Hardened resolve

At the G20 meeting in Hangzhou at the start of September, world leaders took turns to press the Chinese to make cuts in their steel capacity. Xi Jinping responded by reaffirming his target of bringing down output by 100 to 150 million metric tonnes by 2020.

Yet as figures released by the National Reform Development Council suggest, progress has been slow on the shutdown effort. At the end of the first seven months of this year, China had cut just 47% of a targeted 45 million tonne reduction, putting it well behind schedule.

Could the government do more to cut capacity, or is it being hindered by powerful local governments who want to protect their industrial base? Probably a bit of both. During a call with investors to discuss its interim results recently, Angang Steel’s chairman said he thinks the government will meet its 2016 targets. Yet he also believes the authorities won’t take such a harsh line with the steel industry as they have with the coal sector, because demand is returning in some parts of the market, and the government won’t want steel prices to spike further.

A rebounding property market has helped spur prices substantially from 12-year lows last December and industry body CISA has announced that its 373 largest members made combined profits of Rmb16.3 billion ($2.4 billion) over the course of the first seven months of the year (Angang saw profits rise 94% over the first half year-on-year, while Maanshan and many others swung back to profitability for the first time in about four years).

Profits are rising, but margins remain low, which means that many mills are ramping up production, rather than reducing it. Figures from the National Bureau of Statistics show that output rose 4.3% year-on-year in August, for example (output was still down 0.1% overall over the first eight months of 2016).

The central government has plenty of policy commitments to restructure the industry and it has said that it wants a sector led by one or two giants with 100 million tonnes of capacity and about three to five smaller entities with 50 million-tonne capacities.

Industry regulators have another target of increasing the market share of the top 10 producers from 34% to 60% by 2025.

One of the first moves in this direction came last week when the terms of a merger between Baosteel and Wuhan Iron and Steel were announced. As we reported in WiC332, the combination of the world’s fifth and eleventh largest producers will create China’s largest steel group and the world’s second biggest behind ArcelorMittal. The new grouping – known as BaoWu – will have total capacity of 60.7 million tonnes a year, although the terms of the deal are supposed to include a restructuring plan to make cuts.

Shanghai Securities News reports that Angang (the seventh largest steel producer globally) has also been identified for reform, acting as a consolidator for the northeastern region of the country. Citing a leaked State Council document, the newspaper is suggesting that Angang will merge with Shenzhen-listed Bengang before the end of the year.

Financial analysts have also flagged rumours that Maanshan is being prepped to take over Guizhou-based Liuzhou Iron and Steel, while the world’s ninth largest producer Shougang is said to have been tasked with the consolidator role in the Beijing-Tianjin-Hebei region.

The flip side of the policy is how the government wants to deal with the smaller steel companies, many of which are close to collapsing under the weight of their debts. In this respect, the news that Sinosteel is being lined up as a pioneer for a new wave of debt-for-equity swaps has left commentators wondering whether Beijing’s policies will inadvertently keep zombie companies afloat.

Caixin Weekly broke the news that the State Council has agreed a refinancing plan for Rmb30 billion of Sinosteel’s debt to be paid off at an annual interest rate of 3%. The remaining Rmb30 billion of debt will be injected into a new subsidiary via an exchangeable bond with a six-year maturity that swaps debt to equity from year three onwards.

State asset manager Sasac will inject Rmb10 billion into the new entity and transfer enough of Sinosteel’s existing assets to make it financially viable. At some point down the road, investors may be able to exit through an IPO.

Caixin says creditors are not happy but realise it is probably the best option available.

“The banks will have to ride it out because they’d be even more helpless if a borrowing enterprise fails completely,” one creditor tells the magazine.

The pioneering nature of the deal means it is unclear how banks will classify debt-for-equity swaps on their balance sheets, or whether, as we reported in WiC319, they will try to hive off the worst of the loans through a good bank/bad bank model. This would help them to create legally separate vehicles that won’t worsen their bad debt provisions (unlisted equity is costlier for a bank to hold because of capital provision rules and the inability to mark its value to market).

Other companies are lining up for similar swaps, including troubled Huarong Energy, which wants to swap Rmb17.1 billion of debt for equity in a deal brokered by its leading creditor, Bank of China. The deal has, as yet, not gone through.

Earlier this week, the Financial Times reported that creditors in Bohai Steel have also agreed a restructuring plan for Rmb192 billion of loans, in which Rmb50 billion of the debt will be spun off into a new subsidiary holding the company’s premium assets.

Dongbei Special Steel is struggling to find a solution to its own financial woes, however. After creditors rejected a debt-for-equity swap, Liaoning’s provincial government filed for a court-ordered restructuring last week. “This is not what creditors had been hoping for,” an insider told Reuters. “The recovery rate might be as low as 10%.”

A similar story is unfolding at Guangxi Non-Ferrous Metals, where creditors may get less than 20% of their money back, after the firm was put into court-supervised bankruptcy in mid-September.

Nonetheless, Jenny Huang, an analyst at ratings agency Fitch, says that the debt-for-equity swaps are no panacea for the sector at large. Her warning is that local governments could use them to keep zombie companies afloat and avoid massive job losses. “This would hamper the government’s supply side reform,” Huang concludes.

Steel expert Dan Steinbeck takes a slightly different approach, suggesting that governments in Europe and the US should cut China’s steelmakers some slack. He compares the current restructuring efforts to the campaigns in the West when demand slumped in the 1970s. In Europe’s case the answer was what Steinbeck describes as a de facto cartel that kept production quotas and minimum prices in check. “Four decades ago, the leading industrial nations opted for costly protectionist measures,” writes the guest fellow at the Shanghai Institute for International Studies. “In contrast, China is more eager, not just to sustain globalisation but to accelerate world trade and investment.”

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