Is steel industry heading for overcapacity?

By Kang Seung-woo

Following a hefty investment of 13 trillion won in the past four years, the local steel industry is set to pump more than 16 trillion won by 2015 en route to its annual production capacity of 17.50 million tons in order to meet growing overseas demand.

However, with many signs of a possible double dip recession looming, observers say that there are lingering risky factors that can deliver a threat to local steelmakers.

According to a recent research by NICE Investors Service, the nation’s major steelmakers including POSCO, Hyundai Steel, Dongkuk Steel and Hyundai Hysco plan to make an investment of 16.26 trillion won between 2011 and 2015, with an annual investment reaching 4.59 trillion won.

POSCO, the world’s third-largest steel producer, intends to spend 1.60 trillion won and 2.20 trillion won, respectively, on its Gwangyang and Pohang Steel Works, while investing 3.12 trillion won in erecting an integrated steel mill in Indonesia, where it is constructing the steel plant with its joint venture partner PT Krakatau Steel.

Hyundai Steel plans to invest 3.25 trillion in construction of its third blast furnace and Hyundai Hysco will build a new plant for cold-rolled products with 922 billion won, both of which are located in Dangjin, South Chungcheong Province.

Dongkuk, along with Brazilian mining firm Vale and POSCO, is working with the establishment of a steel plant in Brazil at combined 5.15 trillion won.

The projected massive investment is well over the amount spent between 2007 and 2010.

During the cited period, the steel industry invested 13.3 trillion won, with an annual average of 3.7 trillion won and an annual production capacity of 164.5 million tons.

However, market watchers warn lingering risks can hurt the local steel companies.

“Steel companies have decided to invest in where demand is currently higher than supply. But after completing their facilities, a bad economy in the future can reverse the situation into oversupply,” said Lee Hyuk-joon, a chief analyst of NICE Investors Service.

“Low operating rates of new facilities may prevent companies from covering their expenses for them.”

Choi Moon-sun, an analyst at Korea Investment and Securities, also said: “Steelmakers’ focus on boosting production capacity, with continuing weak demand, may result in oversupply.”

The industry estimates that there will be oversupply of 2.2 million tons of steel products by 2014 because POSCO is trying to boost its production capacity in Pohang and Gwangyang, while Hyundai Steel will have built its third blast furnace.

In addition, Japanese and Chinese rivals have exported their steel products at discounted prices since the second quarter, which weighs on local steel companies’ price policies.

“Cut-throat competition with local companies with each other or with Japanese or Chinese counterparts can drop their profit margin,” said Byun Jong-man, an analyst at Woori Investment and Securities.

Worse, the local steel industry has already been hit hard by the current global financial turmoil.

According to the Korea Iron and Steel Association (KOSA), the inventory of flat-steel product at about 100 first steel distributors reached 1.25 million tons as of the end of September, up 22.3 percent from a year ago, and is higher than 1.22 million tons in 2009, when the major steelmakers reduced their production due to the global financial crisis. The stock has been on the increase for eight months in a row since February.

The KOSA said that weak demands from the auto and shipbuilding sectors, battered by the economic slowdown, negatively affected the growth of the steel inventory.

“In August, the stockpile sharply started increasing and it has reached the highest quantity ever since the data was collected for the first time in January 2004,” said an official of the KOSA.

“Just two or three years ago, about 200,000 tons of flat-steel products were sold, but the sales are likely to be held to 150,000 tons this year because most industries other than the auto sector face bad economies.”

In addition, steelmakers saw or are expected to see negative earnings for the third quarter of this year.

POSCO announced Friday that its earnings in the July-to-September period fell 78.4 percent from a year earlier due to weak demand amid the global economic slowdown and foreign currency losses.

Net profit reached 233 billion won on a consolidated basis, compared with a profit of 1.08 trillion won a year ago, according to the company.

The Korean won lost some 10 percent against the U.S. dollar during the third quarter, boosting the firm's costs on dollar-denominated debts and making prices of imported raw materials more expensive.

Hyundai Steel is expected to post a net loss despite its strong operating profit nearly reaching 300 billion won due to foreign currency losses, while Dongkuk is likely to swing back into the red amid a drop in profits of steel plate.

With the uncertain outlook for the future, POSCO said it will cut this year’s investment.

"The fourth-quarter business performance may be the worst, and we may report an operating income of below 1 trillion won," POSCO President Choi Jong-tae said on Friday.

The Pohang-based firm slashed its planned spending for this year to 6 trillion won from the previously set 7.3 trillion won, citing economic uncertainties. Last year, the company spent 9.4 trillion won on facility investment and acquisitions.

It also raised its cost-cutting target to 1.4 trillion won for this year, from the previous 1 trillion won.

Lee said that with POSCO’s planned cuts, other players will follow suit.

“POSCO is the leading company in the industry, so others are also likely to considering the scheme,” he said.

“Although the plans under way will not be touched, other investments that they see as unnecessary will be reduced or scrapped.”