Poor old Baosteel. It spent decades
building up that rarest of creatures, a Chinese state-owned steelmaker that
actually makes a profit and isn't drowning in debt. It survived, and even
prospered, through a once-in-a-generation collapse in the steel market. Margins
widened in the March quarter thanks to a price rebound, according to Bloomberg
Intelligence's Yi Zhu.
And then the government comes along and forces it to
merge with one of the also-rans.
A proposed tie-up between Baoshan Iron & Steel and
Wuhan Iron & Steel -- Baosteel and Wisco -- will certainly
create a force to be reckoned with. With about 61 million
tons of output last year combined, it's likely to be the
world's biggest steelmaker after ArcelorMittal.
Better Together
Based on 2015 production, a combined Baosteel/Wisco
would be the world's second-biggest steel producer
Source: World Steel Association, https://www.worldsteel.org/statistics/top-producers.html
Wisco racked up 7.5 billion yuan ($1.1 billion)
of losses last year, but appears to be turning a corner. It's one of just
a handful of large Chinese steelmakers that made a modest profit in the most
recent quarter, and analysts estimate it will stay in the
black through 2018 -- so the alliance will hopefully do more than fritter away
Baosteel's income.
There's even the prospect of synergies. Both
companies have mills making flat products for automakers, appliances and
other higher-value customers across a swathe of eastern and southern China,
limiting their exposure to the currently hot, but more volatile and low margin,
construction trade.
Wisco's home city lies upstream from
Baosteel's Shanghai base on the Yangtze River, one of China's major inland
freight arteries. Its operations across China's south could help
consolidate Baosteel's exposure to Guangdong's humming manufacturing
economy. The smaller company has even got some stakes in offshore iron-ore
mines that could help integrate the group's supply chain.
So much for the positives. Unfortunately, the
list of negatives is long, as well.
Wisco's revenue over the past 12 months was about a third
of Baosteel's 157 billion yuan, but its 41 billion yuan in net debt
is almost three-quarters of Baosteel's 56 billion yuan. Adding Wisco
will lift Baosteel's debt to about 64 percent of net assets from 45 percent at
present -- a substantial deterioration, even if it remains outside the danger
zone. Both Moody's and S&P declared the plan a credit negative for
Baosteel Tuesday.
What's more, Wisco's earnings seem contingent at
best. While analysts aren't forecasting any losses for the next three years,
they're barely predicting profits either -- just 1.9 billion yuan over the
period, about 1 percent of the 183 billion yuan in expected revenue. It
wouldn't take much of a shift in iron, coal or steel prices to push that back
into the red.
Source: Bloomberg