Debt in the steel sector
Signs of distress in the steel sector are increasing as we see several steelmakers on the verge of bankruptcy and seeking to divest assets to reduce debt.
Debt in the steel sector has reached record highs — net debt of the top-30 steelmakers is about US$150b and debt in the Chinese steel sector is estimated to be around US$500b.1 The average net debt of the top-30 steel companies rose significantly from 2008 to 2013. In 2014, raw material prices fell, bringing some relief to margins and an opportunity for steelmakers to pay down some debt. However, the pressure of excess capacity, rapidly cooling demand in China and the stronger position of steel customers led to a fall of over 30% in steel prices in 2015.
Lower prices and weaker demand mean steelmakers have not gained all the possible benefits from ongoing debt restructuring and the implementation of cost and efficiency measures.
Steel companies in certain regions are experiencing more distress than others.
Regional and corporate variations in distress
- Several players have struggled with profitability as oil and gas capital expenditure collapsed.
- Some steel companies have battled higher energy costs.
- Vertically integrated players have suffered a decline in profits in their mining divisions as prices for coal and iron ore have fallen substantially since 2014.
- In the US and Europe, steel companies have been able to improve their debt situation by decreasing their capital expenditure. Stronger economic growth in both the US and Europe has also resulted in growing domestic steel demand.
- In Brazil, a weaker economy has resulted in a decline in domestic consumption.
- Russian and Japanese steelmakers have been able to significantly reduce their debt towing to an increase in profitability from exports on the back of depreciation in domestic currency.
- China continues to reel under the pressure of excess production.
- Indian steelmakers’ debt has increased significantly as they invested in new capacity to capture rising demand.
Steel companies are adopting several strategies to manage their debt, strengthen balance sheets and increase cash generation.
Strategies to reduce debt and release cash
While many steelmakers already have a firm control over productivity and working capital, there is an increasing need to repair balance sheets. Strategies include:
- Alternative financing
Although large companies like Tata Steel are able to restructure debt at more favourable terms and pricing relative to the earlier debt contracts, small and medium-sized companies are finding it difficult to obtain reasonable terms and conditions.2
As a result, some companies are seeking out alternative financing such as seeking out strategic partners who can invest in their operations, thereby reducing their debt and avoiding default on their loans through financial institutions.
- Portfolio strategy
Some steel companies may have portfolios that are no longer aligned with their current strategies. Undertaking regular and rigorous portfolio reviews is vital in determining the highest performing investment projects and identifying where to focus capital. The embedded optionality and capital intensity of individual assets are the key determinants in deciding what assets form the optimal portfolio to achieve growth aspirations.
Projects previously considered core may become best suited for divestment if growth opportunities are limited and do not fit with the new strategic direction of a company. Several steelmakers have been focusing on divesting non-core assets, e.g., JSPL is in the process of selling its 1,000 megawatt power plant as part of its strategy to divest power assets as a means to safeguard its core steel assets.3
Through regular portfolio reviews, companies may also decide to diversify into higher-margin businesses, e.g., Korean steelmakers have diversified into energy, construction and agriculture to offset falling returns in the steel sector.4
- Unlocking cash flows
A tighter control on costs is essential. We suggest that companies take a PE mindset when evaluating where costs can be taken out of the business. Cost reduction measures need to be sustainable, but it is vital that such measures do not contribute to value erosion. A strong cash position is critical to ensuring a rapid response when market conditions recover, e.g., U.S. Steel Corp. has saved US$1.4b in costs over the last two years through its Carnegie Way improvement program and is maintaining a strong cash position.5
Companies can also look to identify potential activities that can provide a competitive advantage. For example, POSCO’s FINEX steelmaking technology is a market differentiator, which it now plans to sell aggressively to other steel producers. In a recent deal, POSCO has transferred this technology and equipment to Mesco Steel in India in exchange for a 26% minority share in the project.6
Globalization is no longer a matter of choice
While the Chinese Government plans to rationalize the domestic sector and will remove 100mt–150mt of capacity by 2020, it is still unlikely to make a dent in excess capacity which poses a risk to the industry for the foreseeable future. In addition, as capacity is increasing in other parts of the world.
Governments are trying to find regional solutions in tandem with their domestic steel industry by providing solutions. These include imposing safeguard or import duties on imported steel and providing financial assistance. These measures will only help steelmakers if they can maintain viable businesses.
As noted in EY’s Global Steel 2015–2016 report, globalization is no longer a matter of choice; steel businesses’ long-term success depends on it. The businesses that ride the next wave of growth will be those that understand the trends and refine their strategies, business models and portfolios according to a truly global mindset. Ultimately, it’s never been more important for steel producers to find the right balance between globalization and customization.
1“Debts rise at China’s big steel mills, consumption falls, Channel NewsAsia, 2 March 2016; “High Credit Risks in China’s Steel Industry on Overcapacity, Overleverage,” Dow Jones Newswires Chinese (English), 30
2“Tata Steel recasts US$5.4b overseas debt portfolio,” The Hindu, 16 October 2014.
3“Jindal may be set for a deal on Chhattisgarh power plant,” Mint, 22 March 2016.
4“Shagang sells to raise funds,” Steel Times International, 4 March 2015.
5“U.S. Steel plans to conserve cash, cut costs further,” Triblive, 27 January 2016.
6“Mesco to make steel using POSCO technology from 2017,” Business Standard, 25 March 2015.