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China Baowu Steel Group Corp Ltd 20 July 2020 Leverage Will Rise in 2020 As EBITDA Declines with Demand

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China Baowu Steel Group Corp Ltd 20 July 2020 Leverage Will Rise in 2020 As EBITDA Declines with Demand CORPORATES ISSUER IN-DEPTH China Baowu Steel Group Corp Ltd 20 July 2020 Leverage will rise in 2020 as EBITDA declines with demand » Leverage will increase in 2020 as EBITDA declines, then improve in 2021 as steel demand recovers. China Baowu Steel Group Corporation Limited's (A3 stable) EBITDA will decline this year as demand from steel-intensive sectors slows. Baowu's leverage Analyst Contacts reduction in recent years provides a buffer against a moderate increase in adjusted Mike Zhu +86.10.6319.6506 debt/EBITDA. We expect its leverage to improve in 2021 as steel demand picks up with AVP-Analyst economic growth. [email protected] » Weak demand and high supply push down steel price. We expect steel demand to Roy Zhang +852.3758.1515 VP-Senior Analyst decline by a low-single-digit percentage in 2020. An increase in government-backed [email protected] infrastructure investments will be offset by soft demand from other steel-intensive Kai Hu +86.21.2057.4012 sectors and reduced export demand from manufacturing companies that use steel as an Senior Vice President input. Although demand for steel products has declined with the coronavirus pandemic, [email protected] steel production has remained high. This combination, along with an already high steel Li Ma +86.21.2057.4015 inventory level, has weakened steel prices. MD-Corporate Finance [email protected] » Fluctuation in price of iron ore will cause volatility in Baowu's profit margins. Gary Lau +852.3758.1377 The price of iron ore has been volatile this year with fluctuations in iron ore demand and MD-Corporate Finance availability. Baowu can pass on part of the increase in raw material costs to customers, [email protected] but its profit margin will weaken if the iron ore price increases faster than the steel price. » Geographic diversity, strong business profile, high likelihood of government support and ample liquidity are credit strengths. The geographic diversity of Baowu's main steel production sites limits the effect on the company from disruptions at any one site. And we expect Baowu to maintain a high likelihood of support from the Chinese government given its ownership by the central government and its strategic importance. We also expect Baowu will maintain its access to domestic and international capital markets given its state ownership. Baowu also has a large cash balance and liquid financial assets as buffer. MOODY'S INVESTORS SERVICE CORPORATES Leverage will increase in 2020 as EBITDA declines, then improve in 2021 as steel demand recovers The slower economic growth caused by the coronavirus pandemic will lead to higher leverage for China Baowu Steel Group Corporation Limited (A3 stable) in 2020. The company, which is China's largest steel company by production capacity and is wholly owned by the State-Owned Asset Supervision and Administration Commission (SASAC) of China, has a buffer to tolerate a moderate increase in leverage. China's slowing economic growth has slowed activity in steel-intensive industries such as construction - including infrastructure and property development - and auto manufacturing. The reduced demand for steel from these sectors will reduce Baowu's EBITDA. We expect China's economy will grow 1% in 2020, followed by a strong rebound of 7.1% in 2021.1 We expect Baowu's EBITDA to decline around 10% in 2020 versus 2019. As a result, leverage, as measured by adjusted debt/EBITDA, will rise to around 4.0x in 2020 from 3.6x in 2019 (Exhibit 1). This reduction in EBITDA factors in a 2% decline in Baowu's steel sales volume and an 8% decline in Baowu's average selling price of steel. Both declines result from lower steel demand and a resulting buildup of steel inventory. Exhibit 1 We expect Baowu's leverage2016 will rise in 2020 before improving2017 in 2021 2018 2019 E Adjusted debt/EBITDA Upgrade Trigger Downgrade Trigger 6.0x 5.7x 5.0x 4.0x 4.0x 3.5x 3.6x 3.6x 3.0x 2.4x 2.0x 1.0x 0.0x 2016 2017 2018 2019 2020 E 2021 E Sources: Moody's Investors Service and Moody's Financial Metrics The declines in both sales volume and price result in a 10% reduction in Baowu's EBITDA per ton, to $92 per ton. (This is below Baowu's lowest EBITDA per ton of $96 during the last industry down cycle in 2016.) This reduction is on top of the 30% decline in Baowu's EBITDA per ton in 2019 because of a rise in iron ore prices during the year. (2019 figures include Maanshan Iron and Steel Company (Magang), which Baowu acquired that year.) At the same time, we do not expect Baowu will reduce its debt in 2020. Instead, the company will use its cash to help fund its operations and maintain its debt level. Nevertheless, we expect China's steel demand will pick up in 2021 from government initiatives to support the construction, infrastructure and automotive industries. Our expectation for real GDP growth of 7.1% in China next year will also boost steel demand. As such, we expect Baowu's EBITDA to increase and subsequently its leverage to fall below 4.0x in 2021. The economic recovery globally will be closely tied to the ability of governments to open their economies while safeguarding public health. The economic outlook remains highly uncertain for all economies. Given this uncertainty, we conducted a stress test for Baowu. We estimate its EBITDA per ton could fall as much as 19% in 2020 from 2019 - to $82 per ton - before its leverage would reach around 4.5x, the lower end of our 4.5x-5.0x threshold for the company's current baa3 Baseline Credit Assessment (BCA). This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history. 2 20 July 2020 China Baowu Steel Group Corp Ltd: Leverage will rise in 2020 as EBITDA declines with demand MOODY'S INVESTORS SERVICE CORPORATES Baowu's significant leverage reduction in 2017 and 2018 provides a buffer to absorb the leverage increase in 2020. Following its merger with Wuhan Iron & Steel (Group) Corporation in 2016, Baowu's EBITDA increased and its debt declined amid strong steel demand, a rise in steel prices and reductions in selling, general and administrative expenses. Baowu's leverage rose in 2019 because its margin and, subsequently its EBITDA, weakened with a rise in raw material costs. Weak demand and high supply push down steel price The average year-to-date crude steel price in China had declined by around 7% as of the end of June compared with the average price in 2019, according to the China Steel Price Index (Exhibit 2). The drop in price reflects reduced demand and a high supply of steel. Exhibit 2 Average year-to-date crude steel price has declined by around 7% from the average price in 2019 China Steel Price Index (CSPI) 140 120 100 80 60 40 20 0 The crude steel price is indexed at 100 in April 1994. Source: China Iron & Steel Industry Association (CISIA) Demand. Steel demand fell sharply during the first quarter of 2020. In February, project schedules were delayed by a shortage of workers caused by government measures to contain the spread of infection. These measures included travel restrictions and quarantine periods for workers returning to construction sites. In the property sector, the closure of developers' sales centers dampened sales. For auto manufacturers, demand and production declined alongside sales because potential consumers stayed away from crowded dealerships. (Please see Nonfinancial companies - China: Heat map: Most rated companies have low or moderate exposure to virus disruptions, 11 June 2020.) We expect steel demand to decline by a low-single-digit percentage in 2020 because of the slower economic growth. While government-backed infrastructure investments and many construction companies' strong pipelines of existing orders will support steel demand in the rest of 2020, it will be offset by soft demand from other steel-intensive industries such as property and auto manufacturing. In addition, reduced export demand from manufacturing companies that use steel as an input will also dampen steel demand. Supply. Given raw materials stocks, steel production by Baowu and other steel companies has remained high during the pandemic. Year-to-date average daily production by China's largest steel producers has remained around the same level as their average daily production in 2019, according to data from the China Iron and Steel Industry Association (Exhibit 3). 3 20 July 2020 China Baowu Steel Group Corp Ltd: Leverage will rise in 2020 as EBITDA declines with demand MOODY'S INVESTORS SERVICE CORPORATES Exhibit 3 Year-to-date average daily production by China's largest steel producers has remained around the same level from 2019 220 210 200 190 180 Million tons per day per tons Million 170 160 Source: China Iron & Steel Industry Association (CISIA) The soft steel demand, combined with restrictions on road transportation, which impeded steel companies' ability to deliver their finished steel products to customers, caused a substantial buildup of finished steel products in February. The inventory of finished products at China's largest steel producers rose to a historical high of around 21 million tons at the end of February, before recovering after mid-March. As of 30 June, steel inventory among China's largest steel producers was still around 10% higher than the average steel inventory in 2019, according to the latest data available from the China Iron and Steel Industry Association (Exhibit 4).
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