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European Steel - Is the Market Right About Earnings?

For three reasons, the old idiom that ‘lower steel prices lead to lower equity prices’ may not hold true in 2022. First, solid fundamentals in steel (limited risk of de-stocking, China production growth, improving auto demand). Second, the market is discounting an unreasonably large drop in sector profitability in 2022. Finally, for the first time since 2007/08, the sector might become a capital-return story again.

Based on our analysis, the EU steel sector could see lower spot profitability (EBITDA/t) in 2022. The market implies a year-over-year drop of 93%, based on the historical correlation between EBITDA/t and EV/t. Is that too harsh? The consensus appears to be negative on steel developments in China, but we argue that China’s 2022 net exports will drop, while domestic steel demand will increase.

Due to mill supply response, inventory normalization, and lower raw material prices, steel prices (HRC) could drop by the end of 2022. There are also signs that China’s government is incentivising the economy.

Could steel prices rolling over during 2022 lead to negative inventory revaluations for trading businesses? Yes, even though it will free net working capital across the sector, with balance sheets largely healed.

@Carsten Riek