Bank

Indonesia

Malaysia

Philipines

Singapore

Thailand

Viet Nam

Japan

China

India

CanadaGermany

Netherlands

US

France

Italy

Spain

Poland

BrazilSouth Africa

Russia

Turkey

Mexico

Bangladesh

Portugal

UkraineMorocco

Taiwan

Czech Republic

South Korea

Romania

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0 10,000 20,000 30,000 40,000 50,000 60,000

Appa

rent

stee

l con

sum

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n (k

g/ca

pita

)

GDP/capita ($)

Construction, 57%

Machinery, 18%

Automobile, 9%

Home Appliance,

2%

Elec. power, 5%

Shipbuilding, 3%

others, 6%

Construction, 36%

Automobile, 22%

Metal products, 20%

Machinery, 11%

Home Appliance, 3%

Electrical equipment, 4%

others, 5%




US total construction spending Eurozone building permit index


China building starts EU Construction & Engineering PMI

Source: Bloomberg Finance L.P., DBS Bank Source: Bloomberg Finiance L.P., DBS Bank

Gross Fixed Capital Formation growth by country Infrastructure investment growth forecasts

Source: CEIC, DBS Bank Source: Bloomberg Finance L.P., WorldBank, CEIC, DBS Bank US : Government Investment growth

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(pts) 2015 2016 2017

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Indonesia MalaysiaPhilippines ThailandIndia

index, 1Q13 = 100, quarterly data

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15

2016 2017F 2018F 2019F 2020F

(%) China India ASEAN 5 Average U.S.




Steel demand breakdown (2016 vs. 2018F)

Source: WSA, DBS Bank

Chinese demand outlook

Stronger-than-expected demand in housing sector leads us to upgrade demand forecast. During the first five months of 2017, China’s GFA (gross floor area) for new starts of commodity buildings surged 9.5% year-on-year, at a time when GFA under construction rose 3.1% year-on-year. The figures for commodity buildings include both residential and commercial buildings. This is better than our expectations earlier this year, which leads us to revise 2017F steel demand up to 2.8% year-on-year growth, or 709 million tonnes of domestic steel consumption in total, to reflect upgrade in demand from the property segment (-7.0% to +0.5%).

YTD consumer-related steel consumption is broadly in line with expectations. In 5M17, China’s automobile production increased 5.0% year-on-year to 11.4 million units, which is in line with our projection of 3.0% growth for steel demand for the full year, taking into consideration that 2H16 is a high comparison base. During the same period, output of industrial

products household washing machines edged up 2.1% year-on-year and the output of fridges was flattish year-on-year, in line with our projection of steady year-on-year trends for steel demand for 2017.

Recap on 1H17 Chinese steel market. Chinese steel selling prices started the year with a strong rally extending into early-March, driven by: i) high expectations of supply-side reforms to be implemented, ii) dismantling of intermediate frequency furnaces (IFFs), and iii) environmental constraints placed during March NPC (National People’s Congress) meeting. A steep correction in steel selling prices since March was mainly due to: i) the anticipation of weaker than expected downstreamdemand of auto and home appliances in April-May; and ii)temporary liquidity crunch during mid-to-end March as thebanking industry implemented new MPA (Macro PrudentialAssessment) rules. Chinese steel prices of both HRC and rebars,bottomed at end-April, and have recovered to date, driven bycontinuous decline in social steel inventory.

China, 42%

Other Asia, 23%

EU, 10%

North America,

9%

Middle East, 5%

Latin America,

3%

CIS, 3%

Africa, 3%Other

Europe, 2% Australia & New

Zealand, 0%

China, 40%

Other Asia, 24%

EU, 10%

North America, 9%

Middle East, 5%

Latin America, 3%

CIS, 3%

Africa, 3% Other Europe, 2% Australia &

New Zealand, 1%




China steel sector: Supply and demand forecasts

Source: CEIC, Custeel, DBS Vickers

China steel sector: Demand forecast breakdown

Source: CEIC, Wind, China Metallurgical Planning and Research Institute, Custeel, DBS Vickers

2010 2011 2012 2013 2014 2015 2016 2017F 2018F 2019F 2020F

Steel:

Capacity (mt) 740 910 990 1,040 1,055 1,100 1,096 1,070 1,040 1,010 980

Crude steel output (mt) 627 684 709 775 813 804 808 796 788 780 773

Capacity Utilization rate (%) 85% 75% 72% 74% 77% 73% 74% 74% 76% 77% 79%Finished steel (mt) 799 878 955 1,067 1,117 1,123 1,138 1,143 1,146 1,150 1,153

Import (mt) 16 16 14 14 14 13 13 13 13 13 13Export (mt) 43 49 56 62 94 113 108 109 109 109 109Net export (mt) 26 34 42 48 79 100 96 96 96 96 96

Apparent consumption (mt) 773 844 913 1,019 1,038 1,023 1,042 1,046 1,050 1,054 1,057

y-o-y growth (%)Crude steel production 10.3% 9.2% 3.6% 9.2% 5.0% -2.1% 0.5% -1.5% -1.0% -1.0% -0.9%Finished steel production 15.9% 9.9% 8.8% 11.7% 4.7% 0.5% 1.3% 0.4% 0.3% 0.3% 0.3%Net exports 272.7% 29.2% 24.9% 14.4% 64.6% 26.0% -4.5% 0.8% -0.3% 0.0% 0.0%Apparent consumption 13.3% 9.2% 8.1% 11.6% 1.9% -1.4% 1.9% 0.4% 0.4% 0.3% 0.3%

V olume (mt )

y -o-y %

V olume (mt )

y -o-y %

V olume (mt )

y -o-y %

V olume (mt )

y -o-y %

Share (%)

V olume (mt )

y -o-y % Share (%)

Const ruct ion 421 3% 412 -2% 382 -7% 392 3% 57% 403 2.8% 57%--Property 298 3% 272 -9% 237 -13% 237 0% 34% 238 0.5% 34%--Infrastructure 123 3% 140 14% 145 4% 155 7% 23% 165 6.2% 23%Machinery 112 4% 117 5% 117 0% 128 9% 19% 134 5.0% 19%A utomobile 57 13% 60 5% 61 1% 69 14% 10% 71 3.0% 10%Home appliance 11 10% 12 7% 12 0% 12 0% 2% 12 0.0% 2%Container 2 -5% 2 2% 2 0% 2 0% 0% 2 0.0% 0%Shipbuilding 21 -10% 22 5% 22 0% 22 0% 3% 22 0.0% 3%Railway 6 5% 6 8% 6 -1% 6 0% 1% 6 0.0% 1%Pipeline 9 5% 9 10% 9 0% 9 0% 1% 9 0.0% 1%Elec. Power 25 10% 28 15% 32 13% 35 10% 5% 35 0.0% 5%Others 57 0% 20 -65% 22 10% 15 -32% 2% 15 0.0% 2%Total 718 4% 688 -4% 664 -3% 690 3.8% 100% 709 2.8% 100%

2017F2013 2014 2015 2016E




Global Supply Surplus to Decline and Overcapacity Remains

Global steel production to edge up. We expect China’s steel production (in volume terms) to decline 1.5% in 2017 in line with supply reforms. However, global steel production volume will increase 0.9% year-on-year due to production growth in most regions, especially in view of strong growth in the CIS countries and North America. We believe that production in China would grow when steel prices stabilise at a price which

enables steel mills to remain profitable. In fact, China’s crude steel output rose 5.8% to 128.7 million tonnes during the first two months of 2017, generating healthy profits for steel mills.

Supply-demand balance to improve in 2017 and 2018. In light of demand growth in most regions and supply contraction in China, global oversupply conditions are expected to abate in 2017 and 2018. This much-needed fundamental positive development will help support steel prices and the margins of steel mills, though we expect price volatility in the short term.

Forecast of global steel production (by country/region)

Based on crude steel. Source: WSA, EIU, DBS Bank

Source: WSA, DBS Bank

(m tonnes )2013 2014 2015 2016 2017F 2018F 2016 2017F 2018F

China 822.0 822.8 803.8 808.4 796.2 772.4 0.6% -1.5% -3.0%Other Asia 301.6 316.9 309.0 316.7 323.1 326.3 2.5% 2.0% 1.0%EU 166.4 169.3 166.1 162.3 163.9 163.9 -2.3% 1.0% 0.0%North America 119.0 121.1 110.9 111.0 114.3 116.6 0.0% 3.0% 2.0%CIS 108.4 106.1 101.6 102.4 105.5 109.7 0.8% 3.0% 4.0%Latin America 51.6 52.6 53.6 54.6 54.7 54.8 1.9% 0.2% 0.2%Other Europe 38.6 38.4 36.2 36.0 36.7 37.4 -0.6% 2.0% 2.0%Middle East 27.0 30.0 29.4 29.0 29.6 30.8 -1.4% 2.0% 4.0%Africa 16.0 14.9 13.7 12.2 13.4 15.0 -11.0% 10.0% 12.0%Australia & New Zealand 5.6 5.5 5.7 5.8 6.0 6.0 2.1% 2.0% 0.0%World total 1,650.4 1,669.9 1,620.4 1,628.5 1,643.4 1,632.9 0.5% 0.9% -0.6%

Forecast of global steel balance

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(m tonnes)(m tonnes)Balance of supply-demand (R)

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Production




Outlook for Prices of Steel and Raw Materials

Iron Ore Prices Likely to Remain Weak

Iron ore price has reached its trough. 62% Fe iron ore (CFR China) was trading at US$56.3/tonne on 19 June, down by 40% from the recent peak recorded in mid-Mar, but rebounded from US$53.4/tonne on 13 June. We expect iron ore price to remain weak as stocks at Chinese ports are still at historical-high levels and more supply from Australia and Brazil miners is expected to emerge. However, we think that iron ore price has limited downside risk from the current level. Despite the sharp drop of iron ore and coking coal prices, steel prices have not fallen significantly, hence supporting steel mills’ margins. Thanks to sound margins, steel mills have not reduced their production significantly despite the recent retreat of steel prices, which will underpin demand for seaborne iron ore.

Iron ore’s price has plunged since mid-Mar. Iron ore prices had risen since June 2016 from US$48/tonne to c US$80/tonne at

the end of December 2016, and initially we had expected the prices to soften in the beginning of 2017. However, iron ore prices' run-up has been unexpectedly persistent, reaching US$92/tonne in mid-March 2017 despite burgeoning inventory at ports.

Narrowing premium for high-grade iron ore. The decline in iron ore price was sparked by plummeting coking coal price since mid-Mar. The strong coking coal price has pushed up the price of high Fe content iron ore, as using higher Fe content iron ore would require less coking coal to make melted steel. The inventory of low-Fe content iron ore has been building up during this period, as the steel mills’ strong appetite towards more economically feasible high grade ore has increased, and the price gap between Fe 62% and Fe 58% has widened to US$28/tonne from the historical average of US$7/tonne since 2010. While the price gap has narrowed to US$13/tonne, this is still higher than the historical average.

China’s iron ore inventory vs. price Spread between China’s 62% vs 58% iron ore import


Metallurgical Coal Prices to Be Stable

Coking coal has surrendered all of the price gain from Cyclone Debbie. Coking coal price (premium hard coking coal, CFR China) fell as much as 46% to US$145/tonne in mid-June from the recent peak recorded on 13 April, as Australia’s shipment that was affected by Cyclone Debbie in April normalises. The railway shutdown following Cyclone Debbie in April had caused seaborne coking coal prices to surge sharply – premium hard coking coal price (CFR China) and hard coking coal (FOB Australia) jumped by more than US$69/tonne and US$100/tonne, respectively, in just a day on 7 April. In 2016, Australia accounted for 61.6% of the global seaborne coking coal market.

The seaborne coking coal market has ceded ground, with lower-price offers emerging on thin demand. Steel mills have been restocked to prepare for the monsoon season, and it is unlikely for the Chinese government to introduce production-restricting measures at the moment given that the current coking coal price is still about twice the level prior to the imposition of China’s 276-day rule in 2016. The rule had previously been implemented (April-November 2016) to rectify a supply glut and proved to be effective, as production dropped 9.4% and prices soared.

02004006008001,0001,2001,4001,6001,800

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Iron ore domestic price

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(US$/tonne)Spread between 62% vs 58% iron oreimport Qingdao port




Prices to stay at current levels. However, spot trading activities are gaining momentum, driven by opportunistic Chinese end-users who were taking advantage of competitively priced imports when compared with domestic materials. We expect seaborne coking coal prices to have limited downside but there would not be strong upside potential as well, given that i) steel mills have healthy coking coal inventories, ii) China’s domestic coke prices would remain weak due to production increase as the government’s inspection of environmental facilities has completed, and iii) coal miners in China are likely to continue to produce as long as coking coal prices stay above RMB1,000/tonne (US$146/tonne), according to industry experts.

Industry update: quarterly contract to follow average spot index prices. The coking coal market has been characterised by quarterly fixed-pricing contracts negotiated between Australian miners and Japanese steel mills, factoring in spot prices, the market outlook and the long-term relationship between the parties. This price would then be adopted as the benchmark by other market participants. However, Nippon Steel & Sumitomo metal Corp has reportedly decided on 12 Jun, together with the Australian miners, to switch to using the price tagged to spot index average from 2Q17 onwards. The spot indexes are provided by pricing information services such as S&P Global Platts and Argus Media. For example, S&P Global Platts is a

leading provider of such index prices and publishes five daily coking coal price indexes based on its survey of transactional data.

New coking coal pricing system positive for steel mills. We think that steel mills will enjoy lower costs and reduced volatility under the new coking coal pricing system tagged to spot indexes. Our comparison of the historical benchmark price to the average Platts SBB Premium Hard Coking Coal index of the previous quarter shows contract price consistently exceeding that of the average index price for all nine quarters, albeit to differing degrees. Thus, we think that the steel mills could benefit from the lower prices when spot indexes are used for new price contracts. Notably, the gap between the fixed benchmark price and spot average price widened tremendously in 4Q16, when prices were unusually volatile. The 4Q16 benchmark price of US$200/ton was 50%, or US$67/ton, higher than the average spot price prices of 3Q16. Again in April 2017, coking coal price had unexpectedly surged due to Cyclone Debbie which prolonged the quarterly price contract negotiation for 2Q17 and eventually led to the switch to the new pricing system. The new pricing system is advantageous to steel mills as it ensures that they obtain fair pricing amid a volatile price environment. Also, using the average spot index prices eliminates the hassle of quarterly negotiations on the prices.

Coking coal spot prices Hard coking coal benchmark contract prices


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(US$/tonne)(RMB/tonne) China Foundry Coke Domestic Spot PriceShanghai(L )SBB Premium Hard JM25 Coking Coal ChinaImport (CFR Jingtang port)SBB Hard Coking Coal Australia Export (FOB EastCoast port)

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(US$/tonne) Hard coking coal contract price




China’s coking coal imports and exports Coke inventory at major ports and coke prices in China


Quarterly contract Hard Coking Coal price vs. average Hard Coking Coal index price of the previous quarter


Quarterly contract Hard Coking Coal price vs. Hard Coking Coal index price


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China Coke Prices (R)

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300

1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17

(US$/tonne) SBB Premium Hard Coking Coal (FOB Australia) average price of the previous quarter

Hard Coking Coal (FOB Australia) quarterly contract price

0

50

100

150

200

250

300

350

15.1 15.4 15.7 15.10 16.1 16.4 16.7 16.10 17.1 17.4

(US$/ton) SBB Premium Hard Coking Coal Australia Export (FOB East Coast port)

Hard Coking Coal (FOB Australia) quarterly contract price




Price outlook and Mills’ Profitability Steel spread has improved since end-April. Following the fall in iron ore and steel prices in mid-Mar, steel spread, calculated by subtracting iron ore and coking coal prices from the world benchmark HRC price, had been on a downtrend until the end of April. Despite the persistence of weak raw material prices (iron ore price plunged 14% in April and 15% in May; coking coal price dropped 24% in May), the world HRC price was relatively stable – as a result, the steel spread has improved with the world steel spread increasing 12% in May, and reaching US$321/tonne on 9 June. The spread in China has also improved although it had suffered a lot more fluctuations compared to the spread for the world benchmark HRC price. The Chinese market saw domestic HRC price increasing since May, driving a 51% improvement in steel spread in May, and reaching US$233/tonne on 15 June. (The spread had earlier plummeted to US$126/tonne on 26 April). We expect the steel mills will maintain healthy margins backed by improved supply-demand balance going forward. Brightening earnings amid relatively stable steel prices. The improved spread with sound industry activities imply resilient earnings in 2Q17, we believe the key players will deliver stronger results than market consensus. Iron ore and coking coal prices are likely to remain weak as iron ore inventory at Chinese ports has reached a historical high, while China’s domestic coke prices are expected to be weighed down by increasing production as the inspection of China’s coal mines has been completed in end-May. In particular, margins in 2H17 should also improve, as the input cost of iron ore and coking coal are projected to drop by US$50 per tonne of crude steel, while ASP decline will be far smaller (likely a US$15/tonne fall) in 3Q17.

Regional variations in profitability. We believe steel mills will improve their profitability in 2017 in view of i) cost-cutting efforts and process rationalisation, ii) higher domestic prices as a result of steel import barriers, and iii) rising raw material costs to enhance the pricing power of steel players. The Chinese steel mills are likely to be in the black in 2017, while the US-based steel mills, especially electric arc furnace-based (EAF) mini-mills, will continue to be the major winners as steel scrap appears to be more cost-competitive than iron ore and metallurgical coal. Price outlook for 2H17. We expect 3Q17 spot steel prices to be below 2Q17 levels as the world steel prices have started to stabilise following the declines since April. In 4Q17, the prices should see some gains on healthy demand and slightly rebounding raw material prices. We think that there is limited downside to the steel prices in 4Q17, given the China’s capacity cut will have progressed further towards the year-end.

Long-term cycle is turning up. Going into 2018, iron ore and coking coal prices will weaker but more stable compared to 2017, as unexpected surges seen in 2017 (caused by external factors such as cyclone and China’s futures market rally) look less likely, while oversupply persist. The outlook for global steel demand has improved, led by a favorable business cycle with more aggressive infrastructure investments in both developed and emerging countries. We believe we are at the turning point of a long term cycle, which has been on a downtrend in the last 10 years. Steel prices and profitability of steel mills should trend upwards gradually backed by ample availability and stable prices of raw materials.

.




Price forecasts


China’s steel inventory with middlemen Inventory at China’s large and medium mills

Source: Bloomberg Finance L.P, DBS Bank Source: Bloomberg Finance L.P, DBS Bank

(US$/ton) China import I ron Ore

Fine s (62% Fe , CFR Tia n j in port)

Pre mium Ha rd Coking Coa l

FOB AuTtra l ia

MB be nc hma rk HRC pric e s

China Export Re ba r FOB Ma in

China Port

2011 168 289 705 693

2012 128 209 598 599

2013 135 151 566 524

2014 97 126 544 453

2015 56 102 370 321

2016 58 115 383 344

2017F 69 198 504 412

2018F 60 150 470 400

% Chg y-o-y

2012 (23.4) (27.6) (15.1) (13.7)

2013 5.3 (27.9) (5.3) (12.5)

2014 (28.4) (16.7) (4.0) (13.4)

2015 (42.6) (18.6) (32.0) (33.8)

2016 4.7 12.1 3.5 14.7

2017F 18.9 73.1 31.7 19.7

2018F (13.4) (24.3) (6.7) (5.3)

0

1,000

2,000

3,000

4,000

5,000

0123456789

10

11.1 12.1 13.1 14.1 15.1 16.1 17.1

(RMB/tonne)(m tonnes) Steel Inventory in China(L)

HRC spot price in China(R)

0

1

2

3

4

5

6

0

4

8

12

16

20

07.1 08.1 09.1 10.1 11.1 12.1 13.1 14.1 15.1 16.1 17.1

(m tonnes) Finished steel product(L)

Semi-finished steel product(R)

(m tonnes)




Steel scrap prices HRC prices by region


US: HRC & CRC prices CIS export prices


China: HRC & CRC prices China: Rebar & Wire rod prices


100

200

300

400

500

600

11.3 12.3 13.3 14.3 15.3 16.3 17.3

(US$/tonne) SBB US domestic Shredded Obsolete Scrap(Delivered Midwest mill)SBB Turkey import Heavy Melt Scrap #1&280:20 (CFR Turkish port)

200

300

400

500

600

700

800

900

1,000

10.1 11.1 12.1 13.1 14.1 15.1 16.1 17.1

(US$/tonne) Hot rolled coil, World Export MarketUSA East of Miss Hot rolled coilMainland China Hot rolled coil

400

500

600

700

800

900

1,000

1,100

1,200

10.1 11.1 12.1 13.1 14.1 15.1 16.1 17.1

(US$/tonne)USA East of Miss Hot rolled coil

USA East of Miss Cold rolled coil

200

300

400

500

600

700

800

10.1 11.1 12.1 13.1 14.1 15.1 16.1 17.1

(US$/tonne) Steel CIS Export HR coil $ per tonne BlackSea/Baltic SeaSteel CIS Export CR coil $ per tonne BlackSea/Baltic Sea

1,500

2,500

3,500

4,500

5,500

6,500

10.1 11.1 12.1 13.1 14.1 15.1 16.1 17.1

(RMB/tonne)CR Sheet 25mm Average

HR Sheet 25mm Average

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

5,500

10.1 11.1 12.1 13.1 14.1 15.1 16.1 17.1

(RMB/tonne)Steel Rebar 25mm Average

Wire Rod 25mm Average




Asian steel mills’ profitability China: spread between HRC price and iron ore price

Based on large integrated steel mills purchasing raw materials at the contract price basis.

Source: Platts, Bloomberg Finance L.P., DBS Bank

Source: Bloomberg Finance L.P, DBS Bank

Quarterly price forecasts

Source: Bloomberg Finance L.P, DBS Bank

0

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0

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1Q10 1Q11 1Q12 1Q13 1Q14 1Q15 1Q16 1Q17


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600

700

10.1 11.1 12.1 13.1 14.1 15.1 16.1 17.1

(US$/tonne)(US$/tonne) Spread (L)HRC benchmark prices (L)China import Iron Ore Fines 62% Fe spot(R)

I ron Ore (Fine ,

62%) Ha rme rs le y

Contra c t ha rd

c oking c oa l

Ra w ma te ria l c ost/ton of

c rude s te e l

Be nc hma rkHRC

pric e s

I ron Ore (Fine ,

62%) Ha rme rs le y

Contra c t ha rd

c oking c oa l

Ra w ma te ria l

c ost/ton of c rude s te e l

Be nc hma rkHRC

pric e s

1Q16 49 81 137 290 2.3 (8.0) (5.6) 1.0

2Q16 56 84 140 410 7.0 3.0 3.6 119.8

3Q16 58 93 162 373 2.0 9.0 21.6 (37.0)

4Q16 70 200 231 458 12.0 107.0 69.3 84.8

1Q17 85 285 299 525 15.0 85.0 68.0 67.3

2Q17 70 193 247 505 (15.0) (92.0) (52.2) (20.0)

3Q17 60 155 197 485 (10.0) (38.0) (49.9) (20.0)

4Q17 62 160 206 500 2.0 5.0 9.2 15.0

Q-o-q Cha nge s




Page 38

Company

ASIAN INSIGHTS VICKERS SECURITIES ed: TH / sa: YM, PY

BUYLast Traded Price ( 21 Jun 2017): KRW267,000 (KOSPI : 2,358.00) Price Target 12-mth: KRW340,000 (27% upside) (Prev KRW330,000)


What’s New 2Q17 earnings to continue to grow despite fall in

steel prices

Margins to improve in 2H17 backed by stable steel

prices and raw material cost savings

Potential loss from POSPOWER will not disrupt

earnings growth trend

Retain BUY call and raise TP to KRW340,000

Price Relative

Forecasts and Valuation FY Dec (KRW m) 2015A 2016A 2017F 2018F Revenue 58,192 53,084 58,376 60,657 EBITDA 5,628 6,058 7,365 7,581 Pre-tax Profit 181 1,433 2,507 3,041 Net Profit 181 1,363 1,834 2,225 Net Pft (Pre Ex.) 181 1,363 1,834 2,225 Net Pft Gth (Pre-ex) (%) (71.1) 654.7 34.5 21.3 EPS (KRW) 2,072 15,637 21,037 25,515 EPS Pre Ex. (KRW) 2,072 15,637 21,037 25,515 EPS Gth Pre Ex (%) (71) 655 35 21 Diluted EPS (KRW) 2,072 15,637 21,037 25,515 Net DPS (KRW) 8,000 8,000 8,000 8,000 BV Per Share (KRW) 515,470 529,683 537,827 563,314 PE (X) 128.9 17.1 12.7 10.5 PE Pre Ex. (X) 128.9 17.1 12.7 10.5 P/Cash Flow (X) 3.1 4.4 4.2 3.4 EV/EBITDA (X) 7.0 6.5 5.3 4.9 Net Div Yield (%) 3.0 3.0 3.0 3.0 P/Book Value (X) 0.5 0.5 0.5 0.5 Net Debt/Equity (X) 0.3 0.3 0.3 0.2 ROAE (%) 0.4 3.3 4.3 5.1

Earnings Rev (%): 1 11 Consensus EPS (KRW): 21,171 24,777 Other Broker Recs: B: 29 S: 1 H: 7

Source of all data on this page: Company, DBS Bank, Bloomberg Finance L.P

Back to the real POSCO Retain BUY call, raise TP to KRW340,000 on continuous earnings growth. POSCO is expected to register 45% y-o-y growth (to KRW985bn) for the consolidated OP in 2Q17, thanks to the relatively stable ASP despite drop in spot steel prices. The outlook for 2H17 is brightened by improvement in margins, backed by stable raw material prices and sales volume growth as the maintenance and revamping works will be completed by June. Overseas affiliates in the steel business and POSCO E&C would be key contributors for earnings recovery in 2017 following fundamental improvement in the sector. The company will successfully turn around by increasing FY17 OP by 47% to KRW4.18tr. Our TP upgrade follows upward revisions of FY17F/FY18F EPS by 1% and 15% respectively. Where we differ: More optimistic on FY18. Our FY17F EPS forecast is below street consensus as we have factored in potential loss from its affiliate, POSPOWER on cancellation of coal-based power plant construction. The uncertainty over the project could offer a buying opportunity as it should not disrupt its earnings growth. We are more optimistic on FY18F earnings as sector fundamentals are likely to be favourable supported by overcapacity cut and continuous infrastructure investment throughout the region. The power shift for bargaining of raw material prices to the steel mills from miners will lead to higher margins than before for the former. Other potential catalysts. Successful restructuring and higher dividend via introduction of Stewardship Code. Its restructuring has been completed for 126 targeted subsidiaries/assets out of a total 149, and the process is scheduled to be completed in 2017. The targets for the restructuring are those not in the group’s core business area or have been registering loss for the last 3 years. This will remove potential loss from non-core business and enhance earnings visibility. The new Korean government will encourage Korean Institutional investors (especially National Pension Service) to introduce the Stewardship Code. This would boost dividend payout for the company as NPS is its largest shareholder. Valuation: Our KRW340,000 TP is derived using RIM (Residual Income Model), assuming 1.5% risk-free rate and 5.5% equity risk premium, and translates to 0.63x FY17F P/BV. Key Risks to Our View: The key risks would be: (i) imported Chinese steel products and anti-dumping from exporting countries, (ii) potential one-off losses from restructuring.

At A Glance Issued Capital (m shrs) 87 Mkt. Cap (KRWbn/US$m) 23,279 / 20,369 Major Shareholders (%) Citibank NA 11.4 National Pension Services 11.0 POSCO 8.3

Free Float (%) 63.7 3m Avg. Daily Val (US$m) 67.0 ICB Industry : Basic Materials / Industrial Metals

DBS Group Research . Equity 22 Jun 2017

Regional Korea Company Guide

POSCO Version 7 | Bloomberg: 005490 KS | Reuters: 005490.KS Refer to important disclosures at the end of this report

46

66

86

106

126

146

166

186

206

140,400.0

190,400.0

240,400.0

290,400.0

340,400.0

390,400.0

Jun-13 Jun-14 Jun-15 Jun-16 Jun-17

Relative IndexKRW

POSCO (LHS) Relative KOSPI (RHS)


Company Guide

POSCO

WHAT’S NEW

Share price trails earnings improvement

2Q17 earnings to continue to grow. POSCO is expected to register KRW985tr group operating profit (45% y-o-y) which would be in line with our initial expectations. Compared to 1Q17, its spread for carbon steel in 2Q17 is expected to decline by c.US$10/ton as the high-priced raw material has been input into production in April and May. However, this is minimally impacted as spot steel prices in Asia have fallen by US$50/ton. As it has more long-term and stable clients who decide on their purchasing prices on a quarterly basis, its sales prices are relatively less volatile compared to spot market prices. In fact, it could register an upside earnings surprise if stainless steel segment maintains the margins, which registered 15% OP margins in 1Q17. Following the drop in nickel prices, stainless segment is projected to register c.8% OP margins.

2H17 margins to improve. We expect margins in 2H17 to likely improve, backed by a reduction in raw material cost. The input cost of iron ore and coal is projected to drop by US$50 per ton of crude steel, while the ASP is likely to decline c.US$15/ton in 3Q17 in light of recent price negotiation with its clients. This suggest its margins are able to increase US$35/ton in 3Q17. Meanwhile, the spot steel prices are currently stabilising and likely to rebound, which will impact positively on the price negotiation with customers and support its margin improvement.

Potential loss relating to POSPOWER. In 2014, POSCO acquired Dongyang Power Tech which holds the right to build a new coal-fired power plant in SamCheok for KRW430bn. The preliminary permit for the plant's construction expired in December 2016, and in January 2017 it was extended by the government to June 2017, by which time the plant would require a final permit from the Ministry of Power. Before obtaining the licence, POSCO needs to gain local support, but many locals oppose the project on erosion concerns, as the coal loading

dock of the Samcheok Plant will be constructed in a coastal erosion management area, as designated by the Ministry of Maritime Affairs and Fisheries. Samcheok City is requesting consent from the residents of the affected area. Specifically, the new government has announced its restrictions on the construction of new coal-fired power plants to resolve the issue of fine dust, and also recently stopped the operations of an old coal power plant in June. If it does not get the permit, c.KRW480bn loss is estimated. POSCO Energy currently holds a 100% stake in POSPOWER, while POSCO owns 89% of POSCO Energy. We have factored in a potential loss of KRW480bn relating to the cancellation of coal-based power plant construction.

Potential gain from sale of listed stocks. POSCO has c.KRW1.8tr worth of listed stocks including Nippon Steel & Sumitomo Metal, Hyundai Heavy Industries, KB Financial Group and Woori Bank. It had bought the stock as part of a strategic alliance to protect it from hostile M&A by purchasing the other party’s share in the market. To enhance financial soundness and register valuation gains from the recent stock market rebound, the company is considering the sale of these stocks (it appears likely to consider selling bank stocks).

Retain BUY and raise TP to KRW340,000. We revise up our forecast for FY17F OP by 19%. However, we edge up FY17F EPS by 1% due to the potential loss from POSPWER. Meanwhile, we raise FY18F EPS by 15% as it would focus more on steel business going forward as the result of restructuring. Accordingly, we raise our TP slightly to KRW340,000. Our TP is derived using RIM (Residual Income Model), assuming 1.5% risk-free rate and 5.5% equity risk premium, and translates to 0.63x FY17F P/BV. Although there is potential loss from affiliates, we believe its earnings growth will not be dampened by the one-off loss. Thanks to its share price underperformance, its valuation now appears more attractive, which will support current price levels, at least.

ASIAN INSIGHTS VICKERS SECURITIES Page 3

Company Guide

POSCO

POSCO: Quarterly earnings forecasts (KRWbn)

(KRW bn) 1Q16 2Q16 3Q16 4Q16 1Q17F 2Q17F

Revenue 12,461 12,857 12,748 15,017 15,077 14,477 Operating Profit

660 679 1,034 472 1,365 985

Pretax profit 545 268 663 -44 1,325 610

Net profit 338 221 476 14 977 443

OP margins 5.3% 5.3% 8.1% 3.1% 9.1% 6.8%

Pretax margins 4.4% 2.1% 5.2% -0.3% 8.8% 4.2%

Net margins 2.7% 1.7% 3.7% 0.1% 6.5% 3.1% Source of all data: Company, DBS Bank

Steel spread for steel mills contracting raw material quarterly basis.

Source: Company, Steeldaily, DBS Bank

Korea spot steel prices

Source: Company, Steeldaily, DBS Bank

0

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0

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1Q10 1Q11 1Q12 1Q13 1Q14 1Q15 1Q16 1Q17


200

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06.05 07.02 07.11 08.09 09.06 10.04 11.01 11.10 12.07 13.04 14.01 14.11 15.08 16.05 17.02

(k KRW/ton)

POSCO's HRC Prices

Imported Chinese HRC

POSCO's CRC prices


Company Guide

POSCO

CRITICAL FACTORS TO WATCH

Steel prices/steel spread have been a key critical factor for share prices. Obviously, steel prices are the most critical factor for its earnings and the spread between steel and iron ore prices has also strongly explained its share price movements. Following the fall in iron ore and steel prices in mid-March, steel spread had been on a downtrend until the end of April. While weak raw material prices persisted, the world HRC price fell by a smaller degree – as a result, the steel spread was not damaged compared to 1Q17. Accordingly, its margins in 2Q17 are likely to be intact and the margins are expected to improve in 2H17 due to reduction in raw material prices. In 2018, we expect steel prices to be less volatile and to trade within a band (US$400-550/ton based on spot HR prices) with steady iron ore prices, which would be favourable conditions to maintain stable margins. China’s supply reform should benefit it as Korea is the biggest export market for Chinese steel products.

Improving affiliate earnings and narrower losses from restructuring. We expect losses from its affiliates to contract in 2017, backed by steel price hikes and cost savings from restructuring. The overseas affiliates in the steel business are likely to post better results than in 2016 following improved fundamentals. POSCO E&C should especially be a key contributor to earnings as it registered a c.KRW652bn net loss due to delayed completion of Brazil CSP andother losses in the overseas projects. It has completed therestructuring of 126 cases from 149 targeted subsidiaries/assets, andthe entire process should complete by 2017; these have been aburden on group earnings. The potential loss from POSPOWER’scoal-fired power plant project is estimated to be c.KRW480bn whichis smaller than previous non-operating expenses from the affiliates.Of note, its net non-operating expenses were KRW1.4tr andKRW756bn in 2015 and 2016 respectively.

Growth of high-end products, especially autosheets. POSCO has been diversifying its client base globally as it faces declining autosheet sales to Hyundai Motor group following Hyundai Steel's entrance into the market. This has led to sales volume growth of autosheets, which has increased to 9m tons in 2016 from 7.1m tons in 2011. It supplies c.50% of autosheet requirements to 15 major car makers all over the world, and as a result, half of its sales volume are exported. This is the reason why POSCO should be able to maintain its sales volume despite strong inflow of cheap Chinese steel products into Korea's steel market.

Favourable shareholder policy: The new Korean government will encourage Korean Institutional investors (especially National Pension Service) to introduce the Stewardship Code. This would boost dividend payout for the company as NPS is its largest shareholder.

F/X(KRW/US$, end)

Benchmark Iron Ore price(Fe 62%,US$/ton)

Benchmark HRC price(US$/ton)

Total sales volume(k ton)

ASP(k KRW/ton)

Source: Company, DBS Bank

10531131 1161 1145 1145

0.0

167.5

335.0

502.4

669.9

837.4

1004.9

1172.4

2014A 2015A 2016A 2017F 2018F

96.9

55.6 58.5

69.3

60

0.0

19.8

39.5

59.3

79.0

98.8

2014A 2015A 2016A 2017F 2018F

544

370 383

485 470

0.00

110.90

221.81

332.71

443.61

554.51

2014A 2015A 2016A 2017F 2018F

3245734086 34525 33641 34410

0.0

6974.1

13948.1

20922.2

27896.3

34870.3

2014A 2015A 2016A 2017F 2018F

902

747704

764 772

0.0

182.3

364.6

546.9

729.2

911.5

2014A 2015A 2016A 2017F 2018F


Company Guide

POSCO

What drives its share price?

Steel price index vs. POSCO Share price Remark

Overall, POSCO’s share price has been in line with steel price index. Before 2010, its share price had preceded steel price index as investors had taken action in advance of fundamental improvement. Since 2011, it has been moving in line with the steel price index.

Steel Spread = Benchmark HRC price – coking coal & iron ore prices Source: Bloomberg Finance L.P., DBS Bank

World steel spread vs. POSCO Share price Remark

POSCO’s share price is strongly correlated with steel spread which is natural as steel spread implies its profitability.


China Manufacturing PMI SA vs. POSCO Share price Remark

As China contributes c.50% of global steel production and consumption, China’s macro economy is now the key determinant for steel prices. Hence, China’s manufacturing PMI index shows strong correlation with POSCO’s share price.


100

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80100120140160180200220240260280300

02.1 03.1 04.1 05.1 06.1 07.1 08.1 09.1 10.1 11.1 12.1 13.1 14.1 15.1 16.1 17.1

(KRW k)(1994=100)Steel price index (L) POSCO Share price (R)

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(KRW k)(US$/tonne)Steel Spread (world HRC - iron ore)

POSCO Share price (R)

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48

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(KRW k)(pts)China Manufacturing PMI SA POSCO Share price (R)


Company Guide

POSCO

Balance Sheet: Healthy financials, expect deleveraging going forward. POSCO’s net gearing ratio increased to 0.42x in FY14 from 0.25x in FY09 following a series of M&A. However, its gearing declined to 0.3x in 2016 and is expected to decline further following restructuring and limited capex going forward.

Share Price Drivers:

Turnaround with successful restructuring. We believe an earnings turnaround is currently underway due to the improved business environment. Catalysts could come from steel price hikes with fast and successful restructuring. As our assumptions are conservative, there is upside risk to its earnings.

Key Risks:

Imported Chinese steel products and anti-dumping from exporting countries. The key risks would be: (a) more imported Chinese steel products as Korea is the largest export market for Chinese steel products, (b) anti-dumping measures from its exporting countries including US, which is another risk as POSCO exports 50% of its sales volume, and (c) further capacity expansion of its competitors including Hyundai Steel that would threaten its market share and profitability.

Potential one-off loss from restructuring. POSCO disposed 46 affiliates in 2015, and it intends to progressively reduce the number of affiliates by 81 in total by 2017; these would be entities that have yet to contribute to group earnings and have no positive outlook. We believe that the restructuring would have a negative impact on its earnings and POSCO is likely to post losses during the process of selling or closing down its affiliates. Since 2013, the company has missed our earnings estimates due to losses from affiliates and investments. Nonetheless, its asset quality should improve over the long term.

Company Background

POSCO is the fifth largest steel company in the world, producing flat steel products and stainless products. Its crude steel-making capacity is 47m tons globally including 42m tons at its Korean parent company. It produced 43m tons of steel products in FY14. It is also involved in construction (POSCO E&C), energy (POSCO Energy), materials (POSCO Chemtech) and trading businesses (POSCO Daewoo). The POSCO group has 221 companies including 38 Korean and 160 overseas companies (as at the end of March 2017).

Leverage & Asset Turnover (x)

Capital Expenditure

ROE (%)

Forward PE Band (x)

PB Band (x)


0.6

0.6

0.6

0.7

0.7

0.7

0.7

0.7

0.8

0.8

0.8

0.00

0.10

0.20

0.30

0.40

0.50

0.60

2014A 2015A 2016A 2017F 2018F

Gross Debt to Equity (LHS) Asset Turnover (RHS)

0.0

500.0

1,000.0

1,500.0

2,000.0

2,500.0

3,000.0

3,500.0

4,000.0

2014A 2015A 2016A 2017F 2018F

Capital Expenditure (-)

KRWm

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

2014A 2015A 2016A 2017F 2018F

Avg: 36.7x

+1sd: 67.9x

+2sd: 99.1x

‐1sd: 5.4x

-23.2

-3.2

16.8

36.8

56.8

76.8

96.8

116.8

136.8


(x)

Avg: 0.48x

+1sd: 0.57x

+2sd: 0.66x

‐1sd: 0.39x

‐2sd: 0.3x

0.2

0.3

0.4

0.5

0.6

0.7

0.8

Dec-13 Dec-14 Dec-15 Dec-16

(x)


Company Guide

POSCO

Peer comparison

Market Cap

(US$m)

PER PBR EV/EBITDA ROE

21 June FY17F FY18F FY19F FY17F FY18F FY19F FY17F FY18F FY19F FY17F FY18F FY19F

Korea listed players

Posco 20,339 8.8 8.4 7.8 0.5 0.5 0.5 5.3 5.2 5.1 5.9 5.9 6.0

Hyundai Steel 6,634 7.6 7.6 7.3 0.4 0.4 0.4 6.1 6.0 5.9 6.0 5.7 5.7

Seah Besteel 859 9.2 8.3 8.1 0.5 0.5 0.5 6.2 5.7 5.6 6.1 6.4 6.3

HK-listed players

Angang Steel 5,637 13.6 11.4 10.5 0.7 0.7 0.7 7.9 7.4 7.4 5.2 5.9 6.0

Maanshan Steel 3,636 9.6 9.0 8.3 0.9 0.8 0.7 6.9 6.7 6.6 9.7 9.8 9.1

China A-share listed players

Baosteel-A 21,273 11.2 9.6 9.3 1.0 1.0 1.0 7.0 6.4 6.4 9.9 9.0 8.5 Hebei Iron & Steel-A 6,793 23.2 19.2 16.2 1.0 0.9 0.9 12.0 11.3 N/A 4.6 4.9 5.5

Angang-A 5,637 16.1 13.7 11.5 0.8 0.8 0.7 7.7 7.0 6.7 5.1 5.8 6.6 Maanshan Steel-A 3,636 14.5 13.0 10.8 1.2 1.1 1.0 7.1 6.8 6.3 8.8 9.1 9.7

Asian listed players

China Steel Corp. 12,666 20.6 17.5 17.4 1.2 1.2 1.2 10.2 9.5 9.7 6.1 7.1 6.8

Tata Steel 7,784 10.8 9.2 8.8 1.5 1.3 1.1 7.0 6.5 6.3 13.3 13.8 13.1 Steel authority of India 3,664 70.0 10.1 N/A 0.6 0.6 N/A 11.7 8.0 N/A (0.3) 3.9 N/A

JSW Steel 7,491 11.8 9.9 9.2 1.8 1.6 N/A 6.3 5.8 5.8 16.1 16.7 16.2 Jindal Steel & Power 1,766 N/A 15.5 9.7 0.5 0.5 N/A 7.8 6.3 5.3 (2.1) 3.4 3.9

JFE 9,837 10.4 9.0 8.5 0.5 0.5 0.5 7.0 6.5 6.4 5.4 5.6 5.5 Nippon Steel & Sumitomo Metal 20,155 10.7 9.3 9.0 0.7 0.7 0.7 8.0 7.3 7.1 6.9 7.4 7.1

Nisshin Steel 1,148 10.6 9.0 11.4 0.6 0.6 0.5 7.5 7.0 7.4 5.8 6.3 4.8

Kobe Steel 3,376 12.1 9.4 8.6 0.5 0.5 0.5 6.3 5.7 5.3 4.6 5.5 5.6

International listed player

AK Steel 1,949 10.1 7.8 6.0 N/A 15.7 4.3 6.2 5.4 5.0 83.6 1,435.1 58.8 Steel Dynamics Inc 8,039 11.3 11.0 9.4 2.4 2.0 1.7 6.0 5.9 5.2 23.2 20.1 20.1

ArcelorMittal 20,622 7.5 7.7 7.2 0.6 0.6 0.6 4.4 4.4 4.4 8.1 7.3 7.6 United States Steel Corp. 3,680 25.9 10.7 7.3 1.5 1.3 1.1 5.9 4.6 4.0 4.2 13.1 18.8

Thyssenkrupp 15,262 27.4 14.2 12.0 6.5 4.6 3.6 7.3 6.6 6.2 17.8 36.7 33.1 Nucor 17,857 12.9 12.2 10.9 2.0 1.8 1.6 6.7 6.4 5.9 17.2 16.4 17.0Severstal 9,920 6.9 8.4 9.0 2.8 2.5 2.3 4.8 5.5 5.6 42.4 30.0 28.6



Company Guide

POSCO

Key Assumptions

FY Dec 2014A 2015A 2016A 2017F 2018F

F/X(KRW/US$, end) 1,053 1,131 1,161 1,145 1,145 Benchmark Iron Ore 97.0 56.0 59.0 69.0 60.0 Benchmark HRC 544 370 383 485 470 Total sales volume(k ton) 32,457 34,086 34,525 33,641 34,410 ASP(k KRW/ton) 902 747 704 764 772

Segmental Breakdown

FY Dec 2014A 2015A 2016A 2017F 2018F

Revenues (KRWbn)

Parents company 30,544 29,219 26,607 24,325 25,690 Others 34,554 28,973 26,477 34,051 34,967

Total 65,098 58,192 53,084 58,376 60,657 Gross profit (KRWbn)

Parents company 4,048 4,263 4,134 4,421 5,128 Others 3,235 2,271 2,556 3,868 3,485

Total 7,283 6,534 6,690 8,289 8,613Gross profit Margins (%)

Parents company 13.3 14.6 15.5 18.2 20.0 Others 9.4 7.8 9.7 11.4 10.0

Total 11.2 11.2 12.6 14.2 14.2

Income Statement (KRWbn)

FY Dec 2014A 2015A 2016A 2017F 2018F

Revenue 65,098 58,192 53,084 58,376 60,657 Cost of Goods Sold (57,815) (51,658) (46,394) (50,087) (52,043) Gross Profit 7,283 6,534 6,690 8,289 8,613Other Opng (Exp)/Inc (4,070) (4,124) (3,845) (4,109) (4,251) Operating Profit 3,214 2,410 2,844 4,180 4,362Other Non Opg (Exp)/Inc (1,016) (1,328) (888) (1,171) (851) Associates & JV Inc (300) (506) (89.0) (80.0) (80.0) Net Interest (Exp)/Inc (567) (579) (476) (463) (431) Exceptional Gain/(Loss) 0.0 0.0 0.0 0.0 0.0 Pre-tax Profit 1,378 181 1,433 2,507 3,041Tax (821) (277) (385) (673) (816) Minority Interest 69.0 277 315 0.0 0.0 Preference Dividend 0.0 0.0 0.0 0.0 0.0 Net Profit 626 181 1,363 1,834 2,225Net Profit before Except. 626 181 1,363 1,834 2,225 EBITDA 6,452 5,628 6,058 7,365 7,581 Growth

Revenue Gth (%) 5.2 (10.6) (8.8) 10.0 3.9EBITDA Gth (%) 13.6 (12.8) 7.6 21.6 2.9 Opg Profit Gth (%) 7.3 (25.0) 18.0 47.0 4.3 Net Profit Gth (Pre-ex) (%) (54.5) (71.1) 654.7 34.5 21.3 Margins & Ratio

Gross Margins (%) 11.2 11.2 12.6 14.2 14.2Opg Profit Margin (%) 4.9 4.1 5.4 7.2 7.2Net Profit Margin (%) 1.0 0.3 2.6 3.1 3.7ROAE (%) 1.5 0.4 3.3 4.3 5.1ROA (%) 0.7 0.2 1.7 2.3 2.8ROCE (%) 1.8 (1.8) 3.0 4.5 4.6Div Payout Ratio (%) 102.2 354.3 46.9 34.9 28.8 Net Interest Cover (x) 5.7 4.2 6.0 9.0 10.1



Company Guide

POSCO

Quarterly / Interim Income Statement (KRWbn)

FY Dec 1Q2016 2Q2016 3Q2016 4Q2016 1Q2017

Revenue 12,461 12,857 12,748 15,017 15,077 Cost of Goods Sold (10,920) (11,288) (10,786) (13,400) (12,819) Gross Profit 1,541 1,569 1,962 1,617 2,258Other Oper. (Exp)/Inc (882) (891) (928) (1,145) (893)Operating Profit 660 679 1,034 472 1,365Other Non Opg (Exp)/Inc (40.0) (396) (179) (232) 17.0Associates & JV Inc 50.0 112 (71.0) (179) 72.0Net Interest (Exp)/Inc (125) (126) (121) (105) (128)Exceptional Gain/(Loss) 0.0 0.0 0.0 0.0 0.0Pre-tax Profit 545 268 663 (44.0) 1,325Tax (207) (48.0) (188) 58.0 (349)Minority Interest 21.0 71.0 70.0 153 (126)Net Profit 360 292 546 166 851Net profit bef Except. 360 292 546 166 851EBITDA 1,475 1,190 1,603 855 1,454

Growth

Revenue Gth (%) (10.4) 3.2 (0.9) 17.8 0.4EBITDA Gth (%) 47.7 (19.3) 34.7 (46.6) 69.9 Opg Profit Gth (%) 109.6 2.8 52.4 (54.4) 189.3 Net Profit Gth (Pre-ex) (%) 93.9 (18.9) 87.1 (69.5) 411.7 Margins

Gross Margins (%) 12.4 12.2 15.4 10.8 15.0Opg Profit Margins (%) 5.3 5.3 8.1 3.1 9.1Net Profit Margins (%) 2.9 2.3 4.3 1.1 5.6

Balance Sheet (KRWbn) FY Dec 2014A 2015A 2016A 2017F 2018F

Net Fixed Assets 35,241 34,523 33,770 33,563 33,292 Invts in Associates & JVs 4,061 3,945 3,882 3,252 3,212 Other LT Assets 13,323 12,760 12,806 12,428 12,081 Cash & ST Invts 5,553 9,208 8,105 7,173 9,165 Inventory 10,471 8,225 9,052 9,954 10,343 Debtors 13,464 10,849 10,895 11,981 12,449 Other Current Assets 3,140 898 1,253 1,378 1,516 Total Assets 85,252 80,409 79,763 79,730 82,058

ST Debt 9,244 8,416 7,980 7,480 7,480 Creditor 7,333 6,193 7,247 7,763 8,052 Other Current Liab 5,300 5,522 3,688 3,688 3,688 LT Debt 15,349 12,918 12,681 11,981 11,981 Other LT Liabilities 2,735 2,289 2,328 2,328 2,328 Shareholder’s Equity 41,587 41,235 42,373 43,025 45,064 Minority Interests 3,704 3,835 3,465 3,465 3,465 Total Cap. & Liab. 85,252 80,409 79,763 79,730 82,058

Non-Cash Wkg. Capital 14,442 8,258 10,264 11,862 12,568 Net Cash/(Debt) (19,041) (12,126) (12,556) (12,288) (10,296) Debtors Turn (avg days) 74.3 76.3 74.8 71.5 73.5 Creditors Turn (avg days) 49.4 51.0 56.8 58.4 59.1 Inventory Turn (avg days) 67.8 70.4 73.0 74.0 75.9 Asset Turnover (x) 0.8 0.7 0.7 0.7 0.7 Current Ratio (x) 1.5 1.4 1.5 1.6 1.7 Quick Ratio (x) 0.9 1.0 1.0 1.0 1.1 Net Debt/Equity (X) 0.4 0.3 0.3 0.3 0.2 Net Debt/Equity ex MI (X) 0.5 0.3 0.3 0.3 0.2 Capex to Debt (%) 14.3 12.0 11.2 13.4 13.4Z-Score (X) 2.0 2.0 2.0 2.1 2.2


Company Guide

POSCO

Cash Flow Statement (KRWbn)

FY Dec 2014A 2015A 2016A 2017F 2018F

Pre-Tax Profit 1,378 181 1,433 2,507 3,041Dep. & Amort. 3,239 3,218 3,214 3,185 3,219Tax Paid (1,619) (900) (987) (1,346) (816)Assoc. & JV Inc/(loss) 0.0 0.0 0.0 0.0 80.0 Chg in Wkg.Cap. (1,914) 2,754 (426) (1,414) (627) Other Operating CF 2,028 1,842 1,947 2,567 (930)Net Operating CF 3,412 7,602 5,269 5,579 6,790Capital Exp.(net) (3,506) (2,560) (2,324) (2,600) (2,600) Other Invts.(net) 1,141 106 (339) 550 (40.0)Invts in Assoc. & JV 0.0 0.0 0.0 0.0 0.0 Div from Assoc & JV 0.0 0.0 0.0 0.0 0.0Other Investing CF (1,381) (2,080) (1,092) (246) (260)Net Investing CF (3,745) (4,535) (3,755) (2,296) (2,900) Div Paid (677) (823) (709) (640) (640)Chg in Gross Debt 758 (2,577) (3,172) (1,200) 0.0 Capital Issues 0.0 0.0 0.0 0.0 0.0Other Financing CF (157) 1,158 (70.0) (2,657) (1,556)Net Financing CF (76.0) (2,242) (3,951) (4,497) (2,196) Currency Adjustments 12.0 23.0 13.0 0.0 0.0Chg in Cash (397) 849 (2,424) (1,214) 1,695 Opg CFPS (KRW) 61,088 55,602 65,322 80,206 85,073 Free CFPS (KRW) (1,072) 57,825 33,782 34,162 48,060


Target Price & Ratings History

Source: DBS Bank

Analyst: Lee Eun Young

S.No.Date of Report

Clos ing Price

12-mthTarget Price

Rating

1: 18 Jul 16 228000 270000 BUY

2: 22 Jul 16 219500 270000 BUY

3: 14 Nov 16 252000 320000 BUY

4: 15 Dec 16 268500 320000 BUY

5: 12 Jan 17 266500 320000 BUY

6: 17 Jan 17 265000 320000 BUY

7: 26 Jan 17 276000 320000 BUY

8: 28 Mar 17 275500 330000 BUY

9: 09 May 17 268500 330000 BUY

10: 29 May 17 283500 330000 BUY

11: 14 Jun 17 279500 330000 BUY

Note : Share price and Target price are adjusted for corporate actions.

12

3

4

5

67

8

9

10

11

184300

204300

224300

244300

264300

284300

304300

Jun-16 Aug-16 Oct-16 Dec-16 Feb-17 Apr-17 Jun-17

KRW


Company Guide

POSCO

DBS Bank recommendations are based an Absolute Total Return* Rating system, defined as follows:

STRONG BUY (>20% total return over the next 3 months, with identifiable share price catalysts within this time frame)

BUY (>15% total return over the next 12 months for small caps, >10% for large caps)

HOLD (-10% to +15% total return over the next 12 months for small caps, -10% to +10% for large caps)

FULLY VALUED (negative total return i.e. > -10% over the next 12 months)

SELL (negative total return of > -20% over the next 3 months, with identifiable catalysts within this time frame)

Share price appreciation + dividends

Completed Date: 22 Jun 2017 17:53:03 (SGT) Dissemination Date: 22 Jun 2017 18:13:16 (SGT)

Sources for all charts and tables are DBS Bank unless otherwise specified.

GENERAL DISCLOSURE/DISCLAIMER

This report is prepared by DBS Bank Ltd. This report is solely intended for the clients of DBS Bank Ltd, its respective connected and associated

corporations and affiliates only and no part of this document may be (i) copied, photocopied or duplicated in any form or by any means or (ii)

redistributed without the prior written consent of DBS Bank Ltd.

The research set out in this report is based on information obtained from sources believed to be reliable, but we (which collectively refers to DBS

Bank Ltd, its respective connected and associated corporations, affiliates and their respective directors, officers, employees and agents (collectively,

the “DBS Group”) have not conducted due diligence on any of the companies, verified any information or sources or taken into account any other

factors which we may consider to be relevant or appropriate in preparing the research. Accordingly, we do not make any representation or

warranty as to the accuracy, completeness or correctness of the research set out in this report. Opinions expressed are subject to change without

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associated with any of them may from time to time have interests in the securities mentioned in this document. The DBS Group, may have

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Any valuations, opinions, estimates, forecasts, ratings or risk assessments herein constitutes a judgment as of the date of this report, and there can

be no assurance that future results or events will be consistent with any such valuations, opinions, estimates, forecasts, ratings or risk assessments.

The information in this document is subject to change without notice, its accuracy is not guaranteed, it may be incomplete or condensed, it may

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This publication has not been reviewed or authorized by any regulatory authority in Singapore, Hong Kong or elsewhere. There is no planned

schedule or frequency for updating research publication relating to any issuer.

The valuations, opinions, estimates, forecasts, ratings or risk assessments described in this report were based upon a number of estimates and

assumptions and are inherently subject to significant uncertainties and contingencies. It can be expected that one or more of the estimates on

which the valuations, opinions, estimates, forecasts, ratings or risk assessments were based will not materialize or will vary significantly from actual

results. Therefore, the inclusion of the valuations, opinions, estimates, forecasts, ratings or risk assessments described herein IS NOT TO BE RELIED

UPON as a representation and/or warranty by the DBS Group (and/or any persons associated with the aforesaid entities), that:

(a) such valuations, opinions, estimates, forecasts, ratings or risk assessments or their underlying assumptions will be achieved, and

(b) there is any assurance that future results or events will be consistent with any such valuations, opinions, estimates, forecasts, ratings or risk

assessments stated therein.

Please contact the primary analyst for valuation methodologies and assumptions associated with the covered companies or price targets.

Any assumptions made in this report that refers to commodities, are for the purposes of making forecasts for the company (or companies)

mentioned herein. They are not to be construed as recommendations to trade in the physical commodity or in the futures contract relating to the

commodity referred to in this report.


Company Guide

POSCO

DBSVUSA, a US-registered broker-dealer, does not have its own investment banking or research department, has not participated in any public

offering of securities as a manager or co-manager or in any other investment banking transaction in the past twelve months and does not engage

in market-making.

ANALYST CERTIFICATION

The research analyst(s) primarily responsible for the content of this research report, in part or in whole, certifies that the views about the

companies and their securities expressed in this report accurately reflect his/her personal views. The analyst(s) also certifies that no part of his/her

compensation was, is, or will be, directly or indirectly, related to specific recommendations or views expressed in the report. The research analyst (s)

primarily responsible for the content of this research report, in part or in whole, certifies that he or his associate1 does not serve as an officer of the

issuer or the new listing applicant (which includes in the case of a real estate investment trust, an officer of the management company of the real

estate investment trust; and in the case of any other entity, an officer or its equivalent counterparty of the entity who is responsible for the

management of the issuer or the new listing applicant) and the research analyst(s) primarily responsible for the content of this research report or

his associate does not have financial interests2 in relation to an issuer or a new listing applicant that the analyst reviews. DBS Group has

procedures in place to eliminate, avoid and manage any potential conflicts of interests that may arise in connection with the production of

research reports. The research analyst(s) responsible for this report operates as part of a separate and independent team to the investment

banking function of the DBS Group and procedures are in place to ensure that confidential information held by either the research or investment

banking function is handled appropriately. There is no direct link of DBS Group's compensation to any specific investment banking function of the

DBS Group.

COMPANY-SPECIFIC / REGULATORY DISCLOSURES

1. DBS Bank Ltd, DBS HK, DBS Vickers Securities (Singapore) Pte Ltd (“DBSVS”), DBSV HK or their subsidiaries and/or other affiliates have a

proprietary position in Angang Steel, as of 31 May 2017.

2. Neither DBS Bank Ltd, DBS HK nor DBSV HK market makes in equity securities of the issuer(s) or company(ies) mentioned in this Research

Report.

Compensation for investment banking services:

3. DBSVUSA does not have its own investment banking or research department, nor has it participated in any public offering of securities as a

manager or co-manager or in any other investment banking transaction in the past twelve months. Any US persons wishing to obtain further

information, including any clarification on disclosures in this disclaimer, or to effect a transaction in any security discussed in this document

should contact DBSVUSA exclusively.

Disclosure of previous investment recommendation produced:

4. DBS Bank Ltd, DBS Vickers Securities (Singapore) Pte Ltd (''DBSVS''), their subsidiaries and/or other affiliates may have published other

investment recommendations in respect of the same securities / instruments recommended in this research report during the preceding 12

months. Please contact the primary analyst listed in the first page of this report to view previous investment recommendations published by

DBS Bank Ltd, DBS Vickers Securities (Singapore) Pte Ltd (''DBSVS''), their subsidiaries and/or other affiliates in the preceding 12 months.

1 An associate is defined as (i) the spouse, or any minor child (natural or adopted) or minor step-child, of the analyst; (ii) the trustee of a trust of which the analyst, his spouse, minor child (natural or adopted) or minor step-child, is a beneficiary or discretionary object; or (iii) another person accustomed or obliged to act in accordance with the directions or instructions of the analyst.

2 Financial interest is defined as interests that are commonly known financial interest, such as investment in the securities in respect of an issuer or a new listing applicant, or financial accommodation arrangement between the issuer or the new listing applicant and the firm or analysis. This term does not include commercial lending conducted at arm's length, or investments in any collective investment scheme other than an issuer or new listing applicant notwithstanding the fact that the scheme has investments in securities in respect of an issuer or a new listing applicant.

ASIAN INSIGHTS VICKERS SECURITIES ed: TH / sa:YM, PY

BUYLast Traded Price ( 27 Jun 2017): KRW58,900 (KOSPI : 2,392.00) Price Target 12-mth: KRW70,000 (19% upside) (Prev KRW67,000)


What’s New • Successful price increase of autosheets from May

shipment to brighten 2H17 earnings outlook

• Robust earnings expected from long steelproducts amid shortage of rebar

• 2Q17 earnings to be in line with our expectation,trading at undemanding valuation

• Retain BUY call, raise TP to KRW70,000

Price Relative

Forecasts and Valuation FY Dec (KRW m) 2015A 2016A 2017F 2018F Revenue 16,133 16,692 18,017 18,771 EBITDA 2,569 2,806 3,041 3,065 Pre-tax Profit 927 1,130 1,383 1,409 Net Profit 734 819 1,002 1,021 Net Pft (Pre Ex.) 734 819 1,002 1,021 Net Pft Gth (Pre-ex) (%) (4.1) 11.6 22.4 1.9 EPS (KRW) 5,866 6,136 7,509 7,651 EPS Pre Ex. (KRW) 5,866 6,136 7,509 7,651 EPS Gth Pre Ex (%) (11) 5 22 2 Diluted EPS (KRW) 5,866 6,136 7,509 7,651 Net DPS (KRW) 750 750 750 750 BV Per Share (KRW) 114,219 120,427 127,796 135,309 PE (X) 10.0 9.6 7.8 7.7 PE Pre Ex. (X) 10.0 9.6 7.8 7.7 P/Cash Flow (X) 2.4 2.7 3.5 3.1 EV/EBITDA (X) 6.8 6.0 5.3 5.0 Net Div Yield (%) 1.3 1.3 1.3 1.3 P/Book Value (X) 0.5 0.5 0.5 0.4 Net Debt/Equity (X) 0.6 0.5 0.5 0.4 ROAE (%) 5.1 5.2 6.1 5.8 Earnings Rev (%): 15 11 Consensus EPS (KRW): 7,526 7,495 Other Broker Recs: B: 30 S: 0 H: 5

Source of all data on this page: Company, DBS Bank, Bloomberg Finance L.P

Too cheap to ignore Retain BUY call, raise TP to KRW70,000 on price increase of autosheets. In the beginning of June, the company successfully negotiated with Hyundai Motor Group to raise its autosheet prices by KRW60,000/ton (c.7%) retrospectively from May shipment. We think this price hike is positive albeit below initial expectations, as the increased prices will be maintained until January 2018. We expect margin expansion on autosheets to be larger than price increase as raw material cost is estimated to decline US$40/ton in 3Q17 from the previous quarter. This will drive earnings growth in 2H17 as the segment contributes over 50% of the company's operating profit. Hence, we revise up our FY17F EPS by 15% and raise TP to KRW70,000.

Where we defer: Resilient earnings from long steel products. Backed by strong property prices, the pre-sales of new apartments have been growing strongly for the last three years. Although the new government announced policy measures to regulate speculative demand in some areas, the long-term supply of public rental houses should increase. Also, the decline in import of long steel products from China will support the company's sales volume and margins. We expect earnings from long steel products to be sustainable, contrary to market concerns for a sharp drop. The Korean rebar market is currently experiencing a supply shortage amid historical low inventory, leading to an increase in prices.

Where we defer: Concerns on weak car sales of Hyundai Motor Group to resurface. The company’s high sales exposure to long-term customers, such as Hyundai Motor Group, has impacted negatively on its share price given that i) selling prices are set on a quarterly or bi-yearly basis, which does not bode well for near-term earnings despite increase in spot steel prices, and ii) weak car sales performance of Hyundai Motor Group raises concerns on its sales volume. The group's car sales should bottom out with the launch of new car models.

Valuation: Our TP of KRW70,000 is pegged to 0.55x FY17F P/BV, based on its historical average multiple for the last two years, which reflects expectations of low ROEs in FY17F/18F, similar to those achieved in FY15/FY16 under weak fundamentals. Our target P/BV implies a 30% discount to the regional peer average.

Key Risks to Our View: Declining shipments of autosheet products to the Hyundai Motor Group due to sluggish auto sales would be a key risk. The further delay in the normalisation of new specialty steel bar plant is also a key risk.

At A Glance Issued Capital (m shrs) 133 Mkt. Cap (KRWbn/US$m) 7,860 / 6,891 Major Shareholders (%) KIA Motors Corp 17.3 Mong-Koo Chung 11.8 National Pension Service 7.7

Free Float (%) 50.7 3m Avg. Daily Val (US$m) 21.7 ICB Industry : Basic Materials / Industrial Metals & Mining

DBS Group Research . Equity

28 Jun 2017

Regional Korea Company Guide

Hyundai Steel Co. Version 7 | Bloomberg: 004020 KS | Reuters: 004020.KS Refer to important disclosures at the end of this report


Company Guide

Hyundai Steel Co.

WHAT’S NEW

Autosheet price hikes brighten 2H17 earnings outlook.

Successful price increase of auto sheets. In the beginning of June, the company successfully negotiated with Hyundai Motor Group to raise its autosheet prices by KRW60,000/ton (c 7%) retrospectively from May shipment. We think this price hike is positive albeit below initial expectations, as the increased prices will be maintained until January 2018. We expect margin expansion on autosheets to be larger than increase in prices as raw material cost is estimated to decline US$40/ton in 3Q17 compared to the previous quarter. Hence, this will drive earnings growth in 2H17 as the segment contributes over 50% of the company's operating profit. Meanwhile, 2Q17 earnings are expected to be in line with both our/market estimates as the increased raw material cost will be partially offset by autosheet price hike. We estimate an operating profit of KRW392bn, down by 9.2% y-o-y and up by 12.2% q-o-q.

Resilient earnings from long steel products backed by shortage. Backed by strong property prices, the number of new residential launches has been resilient for the last three years. The presales of new apartments in Korea registered 470,000 units in 2015 and 420,000 units in 2016, much higher than the average of 250,000 units recorded in the previous five years. In 2017, the presales of new apartments are likely to decline to 300,000 units but there should be growth in the refurbishment and rebuilding of outdated apartments. Although, the new government recently announced the policy measure to regulate speculative demand in some areas, the long-term supply of public rental houses will increase. Also, the decline in import of long steel products from China will

support the company's sales volume and margins. We expect earnings from long steel products to be sustainable, contrary to market concerns of a sharp drop. The Korean rebar market is currently experiencing a supply shortage amid historical low inventory (120,000 ton, or 1% of annual consumption), leading to an increase in prices.

Concerns on weak car sales of Hyundai Motor Group to resurface. The company’s high sales exposure to long-term customers, such as Hyundai Motor Group, has impacted negatively on its share price given that i) selling prices are set on a quarterly or bi-yearly basis, which does not bode well for near-term earnings despite increase in spot steel prices, and ii) weak car sales performance of Hyundai Motor Group raises concerns on its sales volume. The group's car sales should bottom out with the launch of new car models.

Retain BUY call, raise TP to KRW70,000. Imputing autosheet prices hikes, we revise up our FY17F EPS by 15% and raise TP to KRW70,000. Our TP is pegged to 0.55x FY17F P/BV, based on its historical average multiple for the last two years, and reflects expectations of low ROEs in FY17F/18F, similar to those achieved in FY15/FY16 under weak fundamentals. Our target P/BV implies a 30% discount to the regional peer average. The stock is currently trading at only 0.45x P/BV, which is at its historical low end.

Quarterly Income Statement forecasts(KRWbn)

1Q16 2Q16 3Q16 4Q16 1Q17 2Q17F 3Q17F 4Q17F

Revenue 3,744 4,226 4,063 4,659 4,574 4,594 4,360 4,488

Operating profit 269 432 356 387 350 392 393 426

Pretax profit 208 350 404 168 457 303 326 297

Net profit 159 255 301 120 341 210 238 231

OP margins 7.2% 10.2% 8.8% 8.3% 7.6% 8.5% 9.0% 9.5%

Pretax margins 5.6% 8.3% 9.9% 3.6% 10.0% 6.6% 7.5% 6.6%

Net margins 4.2% 6.0% 7.4% 2.6% 7.5% 4.6% 5.5% 5.2%

Source of all data: Company, DBS Bank


Company Guide

Hyundai Steel Co.

Hyundai Steel : total sales volume & ASP Hyundai Steel: long steel products’ sales volume & ASP


Hyundai Steel CRC sales volume & ASP Hyundai Steel HRC volume & ASP


Korea : Rebar prices vs spread Korea : H beam prices vs spread

Spread = rebar price (or H Beam price) – steel scrap prices Source: Steeldaily, DBS Bank

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Company Guide

Hyundai Steel Co.

CRITICAL FACTORS TO WATCH

Steel prices/steel spread have been a key critical factor for share prices. Obviously, steel prices are the most critical factor for its earnings and the spread between steel and iron ore prices has also strongly explained its share price movements. Following the fall in iron ore and steel prices in mid-March, steel spread had been on a downtrend until the end of April. Despite the persistently weak raw material prices, global HRC prices have fallen less – as a result, the steel spread has not narrowed significantly compared to 1Q17. Accordingly, its margins in 2Q17 are likely to be intact and expected to improve in 2H17 due to reduction in raw material prices.

Sales volume and prices of autosheets. Cold rolled sheets (of which c. 88% are autosheets) contribute 40% and 50% to the revenue and operating profit of the parent company respectively. The segment contributes over 50% of the parent company’s operating profit, hence autosheet prices and sales volume should be key catalysts for its earnings. Unfortunately, the company does not disclose the prices for autosheet but we note that the autosheet prices follow the spot prices, usually lagging by a quarter. The market is concerned about the company's high dependency on Hyundai Motor Group for autosheet sales. In response, the company is trying to diversify its client base and targets to export 1m ton to its other clients by 2020. The sales growth of autosheets to other clients would be the indicator to ease market concerns.

Long steel product prices with construction activities. Long steel products account for 28.7% (rebar 10%, H beam 9.7%) of the parent's revenue in 2016. The demand for long steel is mainly determined by the Korean construction business cycle and imports from China. The domestic prices of long steel have been in line with regional rebar prices, especially the Chinese rebar prices. We can also refer to leading indicators for construction activities, such as permitted area for building and construction orders, to gauge future demand.

Mergers to drive sustainable earnings growth. A series of mergers and acquisitions during the last three years will help boost earnings: i) Hysco, ii) Hyundai Special Steel (Dongbu Special Steel previously), and iii) large-sized forged products segment (formerly SPP Yulchon Energy) and new plants (special steel bar plant / #2 & #3 CGL [continuous galvanising line]). Currently, only Hysco and Hyundai Special Steel are contributing to group earnings and we expect the specialty steel bar business to incur losses in 2017. However, this business segment is likely to register profits from 2018 onwards. Meanwhile, Hyundai Steel is expected to divest a 5.66% stake in Hyundai Mobis (worth KRW1.4tr based on current share price), to reduce its debt (KRW8.5tr as at end-2016).

Construction investment(KRW tr)

Auto production(k units)

Sales volume

ASP of flat steel products

ASP of long steel products



Company Guide

Hyundai Steel Co.

What drives its share price?

Hyundai Steel share prices vs. World steel spread Remark Overall, Hyundai Steel’s share price has been in line with the steel price index and steel spread. Despite recent improvement in steel prices and spread, the company's share price performance is lagging behind its fundamental improvement.


Hyundai Steel share prices vs. CRC price Remark Hyundai Steel’s share price is strongly correlated with Korean domestic CR sheet prices, which is expected as CR sheets account for 40% of its revenue and over 50% of its operating profit based on the parent company.


Hyundai Steel share prices vs. China Rebar prices Remark As long steel products account for 28.7% (of which rebar accounts for 10%) of the parent revenue in 2016, rebar prices should be a key indicator for its earnings and share price.


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Company Guide

Hyundai Steel Co.

Balance Sheet: Healthy financials, deleveraging on the way. Hyundai Steel’s net gearing ratio fell from 0.81x in FY13 to 0.53x in FY16 despite a series of M&As. We expect the company’s net gearing ratio to decline to 0.46x in FY17F. While its asset turnover should improve as major capex would be completed by the end of FY15, with revenue from these investments flowing in from FY16 onwards. Also, its operating cash flow is estimated to improve gradually as its capex will decline to KRW1.3tr in FY17 from KRW2tr in FY16 following the completion of major investments.

Share Price Drivers: Undemanding valuation. Currently, the stock is trading at an undemanding P/BV valuation of 0.45x for 17F. Although FY17F ROE is estimated to be 6.1%, which is lower than the KOSPI average ROE of 8.8%, Hyundai Steel’s shares are currently trading at a significant discount to its peers; the material sector in emerging markets is trading at 15x PE and 0.9x P/BV for FY17F. In addition, the stock is also trading below the low end of its historical trading band despite street expectations of an improvement in earnings.

Sales price hikes and capacity cuts in China. Catalysts should come from improving economic indicators and rising steel prices in China. It is also a key beneficiary of the reduction of overcapacity in China. The sales price hike in auto sheets should be the most crucial catalyst as it significantly contributes to revenue and earnings.

Key Risks: Chinese imported steel products have been a threat to Korea’s steel sector as Korea is the biggest export market for Chinese steel products. For H-beams, Hyundai Steel has succeeded in its anti-dumping lawsuit against such imported products from China. As a result, Chinese H-beam imported products have been slapped with 28.2-32.7% anti-dumping tariffs for the last five years. However, we believe that this measure may not apply to all products. On the other hand, potential anti-dumping lawsuit against its exported products to the overseas market by its competitors is also a major risk as c.28% of the company's sales volume is exported. Also, the sharp contraction in steel demand and falling prices are key risks, which may occur in the event of a hard landing in the Chinese economy.

Company Background Hyundai Steel is the second-largest steel maker in Korea and is ranked the 14th largest mill globally with an annual capacity of 24m tons. It was established as Korea’s first steel maker in 1953 and has grown to be the leading long steel maker in Korea. In 2004, it merged with Hanbo Steel and constructed an integrated steel mill in October 2006 in Dangjin, with a capacity of 12m tons p.a. of flat steel including three blast furnaces. It subsequently merged with the cold rolling division of Hyundai Hysco in December 2013 and the entire Hyundai Hysco in July 2015. It is the biggest long steel provider with 37% market share for long steel products and the second-largest flat steel supplier with 34% market share in 2016.

Leverage & Asset Turnover (x)

Capital Expenditure

ROE (%)

Forward PE Band (x)

PB Band (x)



Company Guide

Hyundai Steel Co.

Key Assumptions

FY Dec 2014A 2015A 2016A 2017F 2018F

Construction investment(KRW tr) 199 212 234 252 259 Auto production(k units) 4,525 4,556 4,229 4,293 4,379 Sales volume 19,445 19,926 20,600 21,027 21,027 ASP of flat steel products 813 736 712 796 811 ASP of long steel products 724 676 656 676 725

Segmental Breakdown FY Dec 2014A 2015A 2016A 2017F 2018F

Revenues (KRWbn) Flat steel products 9,929 8,991 8,688 9,835 10,150 Long steel products 4,483 4,565 4,798 5,261 5,868 Stainless 223 207 216 230 242 Heavy Industries/pipes/others 1,398 1,098 988 1,115 1,148

Others 0.0 1,300 2,000 2,800 3,980 Total 16,762 16,133 16,692 18,017 18,771 Sales volume (k ton) Flat steel products 12,214 12,213 12,209 12,356 12,517 Long steel products 6,196 6,757 7,319 7,784 8,090 Stainless 82.0 83.0 92.0 91.0 93.0 Heavy Industries/pipes/others

953 873 980 796 495

Total 19,445 19,926 20,600 21,027 21,195 ASP(k KRW/ton) Flat steel products 81,292.0 73,616.7 71,163.1 79,592.0 81,088.2 Long steel products 72,353.1 67,556.3 65,552.2 67,582.9 72,534.2 Stainless 271,341.5 249,638.6 234,565.2 252,195.9 261,008.5 Heavy Industries/pipes/others 146,726.1 125,715.9 100,795.9 140,107.3 232,121.7

Income Statement (KRWbn)

FY Dec 2014A 2015A 2016A 2017F 2018F Revenue 16,762 16,133 16,692 18,017 18,771 Cost of Goods Sold (14,442) (13,702) (14,231) (15,361) (16,022) Gross Profit 2,321 2,431 2,461 2,656 2,748 Other Opng (Exp)/Inc (830) (966) (1,016) (1,095) (1,140) Operating Profit 1,491 1,464 1,445 1,561 1,609 Other Non Opg (Exp)/Inc (13.0) (190) (49.0) 71.0 30.0 Associates & JV Inc 12.0 9.00 10.0 10.0 10.0 Net Interest (Exp)/Inc (402) (374) (304) (287) (267) Exceptional Gain/(Loss) 0.0 0.0 0.0 0.0 0.0 Pre-tax Profit 1,099 927 1,130 1,383 1,409 Tax (316) (188) (296) (363) (369) Minority Interest (18.0) (6.0) (16.0) (19.0) (19.0) Preference Dividend 0.0 0.0 0.0 0.0 0.0 Net Profit 765 734 819 1,002 1,021 Net Profit before Except. 765 734 819 1,002 1,021 EBITDA 2,672 2,569 2,806 3,041 3,065 Growth Revenue Gth (%) 23.9 (3.8) 3.5 7.9 4.2 EBITDA Gth (%) 57.1 (3.9) 9.3 8.4 0.8 Opg Profit Gth (%) 95.5 (1.8) (1.3) 8.1 3.0 Net Profit Gth (Pre-ex) (%) 10.5 (4.1) 11.6 22.4 1.9 Margins & Ratio Gross Margins (%) 13.8 15.1 14.7 14.7 14.6 Opg Profit Margin (%) 8.9 9.1 8.7 8.7 8.6 Net Profit Margin (%) 4.6 4.5 4.9 5.6 5.4 ROAE (%) 5.7 5.1 5.2 6.1 5.8 ROA (%) 2.6 2.4 2.5 3.1 3.1 ROCE (%) 4.2 4.5 4.0 4.3 4.4 Div Payout Ratio (%) 11.4 13.6 12.2 10.0 9.8 Net Interest Cover (x) 3.7 3.9 4.8 5.4 6.0



Company Guide

Hyundai Steel Co.

Quarterly / Interim Income Statement (KRWbn)

FY Dec 1Q2016 2Q2016 3Q2016 4Q2016 1Q2017

Revenue 3,744 4,226 4,063 4,659 4,574 Cost of Goods Sold (3,228) (3,535) (3,466) (4,002) (3,960) Gross Profit 516 691 597 657 614 Other Oper. (Exp)/Inc (247) (259) (241) (269) (265) Operating Profit 269 432 356 387 350 Other Non Opg (Exp)/Inc 18.0 (6.0) 117 (150) 171 Associates & JV Inc 4.00 2.00 3.00 0.0 6.00 Net Interest (Exp)/Inc (84.0) (78.0) (73.0) (69.0) (69.0) Exceptional Gain/(Loss) 0.0 0.0 0.0 0.0 0.0 Pre-tax Profit 208 350 404 168 457 Tax (49.0) (96.0) (103) (48.0) (116)

Net Profit 160 244 301 120 341 Net profit bef Except. 160 244 301 120 341 EBITDA 633 774 827 588 884

Growth Revenue Gth (%) (13.0) 12.9 (3.8) 14.6 (1.8) EBITDA Gth (%) (17.1) 22.3 6.9 (28.9) 50.2 Opg Profit Gth (%) (25.3) 60.5 (17.6) 8.7 (9.7) Net Profit Gth (Pre-ex) (%) (39.8) 52.4 23.5 (60.0) 183.8 Margins Gross Margins (%) 13.8 16.4 14.7 14.1 13.4 Opg Profit Margins (%) 7.2 10.2 8.8 8.3 7.6 Net Profit Margins (%) 4.3 5.8 7.4 2.6 7.5

Balance Sheet (KRWbn) FY Dec 2014A 2015A 2016A 2017F 2018F

Net Fixed Assets 19,572 21,411 21,645 22,011 22,298 Invts in Associates & JVs 116 116 116 126 136 Other LT Assets 3,125 3,743 3,833 3,728 3,634 Cash & ST Invts 886 1,034 921 794 937 Inventory 2,954 3,287 3,408 3,678 3,832 Debtors 2,166 2,257 2,376 2,565 2,672 Other Current Assets 115 89.0 90.0 90.0 91.0 Total Assets 28,934 31,936 32,389 32,993 33,601

ST Debt 1,866 1,893 1,106 1,106 1,106 Creditor 1,982 2,554 2,945 3,247 3,533 Other Current Liab 2,037 2,210 2,763 2,763 2,763 LT Debt 8,554 9,004 8,415 7,715 7,015 Other LT Liabilities 680 755 798 798 798 Shareholder’s Equity 13,624 15,242 16,070 17,054 18,056 Minority Interests 191 278 293 312 331 Total Cap. & Liab. 28,934 31,936 32,389 32,993 33,601

Non-Cash Wkg. Capital 1,215 869 166 325 300 Net Cash/(Debt) (9,534) (9,864) (8,599) (8,026) (7,183) Debtors Turn (avg days) 47.2 50.0 50.7 50.1 50.9 Creditors Turn (avg days) 59.4 66.6 78.1 80.9 84.7 Inventory Turn (avg days) 84.7 91.6 95.1 92.6 93.8 Asset Turnover (x) 0.6 0.5 0.5 0.6 0.6 Current Ratio (x) 1.0 1.0 1.0 1.0 1.0 Quick Ratio (x) 0.5 0.5 0.5 0.5 0.5 Net Debt/Equity (X) 0.7 0.6 0.5 0.5 0.4 Net Debt/Equity ex MI (X) 0.7 0.6 0.5 0.5 0.4 Capex to Debt (%) 10.1 20.3 20.8 18.7 19.7 Z-Score (X) 1.5 1.4 1.5 1.6 1.6



Company Guide

Hyundai Steel Co.

Cash Flow Statement (KRWbn)

FY Dec 2014A 2015A 2016A 2017F 2018F

Pre-Tax Profit 1,099 927 1,130 1,383 1,409 Dep. & Amort. 1,189 1,274 1,388 1,389 1,407 Tax Paid (540) (477) (224) (363) (369) Assoc. & JV Inc/(loss) (12.0) (10.0) (10.0) (10.0) (10.0) Chg in Wkg.Cap. (303) 902 490 (240) (22.0) Other Operating CF 504 450 (41.0) (106) (106) Net Operating CF 1,937 3,066 2,917 2,241 2,497 Capital Exp.(net) (1,054) (2,217) (1,976) (1,650) (1,600) Other Invts.(net) 311 (55.0) (138) 0.0 0.0 Invts in Assoc. & JV 0.0 0.0 0.0 0.0 0.0 Div from Assoc & JV 0.0 0.0 0.0 0.0 0.0 Other Investing CF (388) 77.0 131 40.0 36.0 Net Investing CF (1,131) (2,195) (1,983) (1,610) (1,564) Div Paid (58.0) (88.0) (98.0) (98.0) (98.0) Chg in Gross Debt (817) (544) (919) (700) (700) Capital Issues 0.0 0.0 0.0 0.0 0.0 Other Financing CF 0.0 (114) 7.00 40.0 6.00 Net Financing CF (876) (746) (1,010) (758) (793) Currency Adjustments 0.0 0.0 (7.0) 0.0 0.0 Chg in Cash (70.0) 125 (83.0) (127) 140 Opg CFPS (KRW) 19,218 17,300 18,182 18,593 18,874 Free CFPS (KRW) 7,574 6,788 7,051 4,430 6,719


Target Price & Ratings History

Source: DBS Bank

Analyst: Lee Eun Young


Company Guide

Hyundai Steel Co.

DBS Bank recommendations are based an Absolute Total Return* Rating system, defined as follows:








Sources for all charts and tables are DBS Bank unless otherwise specified.


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Company Guide

Hyundai Steel Co.



in market-making.














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COMPANY-SPECIFIC / REGULATORY DISCLOSURES

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Report.











1 An associate is defined as (i) the spouse, or any minor child (natural or adopted) or minor step-child, of the analyst; (ii) the trustee of a trust of which the analyst, his spouse, minor child (natural or adopted) or minor step-child, is a beneficiary or discretionary object; or (iii) another person accustomed or obliged to act in accordance with the directions or instructions of the analyst.


ASIAN INSIGHTS VICKERS SECURITIESed-TH / sa- AH

H: BUY

Last Traded Price (H) ( 28 Jun 2017):HK$5.59 (HSI : 25,684) Price Target 12-mth (H): HK$7.35 (31% upside) (Prev HK$7.25)

A: BUY

Last Traded Price (A) ( 28 Jun 2017):RMB5.67 (CSI300 Index : 3,646) Price Target 12-mth (A): RMB7.06 (24% upside) (Prev RMB7.15) Potential Catalyst: Upbeat 2Q17 results Where we differ: Our FY17/18F EBITDA are 9.3%/16% above consensus on steel selling price assumptions Analyst Addison Dai +852 2971 1931 [email protected]

Price Relative

Forecasts and Valuation FY Dec (RMB m) 2015A 2016A 2017F 2018FTurnover 52,759 57,882 75,192 77,275 EBITDA 1,508 6,357 9,092 10,258 Pre-tax Profit (3,763) 1,620 3,376 4,465 Net Profit (4,593) 1,616 2,524 3,338 Net Pft (Pre Ex) (core profit) (4,593) 1,616 2,524 3,338

Net Profit Gth (Pre-ex) (%)

N/A N/A 56.2 32.3

EPS (RMB) (0.63) 0.22 0.35 0.46 EPS (HK$) (0.73) 0.26 0.40 0.53 Core EPS (HK$) (0.73) 0.26 0.40 0.53 Core EPS (RMB) (0.63) 0.22 0.35 0.46 EPS Gth (%) N/A N/A 56.2 32.3 Core EPS Gth (%) N/A N/A 56.2 32.3 Diluted EPS (HK$) (0.73) 0.26 0.40 0.53 DPS (HK$) 0.00 0.08 0.12 0.16 BV Per Share (HK$) 6.86 7.12 7.40 7.76 PE (X) nm 21.9 14.0 10.6 Core PE (X) nm 21.9 14.0 10.6 P/Cash Flow (X) 6.9 8.1 8.4 4.3 P/Free CF (X) 26.5 11.9 29.1 6.8 EV/EBITDA (X) 32.8 8.5 5.9 4.8 Net Div Yield (%) 0.0 1.4 2.1 2.8 P/Book Value (X) 0.8 0.8 0.8 0.7 Net Debt/Equity (X) 0.3 0.4 0.4 0.3 ROAE (%) (10.1) 3.7 5.5 7.0 Earnings Rev (%): 43 23 Consensus EPS (RMB) 0.338 0.403 Other Broker Recs: B: 13 S: 3 H: 2

Source of all data on this page: Company, DBSV, Thomson Reuters, HKEX

Well worth a look HRC prices are recovering from end-April’s low. A steep correction in hot rolling coil prices since March was mainly due to: i) some demand shock as backlog of orders of auto and home appliances in March-April came weaker-than-expected; ii) steel inventory continued to pile up after CNY holidays before peaked in April; and iii) temporary liquidity crunch in end-March as the banking industry implemented Macro Prudential Assessment rules. Since end-April, HRC prices have recovered due to dwindled social inventory and stabilised demand.

Expect upbeat 2Q. Despite the 13.9% q-o-q decline in HRC spot market prices in 2Q17, HRC steel spread has been improving sequentially in May and June, as raw material prices weakened further q-o-q (iron ore: -26.5% q-o-q; coking coal: -3% q-o-q; scrap: -9.8% q-o-q). We estimate that HRC steel spread was Rmb1,337/t in June and Rmb1,145/t in May, versus Rmb1,031/t in April. For Angang, we forecast that average steel selling prices in 2Q17 have decreased by a small 5% q-o-q given the company’s superior product quality against its peers. As such, we forecast 2Q17 net profit of Rmb806m. This leads us to revise 2017F unit steel GP to Rmb472/t from Rmb406/t previously. We have upgraded FY17F earnings to Rmb2,524mn vs Rmb1,762mn previously.

Profitability outlook is more stabilised in 2H17. This is premised on usually stricter environmental closure in the second half of the year, which should support steel selling prices. Meanwhile, we expect raw material (iron ore, coking coal and scrap) are unlikely to add to steel business margin pressure, as the supply surplus of raw material is worse than that of steel. Valuation: Angang-H’s TP hiked to HK$7.35, Angang-A TP revised to Rmb7.06. Our new TP primarily reflects book value upgrade. We have upgraded FY17F earnings to Rmb2,524m vs Rmb1,762m previously. Nevertheless, we fine-tune our target valuation to 1.0x P/BV versus 1.1x previously, to reflect a seasonal volatility in steel profitability. Currently trading at 0.76x FY17 P/BV, in context of an average 0.7x during 2012-15’s commodity doom and 1.2x during 2004-11’s commodity boom, we think the valuation is attractive to accumulate. Key Risks to Our View:

China’s monetary policy to tighten further.

At A Glance Issued Capital - H shares (m shs) 1,086 - Non H shares (m shs) 6,149 H shs as a % of Total 15 Total Mkt. Cap (HK$m/US$m) 46,003 / 5,897 Major Shareholders

Angang Holding (%) 67.3 Major H Shareholders (%)

NIL (%) H Shares-Free Float (%) 100.0 3m Avg. Daily Val. (US$m) 10.6 ICB Industry : Basic Materials / Industrial Metals

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Relative IndexHK$

Angang Steel (LHS) Relative HSI (RHS)

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207

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Relative IndexRMB

Angang Steel-A (LHS) Relative CSI300 Index (RHS)

DBS Group Research . Equity 29 Jun 2017

China / Hong Kong

Angang Steel Bloomberg: 347 HK EQUITY | 000898 CH Equity | Reuters: 0347.HK | 000898.SZ

Refer to important disclosures at the end of this report


Industry Focus

Angang Steel

Income Statement (RMB m) Balance Sheet (RMB m)

FY Dec 2015A 2016A 2017F 2018F FY Dec 2015A 2016A 2017F 2018F Turnover 52,759 57,882 75,192 77,275 Net Fixed Assets 53,866 51,297 50,158 49,083 Cost of Goods Sold (49,693) (50,457) (65,875) (66,705) Invts in Assocs & JVs 0 0 0 0 Gross Profit 3,066 7,425 9,317 10,570 Other LT Assets 11,135 11,096 8,723 8,723 Other Opg (Exp)/Inc (4,119) (3,554) (4,662) (4,791) Cash & ST Invts 3,601 1,968 1,698 4,105 Operating Profit (1,053) 3,871 4,655 5,779 Inventory 8,008 10,466 13,636 13,808 Other Non Opg (Exp)/Inc (1,364) (965) 392 403 Debtors 9,434 10,294 13,384 13,755 Associates & JV Inc 0 0 0 0 Other Current Assets 2,552 2,948 0 0 Net Interest (Exp)/Inc (1,346) (1,286) (1,671) (1,717) Total Assets 88,596 88,069 87,600 89,473 Dividend Income 0 0 0 0Exceptional Gain/(Loss) 0 0 0 0 ST Debt 16,319 18,995 13,500 11,381 Pre-tax Profit (3,763) 1,620 3,376 4,465 Other Current Liab 26,685 17,794 20,273 21,910 Tax (837) (5) (844) (1,116) LT Debt 962 1,296 5,791 5,910 Minority Interest 7 1 (8) (11) Other LT Liabilities 949 4,696 950 950 Preference Dividend 0 0 0 0 Shareholder’s Equity 43,274 44,882 46,688 48,935 Net Profit (4,593) 1,616 2,524 3,338 Minority Interests 407 406 398 387 Net profit before Except. (4,593) 1,616 2,524 3,338 Total Cap. & Liab. 88,596 88,069 87,600 89,473 EBITDA 1,508 6,357 9,092 10,258 Sales Gth (%) (28.7) 9.7 29.9 2.8 Non-Cash Wkg. Cap (6,691) 5,914 6,747 5,653 EBITDA Gth (%) (77.9) 321.6 43.0 12.8 Net Cash/(Debt) (13,680) (18,323) (17,593) (13,186) Opg Profit Gth (%) (124.6) (467.6) 20.2 24.2 Effective Tax Rate (%) N/A 0.3 25.0 25.0 Cash Flow Statement (RMB m) Key Assumptions

FY Dec 2015A 2016A 2017F 2018F FY Dec 2015A 2016A 2017F 2018F Pre-Tax Profit (3,763) 1,620 3,376 4,465 Key Assumptions Dep. & Amort. 3,925 3,451 4,045 4,076 Output of finished steel

products (Mt) 19.1 19.9 19.7 19.9

Tax Paid 0 0 0 0 Assoc. & JV Inc/(loss) 0 0 0 0 Sales volume of finished

steel products 19.1 19.9 19.7 19.9

(Pft)/ Loss on disposal of FAs 0 0 0 0 Chg in Wkg.Cap. 3,974 (1,590) (3,206) (378) Steel ASP (Rmb/t) 2,762.3 2,902.4 3,810.4 3,886.6 Other Operating CF 1,001 868 0 0 Unit gross profit (Rmb/t) 160.5 372.3 472.1 531.6 Net Operating CF 5,137 4,349 4,215 8,164 Capital Exp.(net) (3,807) (1,393) (3,000) (3,000) Other Invts.(net) 0 0 0 0 Invts in Assoc. & JV 0 0 0 0 Div from Assoc & JV 0 0 0 0 Other Investing CF 1,079 843 0 0 Net Investing CF (2,728) (550) (3,000) (3,000) Div Paid (1,782) (1,303) (485) (757) Chg in Gross Debt 1,262 (4,107) (1,000) (2,000) Capital Issues 0 0 0 0 Other Financing CF 4 (3) 0 0 Net Financing CF (516) (5,413) (1,485) (2,757) Currency Adjustments 0 0 0 0 Chg in Cash 1,893 (1,614) (270) 2,406

Source: Company, DBS Vickers




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DBS Bank and DBS Vickers (Hong Kong) Limited recommendations are based an Absolute Total Return* Rating system, defined as follows:








Sources for all charts and tables are DBS Bank and DBS Vickers unless otherwise specified.


This report is prepared by DBS Bank Ltd and DBS Vickers (Hong Kong) Limited (“DBSV HK”). This report is solely intended for the clients of DBS

Bank Ltd., DBS Bank, (Hong Kong) Limited (DBS HK), DBSV HK, and DBS Vickers Securities (Singapore) Pte Ltd. (“DBSVS”), its respective connected

and associated corporations and affiliates only and no part of this document may be (i) copied, photocopied or duplicated in any form or by any

means or (ii) redistributed without the prior written consent of DBS Bank Ltd and DBSV HK.


Bank Ltd, DBS HK, DBSV HK, DBSVS, its respective connected and associated corporations, affiliates and their respective directors, officers,

employees and agents (collectively, the “DBS Group”) have not conducted due diligence on any of the companies, verified any information or

sources or taken into account any other factors which we may consider to be relevant or appropriate in preparing the research. Accordingly, we

do not make any representation or warranty as to the accuracy, completeness or correctness of the research set out in this report. Opinions

expressed are subject to change without notice. This research is prepared for general circulation. Any recommendation contained in this document

does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. This document is

for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain

separate independent legal or financial advice. The DBS Group accepts no liability whatsoever for any direct, indirect and/or consequential loss

(including any claims for loss of profit) arising from any use of and/or reliance upon this document and/or further communication given in relation

to this document. This document is not to be construed as an offer or a solicitation of an offer to buy or sell any securities. The DBS Group, along

with its affiliates and/or persons associated with any of them may from time to time have interests in the securities mentioned in this document.

The DBS Group, may have positions in, and may effect transactions in securities mentioned herein and may also perform or seek to perform

broking, investment banking and other banking services for these companies.




















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in market-making.














DBS Group. COMPANY-SPECIFIC / REGULATORY DISCLOSURES

1. DBS Bank Ltd, DBS HK, DBS Vickers Securities (Singapore) Pte Ltd (''DBSVS''), DBSV HK or their subsidiaries and/or other affiliates have a

proprietary position in Angang Steel recommended in this report as of 31 May 2017.


Report.











1 An associate is defined as (i) the spouse, or any minor child (natural or adopted) or minor step-child, of the analyst; (ii) the trustee of a trust of

which the analyst, his spouse, minor child (natural or adopted) or minor step-child, is a beneficiary or discretionary object; or (iii) another person accustomed or obliged to act in accordance with the directions or instructions of the analyst.





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RESTRICTIONS ON DISTRIBUTION

General This report is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation.

Australia This report is being distributed in Australia by DBS Bank Ltd. (“DBS”) or DBS Vickers Securities (Singapore) Pte Ltd (“DBSVS”), both of which are exempted from the requirement to hold an Australian Financial Services Licence under the Corporation Act 2001 (“CA”) in respect of financial services provided to the recipients. Both DBS and DBSVS are regulated by the Monetary Authority of Singapore under the laws of Singapore, which differ from Australian laws. Distribution of this report is intended only for “wholesale investors” within the meaning of the CA.

Hong Kong This report has been prepared by a person(s) who is not licensed by the Hong Kong Securities and Futures Commission to carry on the regulated activity of advising on securities in Hong Kong pursuant to the Securities and Futures Ordinance (Chapter 571 of the Laws of Hong Kong). This report is being distributed in Hong Kong and is attributable to DBS Vickers Hong Kong Limited, a licensed corporation licensed by the Hong Kong Securities and Futures Commission to carry on the regulated activity of advising on securities pursuant to the Securities and Futures Ordinance (Chapter 571 of the Laws of Hong Kong).

For any query regarding the materials herein, please contact Paul Yong (CE. No. ASE988) at [email protected].

Indonesia This report is being distributed in Indonesia by PT DBS Vickers Sekuritas Indonesia.

Malaysia This report is distributed in Malaysia by AllianceDBS Research Sdn Bhd ("ADBSR"). Recipients of this report, received from ADBSR are to contact the undersigned at 603-2604 3333 in respect of any matters arising from or in connection with this report. In addition to the General Disclosure/Disclaimer found at the preceding page, recipients of this report are advised that ADBSR (the preparer of this report), its holding company Alliance Investment Bank Berhad, their respective connected and associated corporations, affiliates, their directors, officers, employees, agents and parties related or associated with any of them may have positions in, and may effect transactions in the securities mentioned herein and may also perform or seek to perform broking, investment banking/corporate advisory and other services for the subject companies. They may also have received compensation and/or seek to obtain compensation for broking, investment banking/corporate advisory and other services from the subject companies.

Wong Ming Tek, Executive Director, ADBSR

Singapore This report is distributed in Singapore by DBS Bank Ltd (Company Regn. No. 196800306E) or DBSVS (Company Regn No.

198600294G), both of which are Exempt Financial Advisers as defined in the Financial Advisers Act and regulated by the Monetary Authority of Singapore. DBS Bank Ltd and/or DBSVS, may distribute reports produced by its respective foreign entities, affiliates or other foreign research houses pursuant to an arrangement under Regulation 32C of the Financial Advisers Regulations. Where the report is distributed in Singapore to a person who is not an Accredited Investor, Expert Investor or an Institutional Investor, DBS Bank Ltd accepts legal responsibility for the contents of the report to such persons only to the extent required by law. Singapore recipients should contact DBS Bank Ltd at 6327 2288 for matters arising from, or in connection with the report.

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This report is produced by DBS Bank Ltd which is regulated by the Monetary Authority of Singapore. This report is disseminated in the United Kingdom by DBS Vickers Securities (UK) Ltd, ("DBSVUK"). DBSVUK is authorised and regulated by the Financial Conduct Authority in the United Kingdom. In respect of the United Kingdom, this report is solely intended for the clients of DBSVUK, its respective connected and associated corporations and affiliates only and no part of this document may be (i) copied, photocopied or duplicated in any form or by any means or (ii) redistributed without the prior written consent of DBSVUK. This communication is directed at persons having professional experience in matters relating to investments. Any investment activity following from this communication will only be engaged in with such persons. Persons who do not have professional experience in matters relating to investments should not rely on this communication.

Dubai

This research report is being distributed by DBS Bank Ltd., (DIFC Branch) having its office at PO Box 506538, 3rd Floor, Building 3, East Wing, Gate Precinct, Dubai International Financial Centre (DIFC), Dubai, United Arab Emirates. DBS Bank Ltd., (DIFC Branch) is regulated by The Dubai Financial Services Authority. This research report is intended only for professional clients (as defined in the DFSA rulebook) and no other person may act upon it.




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United States This report was prepared by DBS Bank Ltd. DBSVUSA did not participate in its preparation. The research analyst(s) named on this report are not registered as research analysts with FINRA and are not associated persons of DBSVUSA. The research analyst(s) are not subject to FINRA Rule 2241 restrictions on analyst compensation, communications with a subject company, public appearances and trading securities held by a research analyst. This report is being distributed in the United States by DBSVUSA, which accepts responsibility for its contents. This report may only be distributed to Major U.S. Institutional Investors (as defined in SEC Rule 15a-6) and to such other institutional investors and qualified persons as DBSVUSA may authorize. Any U.S. person receiving this report who wishes to effect transactions in any securities referred to herein should contact DBSVUSA directly and not its affiliate.

Other jurisdictions

In any other jurisdictions, except if otherwise restricted by laws or regulations, this report is intended only for qualified, professional, institutional or sophisticated investors as defined in the laws and regulations of such jurisdictions.

DBS Bank Ltd

12 Marina Boulevard, Marina Bay Financial Centre Tower 3 Singapore 018982 Tel. 65-6878 8888

e-mail: [email protected] Company Regn. No. 196800306E

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