China Steel Mills Diversify to Lift Profits
As China’s construction boom slows, steel mills across the country are scrambling to find ways to bolster profits, and one has hit on an unusual strategy: raising pigs.
Faced with a bleak outlook for its core business, Wuhan Iron & Steel, China’s fourth-largest by production, is investing Rbm30 billion ($4.7 billion) over the next five years in non-steel sectors including pig, fish and organic vegetable farming as well as logistics and chemicals.
Wuhan’s pig farm has quickly become the talk of the industry, but many of China’s powerful steel groups – which account for more than 40 per cent of global steel production and about 8 per cent of China’s gross domestic product – are also quietly expanding beyond their core business.
Most of China’s big steel producers are state-owned companies, giving them access to cheap loans. When steel making becomes unprofitable, as it is now, steel groups can get higher returns by taking loans and investing the funds in other sectors, including real estate or financing vehicles that re-lend the money.
The expansion by China’s steel groups into higher-profit areas has implications for global rivals, as it means Chinese groups will continue to flood markets with steel even when they are making it at a loss.
Exact statistics are hard to come by given limited disclosure by China’s state-owned steel groups, but “there’s no doubt that the diversification trend is growing,” says Zhang Changfu, deputy head of the China Iron and Steel Association, an industry representative body.
“The reason for diversification is weak profits [at the steel mills],” says Jiang Feitao, a steel industry specialist at the Chinese Academy of Social Sciences, a government-backed think tank.
The vast economic stimulus package that Beijing unleashed in 2009 fuelled loans to state-owned enterprises including steel mills. In the second half of last year, steel margins began to slump as China’s construction sector came off the boil, and as steel profits turned negative many groups became even more eager to look elsewhere to bolster revenues.
For Baosteel Group, the world’s third-largest steelmaker, half of its net profit of Rmb18.7 billion ($3 billion) last year came from non-steel businesses – up from 20 percent the previous year. Outside of steel, where it has long dominated the market, Baosteel has extensive non-steel subsidiaries that span a wide range of industries ranging from real estate to telecommunications to manufacturing.
“Baosteel started to diversify early, especially in financial and investment areas ... In these areas Baosteel has advantages over private companies because it can get market entry permits more easily, primarily because of their identity as a large state-owned enterprise,” says Mr Jiang.
The push to diversify is not limited to China’s steelmakers, however. State-owned grains trader Cofco has channelled its access to funds into building luxury hotels in Beijing. Copper producer Tongling, China’s second largest, is expanding into other base metals and timber.
Within the steel sector, the trend has accelerated in recent years as steel production has returned poor profits. Ansteel, one of the biggest steel makers in Hebei province, has moved into the coal sector while Maanshan, a large mill in central China, has invested billions of renminbi in wheel and axle manufacturing.
In January, China’s 80 biggest steel mills collectively saw losses of Rmb2.3 billion on total revenue of Rmb260 billion, and analysts expect that to continue. “The lower profits these days put more pressure on steel mills to diversify,” says Jiming Zou, an analyst at Moody’s. “During the last two to three months of 2011 many steelmakers in China were losing money and this will be the case for the early half of 2012 as well.”
Highlighting the situation, Baosteel – which plays a leading role in setting domestic steel prices – last week announced that its April price list would be unchanged from March. The company earlier this month said it had “no better options” than to expand its non-steel businesses.
China’s big steel mills often opt to operate at a loss rather than shut down because they are owned by local governments that rely on them for tax revenue and local employment.
“For the state-owned enterprises their major job is to keep the rice bowl full for their employees,” says Scarlett Chen, an analyst at Citi. “And steel mills are the least flexible among the heavy industries; it’s not like cement where you can shut down your plant one day and open it again the next.”
Additional reporting by Gwen Chen in Beijing