Steel Industry Outlook

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BOCI research is available electronically on Bloomberg (BOCR ), thomsonreuters.com and www.bociresearch.com.

Metals & Mining Iron and Steel | Sector Update 1 February 2012

NEUTRALCompany Ticker TP Rating

Angang Steel-H 347 HK HK$5.21 HOLD

Angang Steel-A 000898 CH RMB5.80 BUY

Maanshan I&S-H 323 HK HK$2.00 SELL

Maanshan I&S-A 600808 CH RMB2.60 HOLD

Baosteel-A 600019 CH RMB6.20 BUY

Where are we Different?

We include both bottom-up and top-down analyseson demand forecasts.

We expect very slow demand growth at 2.8% YoY.

Our earnings forecasts for Angang and MaanshanI&S are significantly below streets estimates

Key Highlights of this Report

Top-down and bottom-up demand analyses.

We see limited margin squeeze for steel mills innear term.

Iron ore market outlook.

Key Catalysts/Events

Steel prices have dropped to the production cost.

Recent loosening of monetary policy could provideimpetus for steel traders in China, thus driving up

the overall demand.

BOCI Research Limited

Metals & Mining: Iron & Steel

Michelle Leung(852) 3988 [email protected]

2012 Steel Industry

OutlookDim demand outlook with ST upside

Given our expectation that Chinas economy will inevitably enter anera of slow growth in 2012 with prolonged tightening policies on theproperty market, the steel industry can hardly remain immune. Wemaintain our NEUTRALrating on the sector as we see opportunitiesfor steel price rebounds in the near term due to: (i) steel priceshaving dropped to the production cost level; (ii) the gradualresumption of construction projects post-Chinese New Year (CNY);and (iii) the recent loosening of monetary policy, which is providingimpetus for steel traders in China and thus driving up overall steeldemand. Angang remains our preferred stock for H shares and wesee Baosteel as our top pick for A shares.

Expecting Slow Demand Growth of 2.8% YoY in 2012

Overcapacity should remain a headache for steelmakers over the next twoyears. Our bottom-up approach leads us to expect 2.2% YoY growth only,much slower than FY11s almost 10% YoY growth.

Except for the home appliance and machinery sectors (for which we expect10% YoY growth in steel consumption), demand from other sectors should risemildly while that from the construction sector should remain flat overall. Theoutlook on exports remains dim due to the lack of incentives for steelmakersand lacklustre demand. On the other hand, we believe crude steel capacity willcontinue to expand by 30m tonnes (4% YoY) to 830m tonnes in 2012,

assuming 68.66m tonnes of new capacity and 30m tonnes of capacityelimination.

Both ASP and Cost should Decline; Limited Room for MarginSqueeze

Impacted by the economic slowdown and contracting property constructionmarket, we expect steel prices to fall 3-6% YoY and flat steel to outperform longsteel in 2012.

We believe iron ore import prices peaked out in 2011 due to a graduallynarrowing gap between global demand and supply. We project the Australianbenchmark price to fall 8% YoY in 2012.

In November 2011, the average net margin for major medium to large-sizesteel mills was only 0.43% with the loss ratio expanding from 32.5% to 39%.

We expect steelmakers profitability to linger at a low level this year. Chinas per capita steel consumption is still low at 445.2kg as compared with

many developed countries like Germany, Italy, Japan and South Korea. GivenChinas relatively higher GDP and FAI growth potential, we believe there is stillroom for higher per capita steel consumption.

Whats New in 12th 5-year Plan (5YP)?

While China missed its 11th 5-year Plan (5YP) target for consolidation, itremains on top of the agenda in the 12th 5YP period, in which the governmentaims to raise the top 10 concentration ratio from 49% in 2010 to 60% by 2015.

Crude steel demand should reach 750m tonnes by end-2015, implying a 3.7%CAGR within FY11-15E.

Angang Steel Top Pick; Maintain SELL on Maanshan I&S (H)

We maintain HOLDon Angang H shares but upgrade A shares from HOLDtoBUYwith new target prices of HK$5.21 and RMB5.80.

We like Angangs competitive edge in its dominant flat steel exposure.

The iron ore price retreat in 2H11 (around 9% HoH) should benefit Angangs1H12 earnings due to its 6-month booking delay mechanism.


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1 February 2012 2012 Steel Industry Outlook 2This document may not be distributed in or into the PRC.

Table of Contents

2012INVESTMENT STRATEGY AND VALUATION.......................... 3

2012STEEL INDUSTRY OUTLOOK ............................................ 6

DEMAND ANALYSIS ............................................................... 10

2012IRON ORE PRICE OUTLOOK........................................... 21

EVALUATION OF 11TH5-YEAR PLAN ........................................ 26

WHAT IS NEW IN THE 12TH5-YEAR PLAN?.............................. 28

BRIEF REVIEW OF THE STEEL INDUSTRY IN 2011 ..................... 31

COMPANY ANALYSIS ............................................................. 39

COMPANY UPDATE

ANGANG STEEL ...................................................................... 41

MAANSHAN I&S...................................................................... 48

BAOSHAN I&S ........................................................................ 54

APPENDIX I.PRODUCTION FLOW CHARTS ................................ 56

LISTED COMPANIES IN THIS REPORT ....................................... 57


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2012INVESTMENT STRATEGY AND VALUATION

Sector Rating

We reaffirm our NEUTRALrating on the steel sector (both H and A shares)as we expect Chinas economy to enter an era of slow growth in 2012 andbelieve the steel industry can hardly buck the effects. The recent sector rallyhas already reflected the positives from the monetary loosening policies oflate and the potential gradual resumption of construction projects post-CNY.

Demand and Supply

We forecast crude steel capacity in China of around 830m tonnes in 2012. Inaddition to the slim chances for a strong rebound in downstream demandgiven the looming risks in the real estate and manufacturing industries, theproblem of oversupply should remain severe.

Pricing

Unless there are some loosening policies to stimulate demand, we seeChinas steel prices remaining range-bound in 2012 due to weak demand.Cost is expected to fluctuate at a high level and the profitability of steel millsto come under an even more severe test. Industry earnings as a whole shouldcome to just above breakeven. The special steel industry should stand outgiven the advances in Chinas industrialisation and increase in governmentsupport during the 12th 5YP. In industrial countries, the output of specialsteel usually accounts for 10-20% of crude steel output, while in China, it isonly about 5-10%. The output of middle and high-end special steel is evenmore inadequate, and the industrialisation process will fuel the demand forhigh-quality special steel going forward.

Within the steel universe, we prefer industry leaders possessing resources,sound management and low exposure to the real estate sector. We also likespecial steel companies as we believe they operate in a sweet spot under the12th 5YP.

Valuation

While we maintain our NEUTRALrating on the sector, we also reiterate ourHOLDrating on Angang Steel H shares but upgrade its A shares from HOLDto BUYon valuation. We also reiterate SELLon Maanshan I&S H shares andHOLDon its A shares. We prefer Angang to Maanshan I&S due to its higherexposure to flat steel, which should recover sooner under the potentialgovernment policy support. Having said that, we are still cautious onoversupply in the steel industry although the loosening monetary policyincreases demand from traders and supports a short-term rally. The major Hand A-share steel stocks have average 2012 P/Bs of 0.53x and 0.9x,respectively, relatively low levels historically.

The steel industry earnings as a wholeshould come to just above breakeven in2012


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Figure 1. Valuations of Major H-share Steel Companies (as of 31 January 2012)

Stock codeStockcode Ccy

Closingprice Mkt cap

EPS(RMB)

EPS growth(%)

P/E(x)

P/B(x)

ROE(%)

Major H-share steel companies (m) 2010 2011E 2012E 2011E 2012E 2011E 2012E 2011E 2012E 2011E

Angang Steel. 347 HK HK$ 5.58 40,680 0.28 (0.32) 0.04 N/A N/A N/A 110.7 0.68 0.76 0.7

Chongqing I&S 1053 HK HK$ 1.21 5,073 0.01 0.02 0.05 - 150 65.6 29.8 0.32 0.33 (4.1)Maanshan I&S 323 HK HK$ 2.68 23,425 0.14 0.04 0.04 (69) 0 50.8 50.8 0.62 0.62 1.2

Shougang Concord. 697 HK HK$ 0.54 4,835 0.09 0.05 0.09 (44) 80 11.7 7.2 0.44 0.41 3.5

IRC Corp 1029 HK HK$ 1.16 3,799 (0.04) 0.004 0.01 - 150 N/A 110.7 0.68 0.76 0.7

Average 42.7 49.6 0.52 0.53 0.3

Source: WIND Database, BOCI Research estimates

Figure 2. Valuations of Major A-share Steel Companies (as of 31 January 2012)

Stock code Stock code CcyClosing

price Mkt capEPS

(RMB)EPS growth

(%)P/E(x)

P/B(x)

ROE(%)

Major A-share steel companies (m) 2010 2011E 2012E 2011E 2012E 2011E 2012E 2011E 2012E 2011E

Hebei I&S. 000709 CH RMB 2.99 14,607 0.21 0.18 0.20 (14) 11 15.9 14.4 0.6 0.6 4.0

SGIS Songshan 000717 CH RMB 2.73 3,057 0.01 0.02 0.11 60 450 135.5 24.6 0.8 0.7 0.6

Bengang Steel. 000761 CH RMB 4.62 12,996 0.30 0.30 0.34 2 13 15.8 14.0 1.0 0.9 6.0

Angang Steel 000898 CH RMB 4.58 32,991 0.28 (0.29) 0.065 N/A N/A N/A 70.5 0.69 0.79 0.2

Hunan Valin Steel Tube. 000932 CH RMB 2.87 3,140 (0.97) 0.02 0.15 - 650 140.0 18.7 0.6 0.6 0.4

Beijing Shougang 000959 CH RMB 2.87 3,220 0.12 0.03 0.05 (75) 67 89.0 53.4 1.1 1.0 1.2

Sansteel Minguang 002110 CH RMB 7.38 3,700 0.21 0.50 0.60 143 20 13.8 11.5 1.2 1.1 9.0

Wuhan I&S 600005 CH RMB 2.88 29,070 0.22 0.21 0.24 (3) 14 13.7 12.0 0.8 0.7 5.7

Baotou Steel. 600010 CH RMB 4.87 24,024 0.03 0.12 0.14 300 17 31.2 26.7 1.8 1.7 5.8

Baoshan I&S 600019 CH RMB 5.09 85,109 0.74 0.41 0.48 (45) 7 11.9 10.1 0.8 0.8 6.7

Jinan I&S 600022 CH RMB 3.42 10,516 0.03 0.03 0.05 11 67 112.3 67.4 1.4 1.5 1.3

Laiwu Steel 600102 CH RMB 7.14 1,664 0.13 0.32 0.35 139 9 23.4 20.3 1.1 1.0 4.7

Hangzhou I&S 600126 CH RMB 4.10 3,381 0.42 0.43 0.45 2 5 9.4 9.0 0.9 0.8 9.4

Lingyuan I&S 600231 CH RMB 5.34 4,398 0.74 0.60 0.64 (19) 7 9.1 8.5 1.1 0.9 11.6

Nanjing I&S 600282 CH RMB 2.87 4,734 0.24 0.22 0.261 (7) 19 12.8 10.8 1.0 0.9 7.8

Gansu Jiu Steel 600307 CH RMB 4.02 6,482 0.46 0.44 0.50 (4) 14 8.4 7.4 0.7 0.6 7.9

Anyang I&S 600569 CH RMB 2.73 6,295 0.03 0.05 0.08 67 60 52.6 32.9 0.6 0.6 1.1

Ba Yi I&S 600581 CH RMB 7.89 5,488 0.69 0.96 1.20 39 25 7.5 6.0 1.4 1.2 18.6

Xinhua Metal Products 600782 CH RMB 4.84 6,995 0.26 0.26 0.30 0 15 19.3 16.7 0.8 0.8 4.1

Maanshan I&S 600808 CH RMB 2.56 19,630 0.14 0.044 0.061 (68) (1) 58.2 58.2 0.7 0.7 2.2

Liuzhou I&S 601003 CH RMB 3.78 8,560 0.25 0.14 0.18 (43) 29 23.9 18.6 1.6 1.6 6.8

Chongqing I&S 601005 CH RMB 3.02 3,454 0.01 0.02 0.05 100 150 144.5 57.8 0.9 0.9 0.6

Average 14.2 12.3 1.0 0.9 7.9

Major A-share special steel and stainless steel companies

Daye Special Steel 000708 CH RMB 9.59 4,288 1.25 1.20 1.27 (4) 6 8.0 7.5 1.5 1.3 18.9Xinxing Ductile Iron Pipes 000778 CH RMB 6.29 8,505 0.70 0.81 0.99 15 22 7.8 6.4 1.0 0.9 13.1

Shanxi Taigang Stainless Steel 000825 CH RMB 3.76 21,416 0.24 0.28 0.35 17 25 13.4 10.7 0.9 0.9 7.0

Shagang 002075 CH RMB 4.08 1,616 0.23 0.20 0.26 (12) 30 20.4 15.7 2.7 2.3 13.1

Jiuli Hi-tech Metals 002318 CH RMB 17.44 1,849 0.35 0.57 0.80 63 40 30.6 21.8 2.5 2.3 8.0

Zhongyuan Special Steel 002423 CH RMB 8.15 644 0.23 0.22 0.30 (4) 36 37.0 27.2 2.9 2.7 7.9

Xining Special Steel 600117 CH RMB 6.44 4,773 0.31 0.52 0.60 65 15 12.4 10.7 1.6 1.4 13.1

Fushun Special Steel 600399 CH RMB 4.02 1,816 0.06 0.04 0.07 (33) 75 100.5 57.4 1.2 1.2 1.2

Changli Auto Spring 600507 CH RMB 3.88 5,046 0.23 0.40 0.47 74 18 9.7 8.3 1.9 1.6 20.1

Average 6,785 0.47 0.57 0.68 31.2 22.3 14.6 11.6 1.7 1.5 13.3



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Figure 3. Valuations of Major Global Steel Companies (as of 31 January 2012)

Stock code Company name CcyClosing

priceMkt cap(US$ m)

EPS(Local ccy)

EPS growth(%)

P/E(x)

PB(x)

ROE(%)

2010E 2011E 2012E 2011E 2012E 2011E 2012E 2011E 2012E 2011E

MT NA Arcelormittal EUR 15.82 333,268 2.44 2.12 2.29 (13.2) 8.4 9.9 9.1 0.5 0.5 5.5

JSTL IN JSW Steel INR 687.75 485 72.11 64.26 51.01 (10.9) (20.6) 10.7 13.5 1.0 0.9 11.1SESA IN Sesa Goa INR 211.6 582 28.59 48.43 34.32 69.4 (29.1) 4.4 6.2 1.4 1.2 40.1

ACC IN ACC Ltd INR 1197.75 711 59.28 58.63 68.22 (1.1) 16.4 20.4 17.6 3.3 2.9 16.7

HNDL IN Hindalco Industries INR 141.8 858 10.50 16.41 16.30 56.3 (0.6) 8.6 8.7 1.2 0.9 13.1

STLT IN Sterlite Industries India INR 114 1,211 11.33 14.41 16.10 27.2 11.7 7.9 7.1 0.9 0.8 11.7

SAIL IN Steel Authority of India INR 101.95 1,330 16.08 13.27 9.68 (17.5) (27.0) 7.7 10.5 1.1 1.1 14.1

TATA IN Tata Steel INR 443.85 1,345 (10.44) 64.98 50.37 (722.3) (22.5) 6.8 8.8 1.4 1.1 22.5

JSP IN Jindal Steel & Power INR 542.8 1,603 38.94 42.83 42.97 10.0 0.3 12.7 12.6 3.6 2.8 31.7

5711 JP Mitsubishi Materials Corp JPY 238 415 (54.56) 10.50 21.60 (119.3) 105.6 22.7 11.0 0.9 0.9 4.1

5406 JP Kobe Steel JPY 125 516 (2.69) 15.65 5.89 (681.5) (62.4) 8.0 21.2 0.7 0.7 8.8

5411 JP JFE Holdings JPY 1360 1,108 55.50 143.04 (21.63) 157.7 (115.1) 9.5 (62.9) 0.5 0.5 5.6

5401 JP Nippon Steel Corp JPY 187 1,688 (1.22) 15.63 5.46 (1,383.4) (65.1) 12.0 34.2 0.7 0.7 5.5

005490 KS Posco KRW 414,500 221 53,552 41,445 47,214 (22.6) 13.9 10.0 8.8 0.9 0.9 9.5Global peer average (189.0) (13.0) 10.8 7.6 1.3 1.1 14.3



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2012STEEL INDUSTRY OUTLOOK

Overcapacity to Persist

While we expect Chinas economy to inevitably enter an era of slowinggrowth in 2012, given the prolonged tightening policies over the propertymarket, the steel industry can hardly remain immune from the moderatingmacro-economy.

We forecast crude steel demand will post significant growth slowdown to2.8% YoY, totalling 667m tonnes in 2012. Output should rise 2.2% YoY to697m tonnes, implying over 115m-133m tonnes of excess capacity,equivalent to 14-16% of total production capacity. Our macro-economy teamexpects FAI growth to slow from 23.8% in 2011 to 16-17% in 2012 and to14-15% in 2013. We expect steel demand growth to follow a similar trend,down from 8.8% in 2011 to 2.8% in 2012 (667m tonnes) and 3.2% in 2013(705m tonnes). The costs of iron ore and other raw materials should hover at

high levels in 2012, but steel price averages should be slightly lower thanthose in 2011. The profitability of steel companies appears even grimmer,and the industry as a whole should continue to struggle along with meagreprofits.

Under the 12th 5YP for the steel industry, the top priority of the industrialreform will be to improve the industrial concentration ratio, to tighten thecontrols over steel resources in the upstream and to develop the special steeland new material sectors.

Figure 4. BOCI Steel Demand and Supply Forecasts

(mt) 2005 2006 2007 2008 2009 2010 2011 2012E 2013E

Crude steel capacity 424 491 541 660 700 764 800 830 850Changes 0 67 50 119 40 64 36 30 20

YoY growth 0% 16% 10% 22% 6% 9% 5% 4% 2%

Crude steel production 353 419 490 500 566 623 682 697 735

YoY growth 18.5% 16.9% 2.2% 13.1% 10.1% 9.5% 2.2% 5.5%

Capacity utilisation 83% 85% 91% 76% 81% 82% 85% 84% 86%

Imports of finished steel 26 19 17 15 18 16 16 16 16

Exports of finished steel 21 43 63 59 25 43 49 46 46

Net import/(export) 5 (25) (46) (44) (7) (26) (33) (30) (30)

Implied steel consumption 339 374 415 456 561 596 649 667 705

YoY growth 10.3% 10.7% 10.1% 22.9% 6.3% 8.8% 2.8% 3.2%Source: Steelease, CU Steel, BOCI Research estimates

Our macro economy team expects FAIgrowth to slow from 23.8% in 2011 to16-17% in 2012 and to 14-15% in 2013.We expect steel demand growth tofollow a similar trend


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Figure 5. Steel Price Trend by Product (FY09-11)

3,000

3,500

4,000

4,500

5,0005,500

6,000

6,500

01/09

03/09

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11/11

25mm Rebar 6.5mm wire rods3mm HRC 1mm CRC20mm medium and thick plate

(RMB/t)

Source: www.custeel.com, BOCI Research estimates

Figure 6. Steel Demand YoY Growth Trend by Product (2009-11)

-20%

0%

20%

40%

60%

80%

01/09

03/09

05/09

07/09

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09/11

Rebar Wire rods HRC

CRC Medium plate Galv and coated plate

Source: www.steelease.com, BOCI Research estimates

Crude Steel Capacity to Reach 830m tonnes in 2012E

China crude steel production capacity reached 764m tonnes by end-2010 andapproximately 800m tonnes by end-2011 according to our estimates thattake into consideration 61.36m tonnes of crude steel capacity additions andaround 25m tonnes of outdated capacity eliminations. By 2013, crude steelcapacity may reach 850m tonnes.

Based on our channel checks, there will at least be 30m tonnes of newcapacity commissioning in 2012. Within this, small-size mills will be the majorgrowth driver accounting for 74% of total new capacity in 2011-12. Longsteel capacity should rise sharply during 2012, with the newly-added capacityfor wire rod and rebar perhaps reaching 10.75m tonnes and 9.68m tonnes,respectively, representing 9% and 6% of 2011E capacity. The capacity ofhot-rolled coil (HRC) and that of medium plate should increase by 10mtonnes and 3m tonnes, respectively, representing 3.7% and 4.4% of 2011Ecapacity. The newly-added capacity of cold-rolled coil (CRC) may reach 9m

tonnes in 2012, 5.2% of 2011E capacity.

Small-sized steel mills (1,000-2,000 cum) will be the major growth driveraccounting for 74% of total newcapacity in 2011-12


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Figure 7. Capacity and Capacity Utilisation in China Steel Industry

0100200300400500600

700800900

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011E

70

75

80

85

90

95

100(mt)

Crude steel capacity (LHS) Capacity utilization (RHS)

(% )

Source: BOCI Research

Figure 8. Blast Furnaces Built in China (2010-12)

Quantity Design capacity

(mt)

1H10 12 18.18

2H10 26 41.75

HoH % 117 130

2010 38 57.23

1H11 18 23.13

2H11 27 41.46

HoH % 50 79

2011 45 64.59

YoY % 18.4 12.82012E and afterwards >20 >30.00

Source: www.custeel.com

Figure 9. New Production Lines and Capacity at Steel Mills (2011-12)

Type 2011 2012

Quantity Capacity Quantity Capacity

(mt) (mt)

Wire rod 15 lines 9.90 16 lines 10.75

Rebar 15 lines 11.85 8 lines 9.68

HRC 4 lines 8.40 5 lines 10.00

Medium plate 4 lines 7.30 1 line 3.00CRC 33 lines 18.44 23 lines 9.00

Galvanised plate 12 lines 10.17 10 lines 4.85

Silicon steel 9 lines 2.60 6 lines 1.60

Total 92 lines 68.66 70 lines 48.88

Source: China United Steel

High Correlation between Output and Profitability

Based on the data range of 2002-11 as shown in Figure 10, we see a positivecorrelation between steel industry profitability and steel output growth.Given the poor profitability at present, we expect output growth to decelerate

in the near term. In November 2011, the total net profit of major large andmedium-sized enterprises amounted to RMB1.22bn with net margin as low as0.43% and loss ratio (number of loss making enterprises/ total number ofenterprises) increasing to 39%.


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Figure 10. Correlation between Chinas Total Crude Steel ProductionGrowth and Large & Medium-sized Steel Producers Net Margin

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

-25.0% -20.0% -15.0% -10.0% -5.0% 0.0% 5.0% 10.0% 15.0%

Net margin

YoY change in output

Source: WIND Database, BOCI Research

Figure 11. Chinas Total Crude Steel Production YoY Growth Mirrors Large& Medium-sized Steel Producers Net Margin

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

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30%

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50%

Net margin (LHS) YoY growth (RHS)



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DEMAND ANALYSIS

Top-down Analysis

1.

Limited room for large-scale monetary looseningnegative on steel demand

The increase in M2 supply implies higher liquidity, which triggers downstreamdemand. Traders should have more working capital for restocking, thusresulting in a decline in inventory. Although we saw more liquidity looseningpolicies in 4Q11 (i.e. RRR cut to 21% in November, cash injection into themarket via reverse repo purchase, etc), the BOCI macro team sees limitedroom for large-scale monetary loosening going forward given the excessivequantitative easing in the US and Europe since 2009 and the high inflationand property prices in China. Overall, the current neutral-to-relatively-tightmonetary policy looks set to shift toward a neutral one with partial loosening.

Figure 12. M2 Supply and YoY Steel Demand Highly Correlated

10

15

20

25

30

01/08

04/08

07/08

10/08

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07/11

10/11 (20)

0

20

40

60

M2 supply YoY growth (LHS) Steel demand YoY growth (RHS)

YoY growth (%) YoY growth (%)


Figure 13. M2 Supply and YoY Steel Inventory Growth Highly Correlated

10

15

20

25

30

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07/08

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0%

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40%

60%80%

100%

120%

M2 supply YoY growth (LHS) Steel inv entory YoY growth (RHS)

YoY growth (%) YoY growth (%)


BOCI macro team sees limited room forlarge-scale monetary loosening goingforward given the excessive quantitativeeasing in the US and Europe since 2009and the high inflation and property

prices in China


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2. Close relationship between FAI and steel demand; BOCIexpects FAI growth to slow to 16-17% in 2012 from23.8% in 2011

We found that the correlation coefficient between steel demand and FAI hasbeen as high as 69%, based on data over the past four years. As such, we

factor the FAI growth forecasts into our steel demand growth projections.Our macro-economy team expects FAI growth to slow from 23.8% in 2011 to16-17% in 2012 and 14-15% in 2013, and we expect steel demand to followa similar trend, dropping from 8.8% in 2011 to 2.8% in 2012 and 3.2% in2013 (to 667m tonnes and 705m tonnes, respectively).

Figure 14. FAI and Finished Steel Demand (2007-11)

0

500

1,000

1,500

2,000

2,500

3,000

3,500

02/07

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(RMB bn)

30

40

50

60

70

80(m tonnes)

Monthly FAI (LHS) Monthly steel demand (RHS)

Source: NDRC, www.steelease.com, BOCI Research

Figure 15. Regression Analysis of FAI and Finished Steel Demand(2007-10)

y = 0.0145x + 29.561

R2= 0.7105

30

40

50

60

70

80

90

- 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000

(m tonnes)

Source: NDRC, www.steelease.com, BOCI Research

3. Steel demand highly correlated to urbanisation

We find a distinct correlation between steel demand and urbanisation basedon data accumulated over the past 58 years. As shown in Figure 17, thepositive correlation between steel demand growth and urbanisation (i.e.urban population growth) cannot be denied. Under the government policy ofencouraging at least a 1ppt increase in urbanisation each year, steel demandshould find gradual growth support going forward.

Strong correlation coefficient betweensteel demands and FAI with coefficientat 69%


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Figure 16. Steel Demand Growth and Urbanisation Rate Follow SimilarTrend

0%

10%

20%

30%

40%50%

60%

1957

1965

1975

1979

1982

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

0

100

200

300

400

500

600

700(m tonnes)

Urbanization rate (LHS) Crude steel demand (RHS)


Figure 17. Urbanisation Rate and Crude Steel Demand Highly Correlated

y = 1545.6x - 312.18

R2= 0.8009

(100)

0

100

200

300

400

500

600

700

0% 10% 20% 30% 40% 50% 60%

(m tonnes)


Long-term View: Upside for Per-capita Steel Consumptionin China

Although the demand outlook in most steel downstream sectors looks dour in

2012, its lower average per capita consumption of steel compared withdeveloped countries indicates upside for per capita steel use in China.

China registered the fastest growth of steel use per capita in the world duringthe past decade (14% CAGR to 445.2kg). Still, national per capitaconsumption remains well below that of developed countries such asGermany, Italy, Japan and South Korea. Given Chinas rapid growth in GDPand FAI, we believe there is further upside for steel consumption in the longterm.

Further upside for per capita steelconsumption in China in long term


13/59


Figure 18. Apparent Crude Steel Use

0

200

400

600800

1,000

1,200

Canada

US

Germany

Italy

Japan

S.

Korea

Taiwan

Asia

China

India

N.

America

S.

America

Africa

France

EU(15)

EU(27)

OtherEurope

Russia

C.I.S

kg/capita

Country

Global average

Source: World Steel Association, BOCI Research

Figure 19. Apparent Crude Steel Use

0

200

400

600

800

1,000

1,200

1,400

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

kg/capita

Canada US Germany Italy Japan

S. Korea Taiwan Asia China

Source: World Steel Association, BOCI Research

Bottom-up Analysis: Growth Slowdown in DownstreamIndustries

Gauging the downstream industries in 2012, we reckon the downside risk ofthe property sector will intensify and the growth potential for automotives,

machinery and other manufacturing industries will be small. We roughlyforecast the total crude steel demand by analysing each downstreamindustry that entails demand for crude steel and sum them up. Generallyspeaking, under the overall situation of slowing FAI growth for theconstruction industry, the growth rates of crude steel demand and output willsee a notable YoY pullback. We forecast crude steel demand and crude steeloutput picking up 2.8% YoY and 2.2% YoY to 667m tonnes and 697m tonnesin 2012, and growing 3.2% YoY and 5.5% YoY to 705m tonnes and 735mtonnes in 2013. Our detailed analysis is as follows.


14/59


Figure 20. Demand and Output Forecasts by Industry

Industry 2011E 2012E 2013E

Actual consumption (mt)

Construction 301.90 301.90 310.96

Transportation (incl. expressways, bridges, ports and rail) 41.59 44.09 46.29

Resources and energy (incl. minerals, oil & gas andelectricity)

51.75 54.86 59.25

Machinery 108.72 115.24 124.46

Automotive 47.34 49.24 51.21

Shipbuilding 17.72 18.07 18.43

Light industry (incl. household appliances and ironware) 28.73 29.88 31.67

Others 51.00 53.55 62.72

Aggregate consumption (mt) 649 667 705

YoY change (%) 8.8% 2.8% 3.2%

Net export (mt) 33.0 30.0 30.0

Output (mt) 682 697 735

YoY change (%) 9.5% 2.2% 5.5%

Total capacity 800 830 850Capacity utilisation 85.3% 83.9% 86.4%

Source: BOCI Research estimates

Marked Deceleration in Urban FAI Growth

According to BOCIs macro economy team, the year-on-year growth rate ofFAI will fall to around 17% in 2012E from 23% in 2011. The correction in theproperty sector looks set to continue, and property investment growth mayfall to 5-8% from 25-30% in 2011. In addition, the marked decrease in landtransfer income will drag down local government finances and weigh on theexpansion of infrastructure investment. Meanwhile, a modest pullback is

expected in manufacturing industry investment. However, investment inagriculture and social undertakings will maintain robust growth goingforward.

Figure 21. Urban FAI

0

50,000

100,000

150,000

200,000

250,000

300,000

07/01

07/05

07/09

08/01

08/05

08/09

09/01

09/05

09/09

10/01

10/05

10/09

11/01

11/05

11/09

0

5

10

15

20

25

30

35

40

Urban FAI (LHS) Cumulative YoY growth (RHS)

(RMB bn) (%)

Source: WIND, BOCI Research

BOCI estimates FAI YoY growth rate willfall to around 17% in 2012 from 23% in2011


15/59


Intensifying Downside Risk for Property Sector; SocialSecurity Housing to Ensure Steel Demand

In terms of real estate investment, the BOCI property team estimates thatinvestment growth in 2011 should have fallen by 26-29%. Specifically, theyear-on-year growth of real estate investment in 11M11 slowed furthercompared with 10M11, and in November alone, it fell 4.9ppts MoM, markinghistorical low levels for September, October and November. Along with theconfirmation of the deceleration trend, the growth of sales also contracted.Moreover, the National Real Estate Climate Index fell below the 100 line forthe first time since July 2009, further suggesting the persisting downtrend infundamentals. In 2012, the downside risk in property should intensify. Ourproperty team believes the purchase restrictions, lending curbs and othercore adjustments and control policies will remain tight.

Given the overall slowdown of real estate investment, the construction ofsocial security housing will likely provide key support for building materialdemand. The Ministry of Housing and Urban-Rural Development (MOHURD)

recently released its 2012 target for new social housing project starts (morethan 7m units) along with a completion target of 5m units, higher than thetarget of around 3.3m units for 2011. The master plan for social securityhousing under the 12th 5YP remains at 36m new units. We also see thegovernment stepping up efforts to monitor social housing constructionprojects throughout the 12th 5YP period.

Figure 22. Commercial Housing Investment Figure 23. New Construction Area

0

10,000

20,000

30,000

40,000

50,000

01/05

05/05

09/05

01/06

05/06

09/06

01/07

05/07

09/07

01/08

05/08

09/08

01/09

05/09

09/09

01/10

05/10

09/10

01/11

05/11

09/11

0

5

10

15

20

25

3035

40

45

Property development investment (LHS)

Cumulative YoY growth (RHS)

(RMB bn) (%)

0

50,000

100,000

150,000

200,000

01/05

06/05

11/05

04/06

09/06

02/07

07/07

12/07

05/08

10/08

03/09

08/09

01/10

06/10

11/10

04/11

09/11

(20)

0

20

40

60

80

New construction area (LHS) Cumulative YoY growth (RHS)

(10,000sqm) (%)

Source: WIND Database Source: WIND Database

Auto Industry still Lacklustre

Affected by the tightening of government policies in China, the wilting globaleconomy and the sharp decrease in Japanese car production after theearthquake in March 2011, the growth in China steel demand (i.e. galvanisedsheet and CRC) from the auto industry recorded a notable slowdown in 2H11while automobile output growth dropped from 144% YoY in 1M10 to only3.8% YoY in 11M11. The BOCI auto team reckons that the industry grewaround 4% in 2011 and will remain weak throughout 2012.

The National Real Estate Climate Indexfell below the 100 line for the f irst timesince July 2009, further suggesting thedowntrend in fundamentals will persist

The BOCI auto team reckons that theauto industry grew around 4% in 2011and will remain weak throughout 2012


16/59


Figure 24. Monthly Auto Sales Volume Figure 25. Monthly Auto Output

200,000

400,000

600,000

800,000

1,000,000

1,200,000

1,400,000

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2007 2008 2009 2010 2011

0

50

100

150

200

250

01/06

05/06

09/06

01/07

05/07

09/07

01/08

05/08

09/08

01/09

05/09

09/09

01/10

05/10

09/10

01/11

05/11

09/11

(40)

(20)

0

20

40

60

80100

120

140

160

Month ly value (LHS) YoY growth rate for the month (RHS)

(10,000 vehicles) (%)

Source: NBS, BOCI Research Source: NBS, BOCI Research

Slowing Overall Growth of Engineering Machinery

The relatively tight monetary policy in 2011 caused a slowdown in manyengineering projects, thus affecting demand for machinery. Excavator salesshowed a year-on-year decrease in July and the annual growth rate of cranesales slumped in August and September. According to the BOCI machineryequipment team, the overall growth in the machinery sector in 2012 willrecede somewhat to around 15%. Within this, engineering machinery salesare expected to grow only 5-10%.

Figure 26. Cranes

Figure 27. Excavating, Bulldozing and Transport

Equipment Sales

0

100

200

300

400

500

600

700

800

01

/10

02

/10

03

/10

04

/10

05

/10

06

/10

07

/10

08

/10

09

/10

10

/10

11

/10

12

/10

01

/11

02

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/11

04

/11

05

/11

06

/11

07

/11

08

/11

09

/11

10

/11

11

/11

(30)(20)

(10)0

1020

3040

5060

Monthly output (LHS) YoY growth rate for the month (RHS)

(units) (%)

0

10

20

30

40

50

60

70

01

/10

02

/10

03

/10

04

/10

05

/10

06

/10

07

/10

08

/10

09

/10

10

/10

11

/10

12

/10

01

/11

02

/11

03

/11

04

/11

05

/11

06

/11

07

/11

08

/11

09

/11

10

/11

11

/11

(40)(20)

020

4060

80100

120140


(units) (% )

Source: WIND Database, BOCI Research Source: WIND Database, BOCI Research


17/59


Figure 28. Excavators Figure 29. Concrete Machinery

0

5

10

15

20

25

30

01/10

02/10

03/10

04/10

05/10

06/10

07/10

08/10

09/10

10/10

11/10

12/10

01/11

02/11

03/11

04/11

05/11

06/11

07/11

08/11

09/11

10/11

11/11

(60)(40)(20)020406080100120140


(units) (%)

0

10

20

30

40

50

01/10

02/10

03/10

04/10

05/10

06/10

07/10

08/10

09/10

10/10

11/10

12/10

01/11

02/11

03/11

04/11

05/11

06/11

07/11

08/11

09/11

10/11

11/11

(20)

(10)0

1020

3040

5060

70


(units) (%)


Home Appliance Sector Growth Holds Steady

The home appliance industry showed an overall growth slowdown in 2011.The cumulative year-on-year growth for refrigerator, washing machine andair conditioner sales in 11M11 came in at 19.24%, 13.03% and 26.59%,respectively. Following the gradual dissipation of policy effects, we believethe growth rate already peaked out in 2011 and is now steady. Assessing themarket demand for durables in 2012, we see urban demand from renewalsand the rural market remaining the major growth drivers ahead. Overall, thealready high penetration rate of refrigerators and washing machines andnegative impact of the struggling property market could continue to put thehome appliance sector under pressure in 2012. That said, premier WenJiabaos 3 January 2012 speech indicated the governments plan to bolsterdomestic demand, which could boost the household durables industry goingforward, in our view. The BOCI consumer product team forecasts 7.8%growth in air conditioner sales and around 3% growth in refrigerator andwashing machine sales this year.

Figure 30. Output of Automobile and Household Durables in 2010 and11M11

2010 11M11

Cumulativeoutput

Cumulativegrowth

Cumulativeoutput

Cumulativegrowth

(m units) (YoY %) (m units) (YoY %)

Automobiles 18.3 32.4 14.0 4.5

Air conditioners 10.9 34.9 11.3 26.6

Washing machines 62.1 27.14 48.3 13.0

Refrigerators 73.0 23.1 68.3 19.2


The BOCI consumer product teamforecasts 7.8% growth in air conditionersales and around 3% growth inrefrigerator and washing machine salesthis year


18/59


Figure 31. Air Conditioners Figure 32. Refrigerators

0

500

1,000

1,500

2,000

01/06

05/06

09/06

01/07

05/07

09/07

01/08

05/08

09/08

01/09

05/09

09/09

01/10

05/10

09/10

01/11

05/11

09/11

(60)(40)

(20)020

4060

80

100120

Value for the month (LHS) YoY for the month (RHS)

(10,000 units) (%)

0

200

400

600

800

1,000

01/06

05/06

09/06

01/07

05/07

09/07

01/08

05/08

09/08

01/09

05/09

09/09

01/10

05/10

09/10

01/11

05/11

09/11

(60)(40)(20)020406080100120140


(10,000 units) (% )


Figure 33. Washing Machines

0

100

200

300

400

500

600

700

01/06

05/06

09/06

01/07

05/07

09/07

01/08

05/08

09/08

01/09

05/09

09/09

01/10

05/10

09/10

01/11

05/11

09/11

(20)

0

20

40

60

80


(10,000 units) (% )


Acute Slowdown in Railway Investment

At the national railway working conference held on 23 December 2011,railway minister Sheng Guangzhu stated that around RMB500bn will beinvested in railway transportation in 2012 (including RMB400bn forinfrastructure construction), representing around 6.6% YoY growth. This

would go toward building a total length of 45,000km in high-speed railwaysand 83,000km in expressways.

According to the Ministry of Railways, railway FAI amounted to RMB491.6bnin 11M11 (a decrease of 28.4% YoY), including RMB396.3bn in infrastructureconstruction investment (down 34.7% YoY).


19/59


Figure 34. Railway FAI

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

02/03

06/03

10/03

03/04

07/04

11/04

04/05

08/05

12/05

05/06

09/06

02/07

06/07

10/07

03/08

07/08

11/08

04/09

08/09

12/09

05/10

09/10

(100)

0

100

200

300

400

500

FAI in railway transport (LHS) Cumulativ e YoY growth (RHS)

(RMB bn) (% )


Exports should Remain Stable

Bogged down by the sovereign debt crisis, the European economy sufferedan acute downturn in 2011. It even sparked similar situations in South Africaand some other underdeveloped countries. In 2012, the global economyshould continue to encounter difficulties and uncertainties. The president ofthe IMF has recently stated that the growth rate of the global economy in2012 is now estimated at less than 4%. Given the dim demand in the US andEurope amid the high-cost environment, the exports of Chinese steel facequite a grim situation.

We expect Chinas 2012 steel exports to fall 6% YoY to 46m tonnes due to (i)

the weak demand overseas and (ii) the lack of incentives due to the discountsin export prices. According to steelease.com, the steel exports premium formajor steel products were mostly negative as of October 2011 as shown inFigure 35.

Figure 35. Export Premium of HRC and Wire Rod

(200)

(100)

0

100

200

300

400

5/10

6/10

7/10

8/10

9/10

10/10

11/10

12/10

1/11

2/11

3/11

4/11

5/11

6/11

7/11

8/11

9/11

10/11

11/11

(RMB/t)

HRC Wire rod

Source: www.steelease.com, BOCI Research

The continuously negative exportpremium for HRC in 2011 implies littleincentive for exports


20/59


Slight Drop in Steel Price in 2012E Compared with 2011

After a sustained and pronounced fall, the steel price will remain low andsteel inventory will stay high in 2012E. To sum up our judgment of the supplyand demand situation in the steel market, we expect a slight decline in theaverage steel price and greater fluctuations in 2012 than in 2011. Meanwhile,we reckon that a boost in demand is likely post-CNY, and the constructionramp-up for social security housing in 3Q11 could provide a boost to the steelprice.

Figure 36. Steel Price Forecasts

Category Rebar Wire rod HRC CRC Medium plate

Avg. price YoY Avg. price YoY Avg .price YoY Avg. price YoY Avg. price YoY

(RMB/t) (%) (RMB/t) (%) (RMB/t) (%) (RMB/t) (%) (RMB/t) (%)

2012E 4,450 (6) 4,485 (6) 4,438 (5) 5,352 (3) 4,513 (5)

2011 4,734 13 4,771 12 4,672 10 5,518 (2) 4,750 8

2010 4,179 4,253 4,251 5,606 4,384

Source: www.custeel.com, BOCI Research

Figure 37. Steel Inventory

0

500

1,000

1,500

2,000

03/06

06/06

09/06

12/06

03/07

06/07

09/07

12/07

03/08

06/08

09/08

12/08

03/09

06/09

09/09

12/09

03/10

06/10

09/10

12/10

03/11

06/11

09/11

12/11

Total inventory Long steel Flat steel

(mt)



21/59


2012IRON ORE PRICE OUTLOOK

Expect Iron Ore Price to Drop Slightly but Remain High

Looking ahead, against the general backdrop of escalating output atdomestic mines, increasing sources of iron ore imports and output ramp-upsat the three big mines, the middle and long-term iron ore price should showa gradual downtrend. However, an abrupt correction is unlikely given that:

1. China will remain a net importer of iron ore, providing importantsupport to seaborne demand;

2. The three big mines will continue to enjoy dominant market shares;

3. Iron ore exporting regions may adopt policies such as raising resourcetaxes and tariffs, which could reduce the seaborne supply.

While major global mines will not ramp up capacity all in one go, we believeiron ore prices will still fluctuate at a high level, providing a limited boost for

steel mill profits.

Iron Ore Prices to Decline 8% YoY in 2012E

In short, we expect China spot iron ore to decrease at an annual rate of8-13% during 2012-15 due to the gradually narrowing gap between globaldemand and supply because: (i) large international miners continue to rampup their production capacities; and (ii) world iron ore consumption is forecastto register growth slowdown during 2012-15, accordingly to CRU. Weforecast the price will average US cents 240/dmtu in 2012, US cents220/dmtu in 2013, US cents 195/dmtu in 2014, and US cents 170/dmtu in

2015. Our long-term price assumption is US cents 121/dmtu.

Figure 38. Iron Ore Price Assumptions

2011A 2012E 2013E 2014E 2015E LT

Australian (Fe% 62) (US$/t) 161 149 136 121 105 75

YoY growth (%) (8) (8) (11) (13) (29)

China spot (62%) (US$/t) 167 158 150 133 125 90

YoY growth (%) (5) (5) (11) (6) (28)

Source: Bloomberg, BOCI Research estimates

Figure 39. Average Price of China Import Ore Fines (62% Fe) by Quarter (US$/tonne)

1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 YTD

70.2 68.7 87.3 96.8 131.6 159.2 137.4 159.1 178 175.5 175.9 140.8 139.9

Source: Bloomberg, BOCI Research estimates


22/59


Figure 40. Contract Prices Calculated Based on Platts Index

Quarter Price US$/tonne QoQ change(%)

4Q10 137 -

1Q11 149 8.8

2Q11 179 20.1

3Q11 177 (1.2)

Actual

4Q11 160 (9.6)

Priced based on Platts Index

4Q11 176 (0.8)

Source: Bloomberg, BOCI Research

Figure 41. International Long-term Contract Prices (1988-2009)

10

2030

4050

6070

8090

100

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

CVRD Itabira ore fines Rio Tinto 65% Hamersley ore fines

(US$/tonne)


Figure 42. Platts Price Data (2010-present)

100

110

120

130140

150

160

170

180

190

200

01/10

02/10

03/10

04/10

05/10

06/10

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03/11

04/11

05/11

06/11

07/11

08/11

09/11

10/11

11/11

12/11

(US$/t)



23/59


Figure 43. Domestic Iron Ore OutputFigure 44. Investment in Ferrous Metals Mining andDressing

0

20

40

60

80

100

120

140

01/09

03/09

05/09

07/09

09/09

11/09

01/10

03/10

05/10

07/10

09/10

11/10

01/11

03/11

05/11

07/11

09/11

11/11

(40)

(30)

(20)

(10)

0

1020

30

40(% )

Output (LHS) Growth (RHS)

(mt)

0

30

60

90

120

150

180

02/07

06/07

10/07

02/08

06/08

10/08

02/09

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06/11

10/11

(40)

(20)

0

20

40

6080

100

120(% )

FAI (LHS) Growth (RHS)

(RMB100m)


Figure 45. Iron Ore Inventory at Port

3,000

4,000

5,000

6,000

7,000

8,000

06/06

09/06

12/06

03/07

06/07

09/07

12/07

03/08

06/08

09/08

12/08

03/09

06/09

09/09

12/09

03/10

06/10

(mt)


Figure 46. Top 5 Sources of PRC Iron Ore Imports

Country 2007 2007 2008 2008 2009 2009 2010 2010

(mt) Importvolume

% of total PRCiron ore imports

Importvolume


Importvolume


Importvolume


Australia 145.6 38 183.4 41.3 261.9 41.7 265.3 42.9

Brazil 97.6 25.5 100.6 22.7 142.4 22.7 130.9 21.2India 79.4 20.7 91 20.5 107.3 17.1 96.6 15.6

South Africa 12.2 3.2 14.5 3.3 34.1 5.4 29.5 4.8

Iran 5 1.3 5.1 1.2 6.9 1.1 14.6 2.4

Source: China Customs, BOCI Research


24/59


Figure 47. Growth Forecasts for 3 Major Mining Companies

(000tonnes) Vale Rio BHP Total

% ofglobaltotal

Output Chg(%) Output Chg(%) Output Chg(%) Output Chg(%) (%)

2005 23,385 10.70 12,449 15.50 9,750 9.40 45,584 11.70 30.6

2006 26,416 13.00 13,278 6.70 9,907 1.60 49,601 8.80 29.0

2007 29,903 13.20 14,470 9.00 10,288 3.80 54,661 10.20 28.6

2008 30,170 0.90 15,339 6.00 11,752 14.20 57,261 4.80 27.6

2009 23,010 (23.70) 17,154 11.80 11,779 0.20 51,943 (9.30) 27.2

2010 30,778 33.80 18,462 7.60 12,505 6.20 61,745 18.90 28.3

2011E 33,950 10.30 19,490 5.60 14,340 14.70 67,780 9.80 28.8

2012E 38,870 14.50 21,200 8.80 15,480 7.90 75,550 11.50 30.7

2013E 44,900 15.50 24,500 15.60 17,000 9.80 86,400 14.40 34.2

2014E 47,500 5.80 27,800 13.50 18,600 9.40 93,900 8.70 37.8

2015E 48,500 2.10 29,000 4.30 20,000 7.50 97,500 3.80 38.4


Figure 48. Major Mining Companies 2011-15 Capacity Expansion Plans

Company Country Project Capacity Year put into operation Investment

(mt) (US$ bn)

Vale Brazil Carajas+10M 10 2011 0.29

Carajas+30M 30 2012 2.5

Carajas+Serra Sul 90 2013+ 11.3

Concalcao Itabirito 12 2012 1.2

Vargam Grando Itabirito 10 2012 0.98

Blh Tubarao Pellet 7.5 2011+ 0.64

Corumba to 12.8mtpy 10.8 2012+ 0.22

Corumba to 23.2mtpy 10.4 2013+ 0.22

Malaysia Concoptual Project 7 2013+ 1.0

Rio Australia Brockman4 22 2010+ 1.52

Mesa A Worrarnboo 25 2010+ 0.99

Westen Tumper Synclina 29 2011 0.14

Hope downs 4 30 2012+ -

Guinea Simandou 70 2013+ 5.

Canada IOC Concentrate Stg1 5 2011+ 0.5

Funnor Concentrate Stg2 3 2011+ 0.3

India Orissa 5 2013+ -

BHP Australia RPG-4 28 2011 2.2

RPG-5 50 2011+ 5.6

RPG-5 and Quantum 36 2012+ 4

Anglo Brazil Minas Rio-phase 1 25 2013+ 5Minas-Rio expansion TBD TBD TBD

S. Africa Kolomela (previously Sishen South) 9 2012+ 1.1

Sishen Expansion Project 1 1 2011 -

Sishen Expansion Project 2 10 2015 -

Sishen Concentrate 2 2015 -

FMG Australia Solomon Stage1 40 2013 -

Solomon Stage2 20 2015 -


Coking coal, the second largest cost component in steel production (avg.

>20% of total cost) should also fall in 2012 given the price drag from importprices amid the softening demand. Our energy team forecasts 2% YoY and4% YoY declines in 2012 and 2013, respectively.


25/59


Figure 49. Liulin Coal Price

2009 2010 2011 2012E 2013E

Spot mine mouth price for #4 coal at Liulin(RMB/t)

746 833 1007 984 941

YoY growth (%) (18) 12 21 (2) (4)

Source: www.sxcoal.com, BOCI Research estimates

Positive: Limited Room for Significant Price Cut in nearterm

Considering medium/large steelmakers almost breakeven profitability levelof only 0.43% (net margin) in November, we believe the room for a furtherprice cut could be limited assuming iron ore prices to stay at relatively highlevels. We have conducted a study regarding the corresponding productioncost assuming different iron ore price levels. In Angangs case, we believe itsHRC product has already been running at a negative gross margin, thusimplying limited room for a significant price cut.

Figure 50. Scenario Analysis for Angang Steels HRC Gross Margin (2011)

Iron ore price(US$/tonne) CIF Coking coal

HRC productioncost

Angang's HRCmarket price Gross margin

(RMB/tonne) (RMB/tonne) (RMB/tonne) (%)

116 1,000 3,375 3,650 8

120 1,000 3,425 3,650 7

130 1,000 3,523 3,650 4

136 1,000 3,585 3,650 2

140 1,000 3,626 3,650 1

150 1,000 3,817 3,650 (4)

160 1,000 3,978 3,650 (8)Source: Company data, BOCI Research estimates

*highlighted is the base case


26/59


EVALUATION OF 11TH5-YEAR PLAN

Targets vs. Outcome

1) Lower reliance on imports - SuccessDuring the 11th 5YP, Chinas crude steel production increased from 350mtonnes to 623m tonnes (representing a CAGR of 12.2%), successfullyreducing the import ratio from 8% to 3%. Meanwhile, the country has alsoturned from a net importer into a net exporter as it has successfully raised theself-sufficiency ratio for auto-manufacturing and shipbuilding products.

2) Production efficiency - Success

The fresh water consumption per tonne of steel production declined from8.03 tonnes to 4.43 tonnes during the 11th 5YP period, while coalconsumption per tonne of steel dropped from 741kg to 619kg. During the

11th 5YP period, China eliminated 111.7m tonnes iron casting and 66.8mtonnes of steel smelting capacity, meeting Beijings target of 100m tonnesand 55m tonnes, respectively.

3) Industry consolidation- Failure

By 2010, the concentration ratio of Chinas top 10 producers stood at 48.6%.Although this was a 5.1ppt YoY improvement, it failed to achieve the MIIT'sconcentration target of >45% for the top 5 by 2009. We see mixed results forthe acquisition plans. There were successful cases like Baoshans acquisitionof Bayi Steel and Ningbao I&S, the large-scale consolidation of Hebei I&S;Shagangs consolidation of Huaiyin Steel Group and the merger of Henan

Anyang and Yongxing I&S, for example. However, some large-scale dealshave yet to reach fruition, such as Angang and Bengang.

According to 12th5YP for the steel industry, the government will focus onpromoting the mergers of Angang Steel and Pangang Steel, Benxi I&S andSanming I&S, Baosteel and Guangdong I&S, Wuhan I&S and various steelenterprises in Yunnan and Guangxi, along with Shougang and a few steelenterprises in Jilin, Guizhou and Shanxi.

Overall, unless new policies are launched in order to speed up the industryconsolidation, steel mills in general will face a lack of incentives given thepoor profitability, according to our channel checks.

MIIT has been correct in forecasting steel consumptionunder the 11th5YP

During the 11th5YP, the MIIT accurately forecast the CAGR for crude steelconsumption at 10-12% vs. 12% actual growth. This time, the MIIT expectsa much slower CAGR of 3.2% under the 12th5YP, compared to our 4-5% YoYgrowth expectation in 2012-13.


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Government must Step up Consolidation Process

Three key reasons lead us to believe that industry consolidation must speedup (thus benefiting large players). China must raise its industry concentrationratio in order to:

1. Enjoy stronger bargaining power at the iron ore negotiation table,which is very important given the threat from the merger of Rio Tintoand BHP, as the merged entity would control over 30% of global ironore production. Around 39.1% of iron ore consumed in China wassourced overseas in 2011, slightly higher than 2010s 36.7%.

2. Resolve the crucial problem of overcapacity. Currently, around 70% ofsteel production comes from small and medium-sized mills.

3. Improve overall operational efficiency to reduce pollution and minimisewaste of raw materials.


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WHAT IS NEW IN THE 12TH5-YEAR PLAN?

Continuity of Steel Industry Reform in 2012

At end-2011, China unveiled the 12th 5YPs for the iron & steel industry, thenew materials industry and the mineral resources industry. Key points are asfollows:

12th5YP for steel

a) Efforts must be made to enhance product quality and reduce thereliance on imports;

b) Regions to receive more support in terms of industry optimisationinclude the south-eastern coastal areas and the western region.The government targets a 60% market concentration ratio for thetop 10 by end-2015;

c) Crude steel output growth to decelerate and the volume of

domestic consumption to amount to 750m tonnes by 2015,implying a 3.7% CAGR during FY11-15E;

d) Facilitating local steel mills to acquire iron ore resources overseas.

12th5YP for new materials

a) By 2015, the self-sufficiency ratio of new materials should reach70%.

b) Areas to receive official support include steel for high-speed rail,high magnetic-induction grain-oriented silicon steel,corrosion-resisting steel for the shipbuilding industry,low-temperature pressure vessel plates, high pressure boiler

tubes for the power sector, high-strength steel for machinery,high-performance steel for oil & gas transmission pipelines, steelfor ocean engineering and steel for nuclear power to meet thedemand of major projects and major equipment.

c) Special steel companies are encouraged to develop greenlow-carbon, energy-saving and environmentally friendly steel aswell as high-performance special steel needed by the equipmentmanufacturing industry, emerging industries and the aerospaceindustry.

12th5YP for mineral resources

By 2015, the large and medium key mines will enhance efficiency and

the mining recovery rate and ore dressing recovery rate of small minesshall be raised by 3-5ppts from the current level. Compared with 2010,the resources recovery rate shall be improved by 5%.

To summarise the 12th5YP for the steel sector, industry reform is likely to bea top priority, which would result in a higher industrial concentration ratio.We also expect to witness tightening control over upstream resources in thesteel industry, the development of the special steel sector and the keyindustry of new materials, which currently has a heavy reliance on imports.We reckon 2012 will be the prime time for reforms in the steel industry.


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Figure 51. Projected Capacity of 10 Largest Steel Groups

(mt) 2010 2015E CAGR

1 Hebei I&S Group 53 Hebei I&S Group 106 15%

2 Baosteel Group 44 Baosteel Group 93 16%

3 Angang Group 40 Angang Group 87 17%

4 Wuhan I&S 37 Shandong I&S 59 10%5 Shagang Group 30 Wuhan I&S 57 9%

6 Shougang Group 26 Shougang Group 57 13%

7 Shandong I&S 23 Shagang Group 35 3%

8 Hebei Xinwuangang 19 Valin I&S Group 32 NA

9 Boahi Steel Group 17 Maanshan I&S Group 25 11%

10 Maanshan I&S Group 15 Taiyuan I&S Group 25 NA

Top 10 (mt) 305 Top 10 (mt) 576.1

China 627 China 960

Market share 49% Target market share 60%


Figure 52. Top 10 Concentration Ratio of Crude Steel Output in China

36%

35%

37%

49%49%

44%44%

60%

30%

35%

40%

45%

50%

55%

60%

65%

2005 2006 2007 2008 2009 2010 2011E 2012E 2013E 2014E 2015E

Source: www.chinaisa.org.cn, BOCI Research

Special steel industry to receive key government support

Although the Chinese special steel industry has made great strides in recentyears, it is still in a preliminary development stage compared with those ofdeveloped countries. In industrialised countries, the output of special steelusually accounts for 10-20% of the output of crude steel, while in China, it is

only about 5-10%. The output of middle and high-end special steel is evenmore inadequate, and future industrialisation will fuel the demand forhigh-quality special steel. With the advancement of industrialisation in Chinaand the increase in government support, the special steel industry will seefurther development in the 12th5YP period. It is also worth noting that thespecial steel sector has shone compared with other carbon steels. Specifically,Xining Special Steel, Zhejiang Jiuli Hi-tech Metals, Jiangxi Changli AutomobileSpring, Xinxing Ductile Iron Pipes, Daye Special Steel and other special steelcompanies led the pack in 9M11 in terms of year-on-year earnings growth,while large ordinary steel companies such as Angang and Maanshan I&Sshowed significant year-on-year decreases. We believe this was due to thebetter downstream demand for special steel in some categories (i.e. the

transport of petroleum and petrochemicals as well as the mining and powerequipment sectors) given the weak downstream demand for other steelproducts in 2011. We continue to like the special steel sector.

With the advancement ofindustrialisation in China and theincrease in government support, thespecial steel industry will see further

development in the 12

th

5YP period


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Figure 53. Special Steel Price Trend

3,000

4,000

5,000

6,000

7,000

8,000

01/07

05/07

09/07

01/08

05/08

09/08

01/09

05/09

09/09

01/10

05/10

09/10

01/11

05/11

09/11

01/12

Bearing steel (GCr15 50mm hot rolled) Spring steel (60Si2Mn 50mm)

Pinion steel (20CrMnTi) Structural alloy steel

(RMB/tonne)


Figure 54. Robust YoY Earnings Growth for Special Steel Companies(9M11)

0%20%

40%

60%

80%

100%

120%

140%

160%

Xining

Special

Steel

Jiuli Hi-tech

Metals

Changli

Auto

Spring

Taigang

Stainless

Steel

Xinxing

Ductile Iron

Pipes

Fushun

Special

Steel

Daye

Special

Steel


Figure 55. Steel Output of 32 Major Special Steel Companies

Category Segment 2010 2009 Growth

(tonnes) (tonnes) (%)

Crude steel total 88,683,616 7,9701,902 11

Non-alloy steel 34,785,692 3,1728,024 10Plain-quality non-alloy steel 7,923,061 9,174,109 (14)

High-quality non-alloy steel 20,296,245 17,499,365 16

Special-quality non-alloy steel 6,566,386 5,054,550 30

Low-alloy steel 29,117,845 27,768,547 5

Plain-quality low-alloy steel 18,300,572 18,083,693 1

High-quality low-alloy steel 9,964,380 9,294,728 7

Special-quality low-alloy steel 852,893 390,126 119

Alloy steel 20,619,971 16,543,012 25

High-quality alloy steel 3,472,884 3,057,760 14

Special-quality alloy steel 17,147,086 13,485,252 27

Stainless steel 4,160,109 3,662,319 14



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BRIEF REVIEW OF THE STEEL INDUSTRY IN 2011

Daily Output has been Falling since July 2011

In 2011, Chinas production of crude steel increased 9.5% YoY to 682mtonnes, representing a new high. In view of the daily output of crude steel,China registered 1.86m tonnes of average crude steel output per day in 2011,2.01m tonnes per day in late July (the peak for the year) and 1.626m tonnesin late December (the trough).

Figure 56. Daily Output of Crude Steel

150

160

170

180

190

200

210

30/11/09

10/01/10

20/02/10

30/03/10

10/05/10

20/06/10

30/07/10

10/09/10

20/10/10

30/11/10

10/01/11

20/02/11

30/03/11

10/05/11

20/06/11

30/07/11

10/09/11

20/10/11

30/11/11

(10,000 tonnes)


Figure 57. Crude Steel Output

0

100

200

300

400

500

600

700

800

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011E 0

5

10

15

20

25

30

(10,000 tonnes)

Crude steel output (LHS) Growth (RHS)

(% )



32/59


Figure 58. Rebar Output Figure 59. HRC Output

0

300

600

900

1,200

1,500

01/05

06/05

11/05

04/06

09/06

02/07

07/07

12/07

05/08

10/08

03/09

08/09

01/10

06/10

11/10

04/11

09/11

(mt)

(20)

(10)

0

10

20

30

40

50

60(% )


0

300

600

900

1,200

1,500

01/05

06/05

11/05

04/06

09/06

02/07

07/07

12/07

05/08

10/08

03/09

08/09

01/10

06/10

11/10

04/11

09/11

(mt)

(40)

(20)

0

20

40

60

80

100(% )


Source: www.custeel.com, BOCI Research Source: www.custeel.com, BOCI Research

Figure 60. Breakdown of Crude Steel Consumption (2010)

Machinery17%

Energy

8%

Transportation

facilities

6%

Infrastructure

20%

Others

9%Property

26%

Automotive

7%

Household

durables

4%Shipbuilding

3%


Figure 61. Breakdown of Steel Demand by Machinery Product

Special

equipment

17%

Heavy

machinery

17%

Agricultural

machinery

19%

Machine tools

19%

Engineering

machinery

16%

Machinery for

power industry

7%

General

machinery for

petrochemicals

5%



33/59


Figure 62. YoY Growth Rates in Downstream Industries by Month (2011)

YoY change (%) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov

Urban FAI - 24.9 25.0 25.4 25.8 25.6 25.4 25.0 24.9 24.9 24.5

Investment in real estate development - - 33.2 34.6 35.4 28.9 36.5 31.6 25.0 25.0

Area of sold commercial housing - - 15.8 (9.9) 18.5 25.4 17.8 13.5 9.5 (9.9) (1.7)

Area of built commercial housing - - 10.5 11.8 22.4 20.9 16.6 23.3 12.1 (2.7) 14.1New construction area - - 19.5 26.9 22.2 22.8 34.0 32.5 8.9 1.9 9.1

Industrial added value - 14.9 14.8 13.4 13.3 15.1 14.0 13.5 13.8 13.2 12.4

Total output value of machinery industry 22.4 22.3 21.5 17.7 15.8 19.5 16.3 19.1 17.7 16.2 16.7

Automobile output 13.3 6.3 9.9 (1.5) (1.9) 3.7 (1.4) 9.7 2.5 1.3 (1.2)

Power generating equipment 47.5 84.9 44.7 8.1 (8.2) 17.7 5.5 19.4 21.9 (11.8) 15.0

Washing machines 9.1 3.3 12.2 31.8 27.2 31.9 14.8 11.7 12.7 10.4 (9.3)

Refrigerators 25.3 4.2 21.0 10.9 16.0 22.1 21.1 13.5 16.9 26.9 27.5

Air conditioners 57.8 51.2 48.4 32.5 29.4 37.6 28.7 36.5 4.5 (3.8) (1.0)

Source: WIND Database

Figure 63. YoY Growth Rates in Downstream Industries by Month (2010)

YoY change(%) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Urban FAI - 26.6 26.4 26.1 25.9 25.5 24.9 24.8 24.5 24.4 24.9 24.5

Investment in property development - - 39.0 38.5 38.6 34.3 28.1 31.0 32.1 34.5 63.5 12.3

Area of sold commercial housing - - 32.8 27.5 (3.4) (3.2) (15.4) (10.1) 16.6 16.0 14.5 17.8

Area of built commercial housing - - (11.3) 0.8 16.6 10.3 43.3 23.0 10.9 33.7 36.9 2.2

New construction area - - 87.1 72.8 100.6 55.6 65.7 55.2 44.3 51.6 (17.4) 4.7

Industrial added value - 12.8 18.1 17.8 16.5 13.7 13.4 13.9 13.3 13.1 13.3 13.5

Total output value of machinery industry 66.2 30.0 36.9 36.2 33.7 29.6 30.7 28.8 28.9 29.7 30.4 32.0

Automobile output 144.3 47.0 51.7 34.9 26.7 18.6 17.3 13.0 17.9 22.6 27.6 23.6

Power generating equipment 24.7 (13.0) 8.1 39.5 17.1 (8.9) 5.9 2.5 (2.0) 6.2 11.9 6.9

Washing machines 73.7 22.7 28.7 34.3 30.8 24.0 45.3 26.4 12.6 15.2 23.7 12.4

Refrigerators 80.9 21.1 8.6 29.7 30.6 23.5 20.0 22.4 29.7 30.8 28.9 11.1

Air conditioners 94.3 (9.5) 24.4 27.5 69.8 47.3 45.6 34.7 42.0 42.2 33.6 48.4


Most YoY Growth Recorded in 1H11 before Fading in 2H11

Long steel outperformed flat steel in 2011 with an average year-on-yearincrease of 12-13%, vs. flat steels mixed performance. Within this, CRC wasthe worst performer with a 2% decline. Having said that, all steel productsshowed half-on-half declines.

Figure 64. ASP Growth by Product (2011)

Long steel Flat steel

Rebar Wire rod HRC CRC Thick plate

YoY growth (%) 13 12 10 (2) 8

HoH growth (%) (4) (2) (5) (4) (7)



34/59


Figure 65. Price Change Trends in 5 Categories (2005-11)

2,000

3,000

4,000

5,000

6,000

7,000

8,000

01/05

04/05

07/05

10/05

01/06

04/06

07/06

10/06

01/07

04/07

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04/10

07/10

10/10

01/11

04/11

07/11

10/11

25mm Rebar 6.5mm wire rods3mm HRC 1mm CRC20mm medium and thick plate

(RMB/t)


Figure 66. Price Change Trends in 5 Categories (2011)

4,000

4,500

5,000

5,500

6,000

13/04/11

27/04/11

11/05/11

25/05/11

08/06/11

22/06/11

06/07/11

20/07/11

03/08/11

17/08/11

31/08/11

14/09/11

28/09/11

12/10/11

26/10/11

09/11/11

23/11/11

07/12/11

21/12/11

25mm rebar 6.5mm high-speed wire3mm HRP 1mm CRP20mm med-thick plate

(RMB/t)


Figure 67. Pricing Policy of Baosteel in 2011 (tax exclusive, RMB/tonne)

Category

M

aterial

Typ

icalSpec.

PriceinJan

Ch

ange(%)

PriceinFeb

Ch

ange(%)

PriceinMar

Ch

ange(%)

PriceinApr

Ch

ange(%)

Pri

ceinMay

Ch

ange(%)

PriceinJun

Ch

ange(%)

PriceinJul

Ch

ange(%)

Pri

ceinAug

Ch

ange(%)

PriceinSep

Ch

ange(%)

PriceinOct

Ch

ange(%)

Pri

ceinNov

Ch

ange(%)

PriceinDec

Ch

ange(%)

HRC SPHC 3.0*1250*C 5,002 6 5,102 2 5,402 6 5,402 0 5,202 (4) 5,202 0 5,002 (4) 5,002 0 5,002 0 5,062 1 5,062 0 4,862 (4)

CRC SPCC 1.0*1250*C 5,236 4 5,336 2 5,596 5 5,596 0 5,296 (5) 5,296 0 5,196 (2) 5,246 1 5,366 2 5,416 1 5,416 0 5,116 (6)

PickledHRC

SPHC 3.0*1250*C 5,457 4 5,557 2 5,757 4 5,857 2 5,657 (3) 5,257 (2) 5,157 (2) 5,157 0 5,277 2 5,327 1 5,327 0 5,027 (6)

Heavyplate

Shipplate A

16.0-20.0*2000

4,800 3 4,900 2 5,200 6 5,200 0 5,050 (3) 5,050 0 5,050 0 4,950 (2) 4,950 0 4,950 0 4,950 0 4,650 (6)

Hotdippedgalv.

DC51D+Z

1.0*1250*C 5,287 4 5,387 2 5,647 5 5,647 0 5,347 (5) 5,347 0 5,347 0 5,397 1 5,547 3 5,597 1 5,597 0 5,197 (7)



35/59


Significant YoY Rises in Iron Ore Prices

Figure 68. Import Price of Iron Ore at Qingdao Port(CFR)

Figure 69. Tax-inclusive Iron Ore Refined at TangshanPort (66%)

500

700

900

1,100

1,300

1,500

10/08

12/08

02/09

04/09

06/09

08/09

10/09

12/09

02/10

04/10

06/10

08/10

10/10

12/10

02/11

04/11

06/11

08/11

10/11

(RMB/t)

500

700

900

1,100

1,300

1,500

1,700

11/08

01/09

03/09

05/09

07/09

09/09

11/09

01/10

03/10

05/10

07/10

09/10

11/10

01/11

03/11

05/11

07/11

09/11

11/11

(RMB/t)

Source: Bloomberg Source: Bloomberg

Financials of Private Companies Healthier than those ofSOEs

The latest data of China Iron and Steel Association (CISA) indicates that the77 large and medium steel companies cumulatively registered RMB85.297bnin profit in 11M11, representing a year-on-year increase of 8.1%, and a2.55% sales profit margin. In November alone, the 77 producers net profitmargin was down from 0.47% in October to 0.43%, and the percentage ofloss-making enterprises rose from 32.5% in October to 39%. Among these,state-owned enterprises net margins were in general below 2.99%, whilethose of private companies were higher than average.

We note that six A-share-listed steel companies reported net margins ofabove 5% during 10M11, namely Hebei Jinxi I&S, Hebei Xinwuan I&S,Handan Zongheng I&S, Inner Mongolia Baotou Steel Union, Baoshan I&S andCITIC Pacific Limited, most of which are private companies.

Figure 70. Net Profit Margin and ROE Trends

02468

10121416

1820

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011E

(% )

Sales profit margin ROE



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Figure 71. Steel Companies Sales Profit Margin(monthly) Figure 72. Steel Companies ROE (monthly)

(20)

(15)

(10)

(5)

0

5

10

01/07

04/07

07/07

10/07

01/08

04/08

07/08

10/08

01/09

04/09

07/09

10/09

01/10

04/10

07/10

10/10

01/11

04/11

07/11

10/11

(% )

(40)

(30)

(20)

(10)

0

10

20

30

01/07

04/07

07/07

10/07

01/08

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04/09

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10/09

01/10

04/10

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10/10

01/11

04/11

07/11

10/11

(% )

Source: www.custeel.com, BOCI Research Source: www.custeel.com, BOCI Research

Sluggish Global Economy Dragging Steel Exports

The latest customs data indicate that China exported 3.72m tonnes of steel inDecember, a MoM decline of 11.5% and a YoY rise of 30.5%. It cumulativelyexported 48.91m tonnes of steel from January to December, a YoY increaseof 14.9%. China imported 1.19m tonnes of steel in December, a MoM declineof 3.3% and a YoY decline of 15.6%. It cumulatively imported 15.58m tonnesof steel from January to December, a YoY decline of 45.3%. Generally, owingto the weak global economy, the steel export outlook appears grim. Takingthe exports to Europe for example, steel import demand from Europe hasfallen sharply and importers have begun to demand price reductions in viewof the debt crisis.

Figure 73. Steel Exports Figure 74. Steel Imports

01

2

3

4

5

6

7

8

01/07

04/07

07/07

10/07

01/08

04/08

07/08

10/08

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07/09

10/09

01/10

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10/10

01/11

04/11

07/11

10/11

(mt)

(100)(50)

0

50100

150200

250300

350(% )

Exports (LHS) Growth (RHS)

0.0

0.5

1.0

1.5

2.0

01/07

04/07

07/07

10/07

01/08

04/08

07/08

10/08

01/09

04/09

07/09

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04/11

07/11

10/11

(mt)

(60)(40)

(20)

0

20

40

60

80(% )

Imports (LHS) Growth (RHS)

Source: www.custeel.com Source: www.custeel.com

Steel Industry FAI remains Strong, especially amongnon-SOEs

In 11M11, ferrous metal industry FAI grew by 18.6% YoY to RMB349.254bn.This rapid growth suggests robust capacity expansion ahead. In terms ofregions, the investment hot spot is the Bohai Rim (encompassing Hebei,Liaoning, Shandong, Tianjin and Beijing), which recorded RMB85.3bn in steelproject investment during 10M11, accounting for 27.2% of total investments.


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In 10M11, the total FAI among non-SOE steel enterprises was double that ofSOEs. SOE steel mills FAI amounted to RMB115.26bn (down 0.38% YoY),compared with RMB235.85bn for non-SOEs (up 39.4% YoY).

Figure 75. Steel Industry FAI Growth still Strong

0

100

200

300

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500

02/07

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(40)

(20)

0

20

40

60

80(% )

FAI (LHS) Growth (RHS)

(RMB100m)


Sharp Increase in Financing Costs

Given the tightened monetary policy and significant increase in funding costsin 2011, the financial costs of steel companies have risen considerably.

According to CISA, the financial costs of CISA member enterprises soared37.18% YoY from January to November 2011 due to the significant increasein the discount amounts and discount rate of steel companies bank

acceptances. Assuming a moderate adjustment to monetary policy in 2012will bring about a reduction in the funding costs of steel industry, the liquidityof the industry may be improved, the financial strain of downstreammanufacturers may be alleviated and demand may be stimulated to someextent. .

Figure 76. Steep Rise in Financial Expense Ratios of Steel Companies

30

35

40

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55

60

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0

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Financial expense (LHS) Growth (RHS)

(RMB100m)



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Steel Stocks Underperformed in 2011

Impacted by the poor performance of the steel market, the A-share steelsector underperformed in 2011, with the sector dropping 30.2% in the year(CSI 300 down 26.5%). Only Inner Mongolia Baotou Steel Union managed again. Domestic steel shares with only small declines mainly consisted ofcompanies that had completed asset reorganisations (such as Jinan I&S andLaiwu Steel Corp), energy-related/special steel companies and private steelcompanies like Zhejiang Jiuli Hi-tech Metals and Nanjing I&S.

Figure 77. Steel Stock Performances (2011)

-50%

-40%

-30%

-20%

-10%

0%

10%

BaotouSteel

JinanI&S

LaiwuSteel

Jiuli

XinhuaMetal

ZhongyuanSpecial

HangzhouI&S

NanjingI&S

AnyangI&S

ChongqingI&S

CSI300

Ferrousmetals

WuhanI&S

SansteelMinguang

JiangsuShagang

BaYiI&S

DayeSpecialSteel

LingyuanI&S

Shougang

ChangliAutoSpring

AngangSteel

FushunSpecialSteel


Figure 78. Performance of A-share Ferrous Metal Sector vs. CSI 300 (2011)

1,800

2,000

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Steel sector index CSI 300



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COMPANY ANALYSIS

Figure 79. Sales Exposure

(%) Long steel Flat steel

Baosteel 10 90Angang 9 91

Maanshan 50 50

Source: Company data, BOCI Research

*Among Maanshans 50% flat steel, 3% belongs to train wheel rims

Figure 80. Capacity Expansion

(mt) 2007 2008 2009 2010 2011E 2012E 2013E

Baosteel 24.0 24.0 24.0 26.0 26.0 22.0 25.5

YoY growth (%) 0 0 8 0 -15 14

Angang 16.1 16.0 20.1 21.7 21.7 21.7 21.7

YoY growth (%) 6 0 25 8 0 0 0

Maanshan 14.5 17.9 16.7 16.7 16.7 16.7 18.7

YoY growth (%) 57 24 (7) 0 0 0 12

Source: Company data, BOCI Research

Figure 81. Major Applications for Steel Products

Flat steel products Long steel products

HRC CRC Galvinised sheet Medium-thick plate Section steel Wire rods/ rebars Pipe steel

Construc

Steel Industry Outlook

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