Cheap, profitable and geared for growth – that is how Moscow?s investment bankers are selling Russia?s burgeoning steel sector. Years of investment are bearing fruit and high international prices are boosting bottom lines. But the big-four steel companies are getting too big for their boots. As they turn their attention to landing large international contracts, the leading companies are getting ready to step into the big league by getting their corporate governance act together and analysts are expecting a round of mergers.
?Steel is going through the process of consolidation, investment and growth that Russia?s oil companies have just finished,? says Anton Khmelnitsky, the head of equities for Brunswick Asset Management.
Russia has the largest iron ore reserves in the world and is the fourth-largest steel producer, with output growing by 6.4% a year, according to Goskomstat (the state committee for statistics). Almost half its steel production is sold overseas, making it the second-biggest exporter after Japan.
The sector is highly concentrated, with the top four players – Magnitogorsk Metallurgical Plant (MMK), Severstal, Novolipetsk Metallurgical Plant (NLMK), and Evrazholding – producing 70% of Russia?s annual 60 million tonnes of crude steel output. All the companies are privately owned, except for a 17.8% government stake in MMK, which is due to be privatized later this year.
With such a solid basis for business, the steel producers already look attractive but in Russia?s fickle economy they have the added bonus of being a relatively safe investment. As former Yukos CEO Mikhail Khodorkovsky heads to court this month, Russia?s watchdog, the Audit Chamber, finished investigating the major steel companies and pronounced their privatizations free of problems.
A lingering trade row with the European Union, which accuses Russian steel makers of selling steel at ?dumping? prices, made possible by the low cost of Russian power, has almost been resolved. In February the EU increased Russia?s steel export quota by 437,000 tonnes per year, or by more than 30%, to almost as much as the country exports to the 10 new EU states.
Golden boys
NLMK and Severstal, long the steel sector?s golden boys, are analysts? top picks. Severstal?s sales put in a robust 39% year-on-year growth to $2.67 billion at the end of the first quarter of this year and analysts see no let-up in the company?s profitability.
Costs for all the steel companies might be rising by a quarter a year as the economy plays catch-up with the rest of the world but an extensive investment programme has widened production bottlenecks and both companies have been investing in creating vertically integrated production – buying into everything from mines to power plants.
?The era of super-normal profits is coming to an end as labour and input costs start to catch up,? says Khmelnitsky. ?The environment is becoming more challenging and forcing managers to look at their systems and cost base. There is not enough room for five big companies to compete in the international markets – they are big but not big enough – so they are competing now to see who will consume whom in the next few years.?
All this investment activity has been made easier by high international prices pouring cash into the sector. Rising global consumption – driven by China?s insatiable appetite for raw materials – has pushed prices for the different types of rolled steel up by 40% to 80% over the past year.
Severstal has seen profits rise to $898 million in 2003, up from $510 million in 2002, and Troika Dialog forecasts end of year profits to rise again to $1.27 billion, after which profit growth should level out.
The price of steel is still outpacing the rising cost of inputs, but this can?t last for ever. Alexei Mordashov, the urbane CEO of Severstal, warned a Duma budget committee that the price of steel could fall by 40% before the end of this year, but the steel producers are making good use of fat times to create lean production profiles.
The strong results have not passed portfolio investors by and the company?s stock has risen strongly ? Brunswick UBS Warburg raised its fair price target for the steel companies by a fifth, arguing that the business cycle still has a way to go.
Even if international prices do fall hard in the next year, the steel companies are protected by booming domestic sales.
Profits at MMK also soared last year, but the fastest growth came from Russian customers, driving down its exports from 53% to 45% of production. Russia?s second-largest steel mill, MMK dates to the Stalin era, but these days stands on a market footing. Last year?s profits soared by 571% to $664 million (according to Russian accounting standards) on revenues of $2.8 billion, and costs were slashed from Rb5.45 billion ($182 million) in 2002 to Rb890 million.
Flush with cash, steel companies are following their oil peers abroad and have been snapping up foreign assets. In February, Severstal closed a deal to acquire the loss-making Rouge Industries, America?s fifth-largest metallurgical company and US carmaker supplier. A month later, Russian multimillionaire Alisher Usmanov, the head of Gazprom?s investment company, tried to get a man on the board of Anglo-Dutch steel company Corus, in which he has built up a 13.4% stake.
And the steel companies might well lead in the coming wave of IPOs, which analysts expect to take over sometime in the next two years. The Mechel Steel group, Russia?s sixth-largest, has said it hopes to set out an IPO this year and Evrazholding, the largest steel company, has also talked about floating, when conditions are ripe. At the moment all the steel companies are so under-leveraged that it is still cheaper to tap the bond market.
