Korean steelmakers face dismal outlook

Mike Elliott, partner and global mining & metals sector leader at Ernst & Young

POSCO advised

to rethink its

go-after-resources strategy

By Lee Hyo-sik

The golden days are long over for POSCO, Hyundai Steel and other local steelmakers, according to a global steel industry expert who predicted that a meaningful recovery will not materialize until existing global oversupply is resolved.

In a recent interview with The Korea Times, Mike Elliott, partner and global mining & metals sector leader at Ernst & Young, said that POSCO, the world’s fourth-largest steel producer, has to rethink its strategy of buying stakes in mineral mines overseas, and instead make more effort to shore up its weakened financial soundness.

``Before coming to Korea, I visited Japan. My feeling is that Korean steelmakers are more pessimistic about their business outlook than their Japanese counterparts,’’ Elliott said. ``This clearly reflects differences in overall economic conditions between the two nations.’’

Elliott, who is a partner at one of the world’s largest accounting and consulting firms and who is based in Sydney, said Korean and non-Korean steel companies have been going through a hard time, adding that until China’s overcapacity is taken out of the global system, they will continue to struggle.

"The Chinese steel industry will soon undergo a consolidation period. When it is complete, the utilization rate of global steelmakers will go up, which will boost their bottom line,’’ Elliott said. ``This will happen but will take years to complete. So, there will be no handsome recovery for Korean steel firms in the near future.’’

Local steelmakers have continued to suffer since the global financial crisis in late 2008 as shrinking global demand and high raw material costs weigh down on their bottom lines. Additionally, the worldwide supply glut created by Chinese producers has hit Korean firms hard.

The world economy needs about 1.4 billion tons of steel annually, but the industry is capable of producing a combined 2 billion tons. As a result, POSCO and other companies have seen their profitability deteriorate over the past few years.

POSCO’s operating profit plunged to 2.8 trillion won ($2.5 billion) last year from 4.33 trillion won in 2011 and 4.9 trillion won in 2010. The country’s second-largest steel manufacturer, Hyundai Steel, also saw its operating earnings drop to 871 billion won from 1.27 trillion won in 2011 and 1.1 trillion won in 2010.

Another example is Dongkuk Steel, Korea’s third-biggest steel producer, which suffered an operating loss of 115 billion won in 2012, compared with profits of 209 billion won and 303 billion won the two previous years.

Challenges facing Korean steelmakers

Elliot said local steelmakers cannot compete with Chinese rivals purely in cost, due to the latter’s growing price competitiveness.

"It is really difficult for Korean firms to compete with their Chinese counterparts, who produce 50 percent of the entire global supply. China is expected to consolidate its steel industry by 2015, creating 10 large steelmakers,’’ he said. ``This will further boost Chinese producers’ buying power and lower production costs.’’

For domestic steelmakers to remain in the game, Elliot suggested that they make inroads into foreign markets more aggressively and produce high value-added, premium steel goods.

"China produces its entire volume domestically with no plants abroad. But POSCO and other Korean firms have expanded their presence in China, Southeast Asia and South America over the years,’’ he said. ``This means they are closer to the market and can adapt more flexibly to new customer demands.’’

He then encouraged local companies to develop and manufacture high-tech, high-margin steel products. ``Korean makers cannot compete with their Chinese rivals in the market for hot rolled plates and other conventional products. They need to focus on electrical steel sheet and other value-added, premium products that require a high-level of technology and sophisticated manufacturing.’’

Steelmakers here have gone into emergency mode over the past few years to cope with the continued global economic downturn. On top of the implementation of a wide range of cost-saving measures, they have cut production to prevent steel prices from falling further.

POSCO needs to brush up global strategy

Elliot expressed a cautious view of POSCO’s global business strategy. ``It is necessary for Korea’s largest steel producer to head overseas. Given the nation’s small market size, its outward approach is valid and could be successful in the long term. I think POSCO has been relatively successful in internationalizing itself so far.’’

Even though POSCO faces challenges with constructing a plant in India, he said it is not a bad idea because the world’s second-most populous nation has been growing fast.

"The opportunity for growth is certainly huge in India. But at the same time, it is extremely difficult for foreign entities to get a project approved. Things move really slowly in a place like India,’’ Elliott said. ``It would have been much easier for POSCO to set up a joint venture with local partners.’’

Elliott also said there are many risk factors associated with the firm’s entry into emerging markets. "First, POSCO needs to find the right local business partner and understand the risk profile in each country. Perhaps, POSCO can learn valuable lessons from its struggle in India. Then, it can enter foreign markets more professionally next time.’’

POSCO’s mineral buying-spree no longer valid

Elliot encouraged POSCO to rethink its strategy of buying stakes in coal and iron mines abroad, citing rapidly changing business environments.

"I think the steelmaker needs to stop purchasing overseas coal and iron mines because a vertically-integrated business model is no longer the best strategy,’’ he said. "POSCO has been aggressive in seeking upstream assets such as iron ore over the past few years. But the company has to think about how much corporate value it has created.’’

Under the leadership of Chairman Chung Joon-yang, the steelmaker has spent billions of dollars to buy stakes in mineral mines overseas amid surging prices in raw materials largely fueled by China’s increasing appetite for natural resources.

"Having stakes in natural resource mines reflects negatively on company valuation because it has to spend a significant amount of capital, which is also not good for stock prices,’’ Elliot said. "I think there are three main reasons why POSCO entered the upstream sector. It wanted to take away volatility in material costs, secure a stable supply and gain information about resources cost structures.’’

During boom years, he said it is hard for manufacturers to secure raw materials amid high prices so they have every reason to go after resources.

"But these days, the supply of raw materials is abundant and the demand is low amid the global economic downturn. So there is no reason for steelmakers to spend tens of millions of dollars to own resources,’’ he said.

POSCO can hedge against fluctuations in mineral prices to some extent by taking part in the derivative market, Elliot said, adding that securing supply is no longer an issue and information about raw material markets can easily be obtained from trading firms.

"The strategies of a few years ago do not work anymore. POSCO has to introduce new strategies to cope with the new business environment. But it seems the company remains reluctant to change its direction because it is still concerned about the return of high commodity prices,’’ he said.