06 September 2012 Global Equity Research Steel (Steels/Metals & Mining)

Global Steel Equities Research Analysts COMMENT Michael Shillaker (Global Head) 44 20 7888 1344 [email protected] Structurally challenged, cyclical optionality Trina Chen 852 2101 7031 Figure 1: Global steel equities versus Global steel output yoy [email protected] Richard Garchitorena, CFA 212 325 5809 [email protected]

Dmitry Glushakov, CFA 7 495 662 8512 [email protected]

James Gurry 44 20 7883 7083 [email protected]

Semyon Mironov 7 495 662 8510 [email protected]

Neelkanth Mishra 9122 6777 3716 [email protected] Nihal Shah Source: WSA 44 20 7888 3270 [email protected] ■ The steel industry remains burdened with chronic structural overcapacity Minseok Sinn that could take seven to close to 20 years to eliminate. Across almost all 822 3707 8898 regions—from Australia to China, Europe to Japan, South Korea to Russia— [email protected] this overcapacity has forced domestic steel producers to seek additional Michael Slifirski volumes in the global export market. Pricing power remains cyclical and not 61 3 9280 1845 [email protected] structural as a consequence and returns could be muted for many years. But

Ivano Westin the performance of global steel equities over the past 24 months (down 39% 55 11 3841 6318 rel to MSCI World up 13%) suggests the market is aware of this trend; thus [email protected] we see a cyclical window of opportunity to own steels. Shinya Yamada 813 4550 9910 ■ Differentiation: We include in this report the regional views and analysis that [email protected] drive our fundamental analysis and stock calls across our team’s global steel coverage. We use Credit Suisse HOLT® as a further valuation tool. ■ Stock calls: On a range of valuation metrics we favour ArcelorMittal (OP, $21 TP), Reliance Steel (OP, $65 TP), Nucor (OP, $45 TP), POSCO (OP, W450,000 TP), Ternium (OP, $29.4 TP), MMK (OP, $5.9 TP) and Jindal (OP, Rs500 TP). ThyssenKrupp (OP, €25 TP) remains the most interesting structural change play arguably in the global steel space. Our least preferred names include Salzgitter (N, €40 TP), Olympic Steel (N, $19 TP), CSN (UP, BRL 10.5), SAIL (UP, Rs 66 TP) and Angang (UP, HK$2.3).

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06 September 2012 Table of contents

Key charts 3 Summary 4 Outlook for global steel returns 6 Pricing/costs and returns outlook 11 Valuation and stock picks 21 China (c700mt output 2012E) 24 Europe (c180mt output 2012E) 27 Japan (c110 mt output 2012E) 32 US (c90mt production 2012E) 37 India (c75mt output 2012E) 43 Korea (c72mt output 2012E) 48 Latam (c70mt output 2012E) 53 EEMEA: Russia, Turkey, South Africa (c110mt output 2012E) 58 Australia (c6mt output) 68 Appendix: Equity performance and comps 70 Appendix: Key regional snapshots 73 Analyst coverage 81

Global Steel Equities 2 06 September 2012 Key charts

Figure 2: Global steel prodn.(mt) vs. capacity, utilisation Figure 3: Global steel o/p (kt) vs. CAGR trend 140,000 4%

120,000

100,000 8%

80,000 3%

60,000

40,000

20,000

0 Jan-96 Jun-97 Nov-98 Apr-00 Sep-01 Feb-03 Jul-04 Dec-05 May-07 Oct-08 Mar-10 Aug-11

Global steel output

Source: WSA, Credit Suisse research Source: WSA, Credit Suisse research

Figure 4: Global steel o/p y/y vs. CIS export HRC y/y Figure 5: Steel implied cost analysis (3 month cost lag)

60% 140% 50% 120% 40% 100% 30% 80% 20% 60% 10% 40% 0% 20% -10% 0% -20% -20% -30% -40% -40% -60% Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

Global y/y steel production growth CIS export price HRC y/y

Source: WSA, Thomson Reuters, Credit Suisse research Source: CRU, Credit Suisse research

Figure 6: Global steel Output and IP (with forecasts) Figure 7: Global steel equities (rhs) & steel o/p (both yoy)

15% forecast 20.0% 10%

10.0% 5%

0.0% 0%

-10.0% -5%

-10% -20.0%

-15% -30.0% Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13

Global IP y/y lhs Global steel y/y

Source: WSA, Thomson Reuters, Credit Suisse research Source: WSA, Thomson Reuters, Credit Suisse research

Global Steel Equities 3 06 September 2012 Summary Our global analysts have contributed their views of domestic fundamentals and stock picks to this Global Steel report. We have also added a global view of pricing based on the analysis of fundamentals across the steel and raw materials markets. We draw the following conclusions:

■ Structurally challenged: Demand remains weak across all major regions and in many places (especially the developed world) it has not recovered to pre-crisis levels. Where demand has recovered (China, India and South Korea for example) it has been more than matched by new capacity build. Structurally, we think it could take between 7 (assuming 1.5% pa capacity growth) to c20 (assuming 3.0% pa capacity growth) years to see the steel industry return to effective “full capacity” and hence structural pricing power. ■ Pricing power limited as producers seek to improve utilisations: Across almost all regions, this demand dynamic has forced domestic steel producers to seek additional volumes in the global export market. As we have seen in the past, the dynamics of significant excess global capacity and highly liquid export markets have pushed steel prices and hence conversion margins lower—steel pricing is now very much attached to the global cost curve. ■ Cyclical game for now: Cyclically it appears that we are at the low end of apparent consumption, suggesting at some stage an upturn in the steel market is likely… whether this is 2013 or 2014 (or beyond) remains unclear for now. ■ We do not expect windfall profits/losses: The change in raw material pricing (from fixed annual contracts to spot pricing) suggests the windfall profits seen in 2000 and 2004, for example, no longer exist. The counterbalance is that falling raw material prices in a downturn should provide some margin protection on the downside, each downturn suggesting the kinds of material margin squeezes that were seen in 2001, 2005 and 2009 are also now less likely. ■ Raw materials – narrowing advantage: Raw material prices look to have structurally peaked which will ultimately both bring down longer-term steel prices and flatten the lower end of the global cost curve, leading to a decrease in competiveness for backward (raw material) integrated steel makers. ■ Valuation: In general steel equities appear to be pricing in a weak cycle and as such any cyclical upturn should be relatively positive. Surprisingly, while there are stock- specific stories, steel names globally are generally at or near historical valuation lows on a P/B metric, suggesting little is priced in for a cyclical rally. On HOLT, the majority of steel names score in the worst quintile on an even blended operational/momentum and valuation framework but on pure valuation alone many score in the top quintile, effectively suggesting a counter consensus value play. ■ Stock picks: On a relative basis our analysts have identified several preferred names across the world, rated Outperform and including. ThyssenKrupp, ArcelorMittal Reliance Steel, Nucor, POSCO, Ternium, MMK and Jindal. These picks are supported by catalysts and valuations. A HOLT valuation supports our preference for ArcelorMittal, Ternium, Voestalpine, and Reliance on a global scale. Figure 8: Regional picks

Source: Credit Suisse research

Global Steel Equities 4

Global Steel Equities Steel Global Figure 9: Mind Map: steel prices

China China Steel Ex china steel Ex-China Demand production production Demand

China IO Available IO Demand Supply into China

Iron Ore Price

Met coal price

Fixed cash Variable Steel Margin ? China Steel arbitrage Global Steel costs Cost Price Price

 What is the margin that is needed to keep  A world of overcapacity Chinese/global players producing medium term  Will the Chinese producers export at all costs? (require LR return).  Who has fixed cost advantage?  Differential routes of making steel. Are there any advantages to be had (e.g. Shale?)

 Currencies can give advantages on fixed costs 06 September

Source: Credit Suisse estimates

2012 5

06 September 2012 Outlook for global steel returns Excess capacity caps pricing power The reality for the global steel industry is severe overcapacity. Capacity was built during the boom years of a commodity supercycle fuelled by Chinese demand and debt in 2001- 08 and against a backdrop of limited new capacity built from the end of the 1990s. In the period since Lehman’s collapse, demand has fallen back sharply in developed economies and is yet to recover, and new capacity has continued to be built in China, and other key regions such as South Korea and Latin America. Globally, there is currently c1.87bt of capacity, versus our forecast for production in 2012 of 1.5bt. With capacity utilisation therefore at c80%, the near- to mid-term outlook for the industry is one of sustained overcapacity, and pricing power therefore on a structural basis is unlikely to be present unless demand can recover or supply be cut. The latter is, in our view, happening in markets that are not forecast to recover (such as South Europe) but on a global scale this is not sufficient. Without comfort that supply will meaningfully adjust over the near term, believing in structural pricing power is contingent on a demand story.

Figure 10: Global steel production (Monthly, mt) vs. capacity (lhs) capacity utilisation (rhs)

Source: WSA, Credit Suisse research

However demand growth looks likely to remain muted over the next few years given the problems in the developed economies and a likely slowdown in demand growth rates. This is not to say there is no growth—our forecasts still assume GDP-aligned growth over the next few years of around 4% CAGR in steel demand, but is only likely to address some of the overcapacity, and not all.

Global Steel Equities 6 06 September 2012

Figure 11: Global steel output (kt, lhs) and Growth Figure 12: Global steel output (kt, lhs) and CAGR trend 140,000 4%

120,000

100,000 8%

80,000 3%

60,000

40,000

20,000

0 Jan-96 Jun-97 Nov-98 Apr-00 Sep-01 Feb-03 Jul-04 Dec-05 May-07 Oct-08 Mar-10 Aug-11

Global steel output

Source: WSA, Credit Suisse research Source: WSA, Credit Suisse research What we think is clear is that cyclically, steel output growth rates are running below trend (which gives us some hope of a cyclical upturn at some stage) but that structurally, growth rates have slowed significantly (halved) since the pre-crisis 8% growth levels from 2001- 08. This gives some cyclical optionality (similar to that in 2001-03) but little chance of a return to a structurally tight market, as we discuss below. The industry should close capacity… In 2002 the OECD began a global steel capacity closure programme aimed at removing some 200-300mt of excess capacity that the OECD had identified at the time. After over a year of talks and discussion papers the plan was shelved as the 2003/04 steel market recovery (and subsequent boom) put paid to any thoughts that excess capacity was a hindrance to future returns. We think it is time for the industry globally to revisit these former plans.

Figure 13: Estimated regional steel excess capacity and utilisation rates (2012) Mt (lhs); % (rhs) 200 95%

180 90%

160 85% 140 80% 120 75% 100 70% 80 65% 60

40 60%

20 55%

- 50% EU 27 NAFTA China India Japan S Korea Taiwan Russia Ukraine Turkey Brazil ROW

est excess capacity est utilisation

Source: WSA, Credit Suisse research

We have estimated capacities by region (based on known additions and prior peak production rates pre crisis). The data suggests Europe, China, Ukraine and the ROW have the greatest single problems of overcapacity.

Global Steel Equities 7 06 September 2012

Capacity closures would in our view be a quick solution to restoring pricing power to the industry (which comes at structural utilisation rates of above c 90%). We think some 180mt of capacity closure would return the industry to 90% utilisation, which should in theory return steel prices to the ‘incentive price for new build’—some US$150/t higher than current spot HRC of c US$600/t. We calculate that even US$100/t of additional margin on c 1.5bn tonnes of crude steel production (or c 1.4bn tonnes of finished steel output) would generate an additional c US$140bn of annual EBITDA for the industry, which would we think far outweigh the net closure costs for the industry. The payback period would be rapid and the net gains for the industry substantial. As became clear in 2002, the problem remains one of ‘prisoner’s dilemma’ in that all participants would gain from the outcome of capacity closure, but deciding who should close capacity and then agreeing on sharing the burden of the costs of closure would likely not be possible. There was an attempt in 2002 that ultimately achieved nothing. … or at least not build more As a minimum we believe the industry should shelve any new capacity plans. Steel companies still often appear to see steel as feeding regional markets, and it is that pursuit of regional market share which perpetuates investment in markets where demand maybe regional, but supply and hence returns are driven by global not regional factors.

Figure 14: Global steel output 1950-2015E (mt) (1973-2003: 30 year period of "disaster" for steels) 2000 1800 4% 1600 1400 1% 1200 1000 6% 800 600 400 200 0 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015E

Source: WSA, Credit Suisse estimates

Much of the capacity still coming on stream in regions such as South Korea, Latam, and Russia is being driven by legacy decisions taken pre-financial crisis. In the long term, the fact that new steel-making capacity (notably outside of China) should not make a required post-tax IRR, and that some capacities (notably in Europe) should be closed, suggests that at some stage the dynamic of the mid 2000s could return, ie, demand growth ultimately catches up with capacity—very much the opposite to what we are seeing currently in iron ore, for example. We have in previous research calculated a required long-term margin of around US$250/t of EBITDA to meet a 15% pre-tax IRR on new blast furnace capacity, which would suggest a long-run steel price of around US$750/t required to incentivise new build—some US$150/t above where global HRC is currently trading. Limiting its new capacity plans could in our view help the global steel industry reverse its current situation. The maths is relatively simple. Assuming around US$100-150/t of cost is fixed (depending on region) or equivalent, then even at current steel prices this allows for around US$100-150/t of EBITDA for each accretive tonne sold on a capex free basis.

Global Steel Equities 8 06 September 2012

If the industry on a current capacity basis ever returned to c 90% utilisation rates, this would suggest c 200mt of steel production could come from existing capacities, or around US$20bn-30bn of additional EBITDA for the global steel industry. On a 6x mid-cycle EBITDA multiple, this would create around US$240bn of value for the global steel industry. While the maths maybe simple, the reality is not. China is unlikely in our view to freeze new capacities and debottlenecking constantly adds 1-2% capacity at a much lower capex per tonne than new-build. Such challenges explain why after the peak of 1950-1973 boom, the steel industry took some 30 years to enter a phase of supply constraint again, which lasted briefly from mid-2004 to September 2008. Unless action is taken either to close capacity or at least curb new capacity, then we think industry returns could be structurally very low for a significant number of years. 7–c20 years to see a tight market again?

Figure 15: Scenario A supply/demand / utilisation (x axis Figure 16: Scenario B supply/demand / utilisation (x axis no of years, y axis bn tonnes) no of years, y axis bn tonnes) 2.50 100% 3.50 100%

95% 3.00 95% 2.00 2.50 90% 90% 1.50 2.00 85% 85% 1.50 1.00 80% 80% 1.00 0.50 75% 0.50 75%

- 70% - 70% 01234567 01234567891011121314151617

Capacity demand Utilisation Capacity demand Utilisation

Source: Credit Suisse estimates Source: Credit Suisse estimates

Ultimately the dynamic of inadequate returns on new build and on-going demand growth globally should see the steel industry return to a period of tighter supply/demand dynamics, but across the 2 scenarios we choose, at an optimistic rate this could take 7 years and a more pessimistic view this could take more like 17 years. In scenario A) we assume no new capacity build (optimistic) and 1.5% capacity creep from debottlenecking, and an ongoing 4% demand growth. Under this dynamic it would take 7 years for the global steel industry to hit c 95% (full) capacity and with it the structural pricing power that comes as a requirement for the industry to incentives new plant construction. In scenario B) where we see 3 % capacity creep and 4% demand growth it would take more like 17 years for the industry to hit effective ‘full’ capacity and with it, structural pricing power.

Global Steel Equities 9 06 September 2012

The market has priced in a good degree of this dynamic

Figure 17: Global steel equities and steel output (kt) (lhs) Figure 18: Global steel equities(rhs) & steel o/p (both yoy)

Source: WSA, Thomson Reuters, Credit Suisse research Source: WSA, Thomson Reuters, Credit Suisse research

While the analysis above presents a relatively bleak outlook for the industry, it is also fair to say that post the 2004-08 boom the market has been relatively quick to derate the sector for a prolonged period of lower returns. As we see above, steel equities decoupled from global steel output in 2009 and this is reflected in share prices, representing structural overcapacity. On a more cyclical view it is also clear that in general (in a similar pattern to 2000/2001) steel equities’ pricing has been relatively responsive to weak growth rates and the subsequent poor sector earnings at the current stage of the cycle. While there may be limited if any structural opportunities to play the broader sector, there should still be opportunities to benefit from a cyclical upturn if and when it comes. In general given all of the above, and where we are in the cycle we would err towards owning the sector for now. The problem is that steel equities will likely trade as they did in the 1990s, in that rallies should be treated as an opportunity to take profits. There remains a risk of a longer term structural de-rating of the sector as we saw in the 1970s and 1990s.

Global Steel Equities 10 06 September 2012 Pricing/costs and returns outlook Steel prices Figure 19: Global HRC by region (US$/t) Figure 20: Global Rebar by region (U$/t)

1,200 1400

1200 1,000 1000 800 800

600 600

400 400 200 200 0 0 Jul-96 Jul-01 Jul-06 Jul-11 Apr-95 Oct-97 Apr-00 Oct-02 Apr-05 Oct-07 Apr-10 Jan-94 Jan-99 Jan-04 Jan-09

Jul-82 Jul-87 Jul-92 Jul-97 Jul-02 Jul-07 Jul-12 USA Germany Italy CIS China Far East Apr-81 Oct-83 Apr-86 Oct-88 Apr-91 Oct-93 Apr-96 Oct-98 Apr-01 Oct-03 Apr-06 Oct-08 Apr-11 Jan-80 Jan-85 Jan-90 Jan-95 Jan-00 Jan-05 Jan-10 USA Italy Japan Far East China

Source: CRU, Credit Suisse research Source: CRU, Credit Suisse research At a global level steel prices have, with the odd blip, been on a downward trend since the post-crisis peak in early 2011 and have converged at around US$600/t for HRC. This is now broadly around industry cash cost and has been the decisive factor recently in steel output cuts and hence falling raw material prices. Steel prices of late have rallied in the US, stabilised in Europe and continued to fall in Asia (notably China). This is a normal pattern however, looking at the last 10 years or so, in that the US tends to recover first, then Europe then Asia. Steel costs Figure 21: Global steel cost curve HRC Q4 2011($/t)

Source: MBR The global steel cost curve for HRC is relatively flat – with the steeper lower end dominated by backward integrated producers with raw materials. The change in raw material pricing had a significant effect on flattening the curve, as all buyers in effect moved to the same methodology for purchasing raw materials. In Q4 2011 the 75th percentile (roughly global utilisation in that period) saw an operating cost of HRC of around US$750/t. Since then steel costs have fallen by some US$160/t as ore and coal prices have dropped, leading to a 75th percentile operating cost of c US$600/t—which is broadly where the global steel price is currently trading.

Global Steel Equities 11 06 September 2012

Figure 22: Global steel output (monthly, t) vs. iron ore price ($/t)

Source: WSA, Thomson Reuters Structurally, costs appear to have peaked and look set to decline. Already in 2012 iron ore has visibly decoupled pricing-wise from steel output, which by definition means supply is now structurally outpacing demand. Met coal has suffered a similar dynamic. We expect iron ore and coal prices to structurally drift down, although with the price action we have seen YTD, the decline looks at this time to have more leverage to the downside than upside. Price fluctuations (and cyclical returns) driven by apparent demand As we noted above, we believe the steel industry will not see structural pricing power until excess capacity is removed through closure or demand outstripping supply for a sustained period. Structural pricing power in effect (like copper and iron ore) would see the steel prices move off the cost curve to meet the incentive price for building new mills – and ex China this would eventually see a normalised steel price of c US$750/t on our estimates (on current RM prices).

Figure 23: Global steel o/p growth (lhs) vs. CIS export price y/y

60% 140% 50% 120% 40% 100% 30% 80% 20% 60% 10% 40% 0% 20% -10% 0% -20% -20% -30% -40% -40% -60% Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

Global y/y steel production growth CIS export price HRC y/y

Source: WSA, Thomson Reuters

Global Steel Equities 12 06 September 2012

Steel prices are likely, therefore, to rise and fall with the apparent demand cycle (which is largely driven by macro confidence) – similar to the cycles of the 1990s, and it is likely to be this dynamic only that drives the broad sector for the foreseeable future. On balance, steel equities are broadly likely to be a long-term zero gain as they were for much of the 1990s, but the upside to peak and the downside to trough are likely to produce relatively wide swings in the equities across a cycle. Steel margins are however, likely to be far more constrained than they were in the pre- 2010 period given the structural change in the nature of raw material pricing, which on the upside no longer allows steelmakers a windfall profits year (higher prices stable raw material costs) but on the downside should also help to protect steel margins to some extent.

Steel margins… Converging costs and a changed dynamic

Figure 24: Steel implied cost analysis (3 month cost lag) Figure 25: Iron ore/met coal vs scrap 700 600 500 400 300 200 100 0 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

IO + Met Scrap

Source: CRU, Credit Suisse research Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse research

Regarding margins, there are 2 key issues to note. Firstly the inputs into steel-making have recently converged post the change in pricing structure for ore and coal, with scrap prices now broadly equivalent (aside from short term fluctuations) with the iron ore/met coal equivalent. This has in effect brought the raw material cost for arc furnaces into line with Blast furnace producers (the Blast Furnaces used to have a relative advantage). As we discuss below, from a variable cost perspective margin differentiation between producers will be dependent on access to cheaper than market sources of raw materials and fixed costs advantages such as labour (and this can include currency).

Global Steel Equities 13 06 September 2012

Figure 26: Global steel o/p (mt) vs. CIS spread (HRC price vs. iron ore, coal and scrap)

140 900

130 800 700 120 600 110 500 100 400 90 300 80 200

70 100

60 0 Jul-01 Jul-02 Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

Global steel o/p Raw material margin (RHS) ($/t)

Source: WSA, the BLOOMBERG PROFESSIONAL™ service, Credit Suisse research

Since the introduction of more or less spot raw material prices in 2010 steel margins have become relatively more stable (albeit at a much lower level) than the 2003–09 period when the fixed nature of raw material contracts led to significant windfall profits and losses on an annual basis depending on the restock/destock cycle for steel (which drive steel prices one year and raw material prices the next). Excess capacity shows up in global export market liquidity Although steel prices differentiate from region to region for short periods of time, it is ultimately the global export price that sets domestic steel prices in the long run (plus or minus any differentials from tariffs or transportation costs). Figure 26 shows the CIS export price versus the variable cost equivalent (ore coal and scrap) for a BoF producer. It suggests that other than in periods where the industry is temporarily short of supply (such as the second half of 2009 and early 2010) in a steady state market the global HRC price is in effect priced at a c US$100-200 per tonne margin above RM price – with the average spread around US$160/t broadly covering fixed costs and transportation. This dynamic will likely be the driver of the long term steel price until ultimately we see excess capacity eliminated. Chinese exports… increasingly structural While it is global and not simply Chinese overcapacity that has caused a loss of structural pricing power, we think it is fair to say that the risk of increasing structural exports of steel from China has become a threat to the chances of excess capacity in developed economies being eliminated. We think it is also fair to say that total excess capacity in china is greater than anywhere else in the world.

Global Steel Equities 14 06 September 2012

Figure 27: China steel exports vs. China US price diff ($/t, Figure 28: China steel exports vs. China EU price diff rhs) 400 7000 7000 280 300 6000 6000 230

5000 200 5000 180

4000 4000 130 100 3000 3000 80 0 2000 2000 30 -100 1000 1000 -20

0 -200 0 -70 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

Chinese steel exports (T) Diff (China US) HRC price Chinese steel exports (T) Diff (China Europe) HRC price

Source: CRU, Credit Suisse research Source: CRU, Credit Suisse research While Chinese exports are still to some degree correlated with price differentials and profitability, exports appear to have become increasingly structural. Chinese producers, so long as they are making a margin, seem to be willing to export no matter what the price. Even when margins (price – iron ore – coking coal – scrap) turn negative, exports over the short term have been present.

Figure 29: US HRC price ($/t,rhs) vs US. Imports (kt lhs)? 4500 1400 4000 1200 3500 1000 3000 2500 800 2000 600 1500 400 1000 500 200 0 0 Jul-98 Jul-99 Jul-00 Jul-01 Jul-02 Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

US IMPORTS US HRC price (U$/t)

Source: CRU, Credit Suisse research

But as we show in the chart above (which shows how rising prices in the US attract greater imports) pricing arbitrages in a world of excess capacity are ultimately driven away by tradeflows which add additional supply to a domestic market with around a 3 month lag. Against a backdrop of muted but volatile demand growth and relativity constant supply, cycles are likely to be remain short and sharp. With mills operating below full utilisation the supply side response is likely to remain relatively swift on a global scale but regionally at least, there will likely be periods of oversupply and under supply. So while the structural outlook for pricing is weak, it will be these mini or perhaps micro cycles that allow prices in certain geographies to move out of line with global prices.

Global Steel Equities 15 06 September 2012

We acknowledge there will be brief periods where regional pricing falls out of kilter across regions – this is a normal part of the steel cycle given steel pricing is locally priced but globally arbitrage-able. Mini-cycles in local markets can force prices up above the long term global export price for a period of time. Furthermore if we do see a sustained global IP recovery such as in 2010, then it is likely steel markets will for a while appear “short of steel”, driving prices off the global cost curve for a while. Cycles such as the boom of 2000, or the recovery of 2009/2010 forced steel prices high above the cost curve for some time. Cycle and pricing outlook

Figure 30: Global Steel IP vs Steel output

15% forecast 20.0% 10%

10.0% 5%

0.0% 0%

-10.0% -5%

-10% -20.0%

-15% -30.0% Jan-97 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13

Global IP y/y lhs Global steel y/y

Source: WSA, Credit Suisse research

Steel apparent demand is a function of the global IP cycle, with the inventory changes in steel being significant enough to leave apparent steel demand oscillating at around 2x the IP growth trend.

Figure 31: Global steel o/p vs. growth trend Figure 32: Global steel o/p vs. growth trend (CS forecast) 140,000 40.0% 140,000 40.0%

120,000 30.0% 120,000 30.0%

100,000 20.0% 100,000 20.0%

80,000 10.0% 80,000 10.0%

60,000 0.0% 60,000 0.0%

40,000 -10.0% 40,000 -10.0%

20,000 -20.0% 20,000 -20.0%

0 -30.0% 0 -30.0% Jan-96 Jul-97 Jan-99 Jul-00 Jan-02 Jul-03 Jan-05 Jul-06 Jan-08 Jul-09 Jan-11 Jan-96 Aug-97 Mar-99 Oct-00 May-02 Dec-03 Jul-05 Feb-07 Sep-08 Apr-10 Nov-11

Global steel output global steel output growth Poly. (global steel output growth) global steel output global steel output growth Poly. (global steel output growth )

Source: WSA, Credit Suisse research Source: WSA, Credit Suisse estimates

The cycle itself is looking similar to 2001-2003… not the crises of 1998 and 2008 but a slow trawl along the bottom of no growth. The problem is there remains the spectre of an Asian/Russian type crisis overhead if Europe suffers from some kind of accelerating crisis scenario. In 2001–03 we saw trend growth of around 3% and in the recession of those years, growth averaged zero, 300bps below trend for the best part of 2 years before rebounding sharply in 2004.

Global Steel Equities 16 06 September 2012

Since the 2009 recovery growth rates have been running at around 4% globally with the apparent demand growth average of the last 12 months around 1% or c 300bps below that trend. In principle therefore and barring a crisis scenario, we should at some stage see a repeat of the 2003-04 recovery period which is supported by Credit Suisse’s IP forecasts. Extrapolating current output as we do on the chart above, we would see a rebound in growth rates similar to 2004 commencing at the back end of 2012E. 10-15 years on… does history repeat? 1997 and 1998 saw 2 major crises hit the steel market hard. We saw a rebound commence in 1999 and peak in 2000 and then a recession in 2001-2003 before the recovery in 2004 took hold. Ten years on, we saw the US/UK move into crisis in 2007, a global crisis in late 2008 and a rebound in 2010 and a recession thereafter. Based on history, this suggests the recovery should only commence from mid-2013E and should show its true strength in 2014E and early 2015E.

Figure 33: Credit Suisse GDP and IP forecasts Annual average 10 11 12E 13E Global Real GDP y/y 5.0 3.8 3.3 3.8 IP y/y 9.6 5.1 3.4 4.7 Inflation y/y 3.5 4.7 3.6 3.3 China Real GDP y/y 10.3 9.2 7.7 7.9 IP y/y 15.7 13.9 11.6 12.1 Inflation y/y 4.6 4.1 2.8 2.4 US Real GDP y/y 2.4 1.8 2.2 2.4 IP y/y 5.4 4.1 4.2 3.9 Inflation y/y 1.6 3.1 2.1 1.5 Japan Real GDP y/y 4.5 -0.8 2.3 1.3 IP y/y 16.5 -2.4 2.5 2.3 Inflation y/y -1.0 -0.3 0.0 -0.2 Euro Area Real GDP y/y 1.9 1.5 -0.5 0.5 IP y/y 7.3 3.6 -2.5 -0.4 Inflation y/y 1.6 2.7 2.5 2.0 Brazil Real GDP y/y 7.5 2.7 2.0 4.0 IP y/y 10.4 1.6 0.6 3.7 Inflation y/y 5.0 6.5 5.1 5.0 India Real GDP y/y 8.4 6.5 6.3 7.6 IP y/y 8.2 2.9 4.3 7.8

Inflation y/y 9.6 8.9 6.7 7.0 Source: Credit Suisse estimates Examining our house GDP and IP forecasts on a global basis, we believe that both GDP and IP will accelerate in 2013E, leading to acceleration in apparent steel consumption through 2013 and into 2014. This in turn should see steel prices higher and the underlying margins of the steel industry expand closer to 2010/2011 levels. This macro dynamic is reflected in our supply and demand estimates are shown below:

Global Steel Equities 17 06 September 2012

Figure 34: Global Crude steel Production and forecasts (mt) 2004 2005 2006 2007 2008 2009 2010 2011 2012E 2013E 2014E 2015E 2016E EU 27 202 196 207 210 198 139 173 177 170 175 181 185 188 NAFTA 131 125 130 131 123 81 110 119 123 127 129 130 130 China 280 354 424 493 499 574 624 679 700 750 790 840 890 India 33 38 46 53 58 63 68 74 76 80 88 93 98 Japan 113 112 116 120 119 88 110 108 109 115 116 116 117 S Korea 48 48 49 51 54 49 58 69 68 69 71 72 74 Taiwan 19 19 20 21 20 16 20 23 21 22 22 23 24 Russia 66 66 71 72 69 60 67 69 70 72 74 76 77 Ukraine 39 39 41 43 37 30 33 35 30 32 33 34 36 Turkey 20 21 23 26 27 25 29 34 34 35 37 39 41 Brazil 33 32 31 34 34 27 33 35 33 35 37 38 39 ROW 88 96 90 92 93 61 66 66 66 69 71 73 75 Global total 1,072 1,144 1,247 1,346 1,329 1,211 1,392 1,487 1,500 1,580 1,649 1,719 1,788 Growth y/y % 10% 7% 9% 8% -1% -9% 15% 7% 1% 5% 4% 4% 4% ex-China 791 791 824 853 830 638 767 808 800 830 859 879 898 Growth ex-China 6% 0% 4% 4% -3% -23% 20% 5% -1% 4% 3% 2% 2% Growth China 27% 26% 20% 16% 1% 15% 9% 9% 3% 7% 5% 6% 6% Source: WSA; Credit Suisse estimates (2012E-2016E). We note that our Chinese analyst, Trina Chen, has lower forecasts (750mt in 2015) than that in our house base case.

Figure 35: Global Steel Apparent Demand and forecasts* mt 2004 2005 2006 2007 2008 2009 2010 2011A 2012E 2013E 2014E 2015E 2016E EU 27 172 166 189 198 183 119 147 153 145 150 154 156 158 Change % y/y 8% -4% 14% 5% -8% -35% 24% 4% -5% 3% 3% 1% 1% Other Europe 22 23 27 30 27 24 30 33 32 33 33 34 35 Change % y/y 14% 4% 16% 12% -10% -12% 24% 11% -3% 2% 2% 2% 2% CIS 38 42 49 57 50 36 49 54 53 56 58 61 64 Change % y/y 3% 9% 18% 16% -12% -28% 34% 11% -2% 5% 4% 5% 5% NAFTA 151 138 155 141 135 85 116 121 126 130 132 134 135 Change % y/y 15% -9% 13% -9% -4% -37% 36% 5% 4% 3% 2.0% 1.0% 1.0% Central and South Am 33 32 37 42 41 31 43 46 46 48 51 53 55 Change % y/y 20% -2% 14% 13% 0% -24% 36% 8% 0% 5% 5% 4% 4% Africa 18 19 20 21 24 27 25 23 23 24 25 26 27 Change % y/y 4% 10% 3% 3% 17% 11% -8% -8% 1% 3% 5% 5% 5% Middle East 32 34 34 44 46 42 47 48 50 51 54 57 61 Change % y/y 3% 6% 1% 27% 5% -9% 13% 3% 3% 3% 6% 6% 6% Asia ex China 227 232 243 257 246 215 254 265 265 273 284 295 304 Change % y/y 6%2%5%6%-4%-12%18%4%0%3%4%4%3% China 276 348 378 418 447 551 588 624 640 672 708 747 787 15% 26% 9% 11% 7% 23% 7% 6% 3% 5% 5% 5% 5% World 981 1,048 1,143 1,226 1,210 1,139 1,294 1,373 1,389 1,445 1,509 1,572 1,636 Change % y/y 9.8% 6.8% 9.1% 7.2% -1.3% -5.9% 13.6% 6.2% 1.2% 4.0% 4.4% 4.2% 4.0% Ex China 705 700 765 808 763 588 706 749 750 773 801 826 848 World ex China 8% -1% 9% 6% -5% -23% 20% 6% 0% 3% 4% 3% 3% Source: WSA; Credit Suisse estimates *(note key difference between crude steel production and finished steel consumption is c 10% yield loss)

Global Steel Equities 18 06 September 2012

Global Pricing outlook

Figure 36: CS derived global HRC price using 1.6t ore/0.6t met coal and 20% scrap per tonne of hot metal Iron Ore (CIF, 62% Cost (1.6x IO, 0.6x US HRC CIS HRC CIS export China) Coking coal Scrap CC, 0.2x Scrap) Margin margin price ($/t) 2001 18 42 76 68 178 96 164 2002 17 47 89 74 281 154 228 2003 18 47 118 81 239 206 287 2004 21 56 207 109 562 415 524 2005 34 109 191 158 441 286 444 2006 44 117 218 184 457 319 504 2007 49 102 247 189 396 378 566 2008 80 250 358 349 597 509 858 2009 68 172 205 252 279 199 451 2010 114 190 323 361 304 247 608 2011 164 292 409 520 294 155 675 2012E 139 221 355 426 282 167 593 2013E 145 210 358 430 287 187 617 2014E 128 205 328 393 300 200 593 2015E 115 200 304 365 310 210 575 Source: CRU, Credit Suisse Research, Credit Suisse estimates

Looking forward at global pricing we take the following into account: (1) Sustained overcapacity and hence cost curve driven pricing (2) Some cyclical pricing power as steel output recovers in line with GDP/IP forecast acceleration driving improved apparent steel demand (3) Changes to the cost curve primarily based on our longer term forecasts for iron ore and met coal (4) Structural differentials in markets - for example the US is a natural net importer of steel and as such has a cushion of transportation costs for domestic producers. (5) In local markets, quality differentials and preferred buyer focus, in that local market buyers of steel will generally pay a premium for locally sourced higher grade steels than basic export market equivalents. In general for example European domestic HRC trades some €50 per tonne higher than imported material for (perceived) quality and service reasons. On this basis we derive the global mid-range HRC export price as US$593/t in 2012E up to US$617/t in 2013E. We expect the margin to improve over the next few years in line with an improving demand environment, but margins are still likely to be well below 2010 levels.

Global Steel Equities 19 06 September 2012

Figure 37: Regional prices $/t with premium versus CIS export price by region 2005 2006 2007 2008 2009 2010 2011 2012E 2013E 2014E 2015E CIS export 444 504 566 858 451 608 675 593 617 593 575

US 600 641 585 946 531 665 814 693 717 693 675 diff 155 138 19 89 80 58 139 100 100 100 100

Germany 562 585 666 926 569 691 773 683 692 668 650 diff 118 81 100 68 118 83 97 90 75 75 75

China 530 490 565 727 528 633 736 673 632 608 590 diff 85.6 -13.2 -1.9 -130.7 76.6 25.6 60.4 80.0 15.0 15.0 15.0 Source: CRU, Credit Suisse estimates

Within this context we then derive local market HRC prices based on historical differentials versus the derived HRC export price. Although our steel price forecasts are lower in 2014 than 2013, the actual return to the steel industry (non-integrated producers) should be higher given lower raw material prices.

Global Steel Equities 20 06 September 2012 Valuation and stock picks P/B Globally, steel names are trading at near trough levels of P/B vs. their own historical averages, with little differentiation. This supports the view that cyclical stocks have priced in a weak cycle and as such any cyclical upturn should be relatively positive for the equities. Regionally, pure carbon Western European names are nearer these floors than other regions, with niche names trading at a premium still (reflecting in part OCTG strength and German industrial strength). Eastern European names remain elevated on P/B metrics— more a reflection perhaps of the crisis in the 2008 than of current operating fundamentals (which remain weak) Chinese and Korean names have also hit low levels, and in both regions, while analysts remain relatively subdued on the structural outlook for physical steel markets, they are more optimistic on the stocks. US names are varied, with distributors such as Reliance trading above previous lows, reflecting relative earnings resilience. Latin American names we cover all trade above historical P/B lows while Indian companies we cover are all sub 1x Book but still above the 2008 lows.

Figure 38: Europe/E.Europe/Africa – PB range 2009-current

3.50

3.00

2.50

2.00 High 1.50 Low Now 1.00

0.50

0.00

Source: Company data, Credit Suisse estimates

Global Steel Equities 21 06 September 2012

Figure 39: Americas – PB range 2009-current

6.00

5.00

4.00 High 3.00 Low Now 2.00

1.00

0.00

Source: Company data, Credit Suisse estimates

Figure 40: Asia and others – PB range 2009 - current

4.00

3.50

3.00

2.50 High 2.00 Low Now 1.50

1.00

0.50

0.00

Source: Company data, Credit Suisse estimates

Credit Suisse HOLT The HOLT Scorecard is a multi-factor stock selection tool. Stocks are ranked based on a weighted score across 10 HOLT factors which are grouped across Operations, Momentum and Valuation. Quintile 5 denotes best score and 1 denotes the lowest score. Universe: Steel stocks >$ 3bn market cap. Ranking is relative to World Stocks. While steel names do not screen generally as top quintile investments on an aggregate basis, on a valuation basis there are many top quintile investments based on the HOLT framework.

Global Steel Equities 22 06 September 2012

Figure 41: HOLT Screen (sorted by valuation quintile, 5=Top. 1 = Bottom) Ops Overall Company Name Quintile Mom Quintile Val Quintile Quintile ARCELORMITTAL 2152 VOEST-ALPINE AG 2153 RELIANCE STEEL & ALUMINUM CO 5355 TERNIUM SA 3153 EREGLI DEMIR VE CELIK FABRIKALARI T.A.S. 2152 UNITED STATES STEEL CORP 2153 JSW STEEL LIMITED 3454 NIPPON STEEL CORPORATION(C) 1141 BAOSHAN IRON & STEEL COMPANY LIMITED 1242 JFE HOLDINGS, INC.(C) 1241 SUMITOMO METAL INDUSTRIES, LTD.(C) 1141 JINDAL STEEL & POWER LIMITED 4143 STEEL AUTHORITY OF INDIA LIMITED 1141 USIMINAS - USINAS SIDERURGICAS DE MINAS GERAIS SA 1141 MAGNITOGORSK IRON & STEEL WORKS 1141 SSAB SVENSKT STAL AKTIEBOLAGET 2142 KOBE STEEL, LTD.(C) 1141 SALZGITTER AG 2142 POSCO 2232 NUCOR CORP 4233 SEVERSTAL 4132 TATA STEEL LIMITED 1131 HITACHI METALS, LTD.(C) 2232 ACERINOX, S.A. 1131 ARCELORMITTAL SOUTH AFRICA LTD 2131 GERDAU S.A. 1221 CHINA STEEL CORPORATION 2121 NOVOLIPETSK STEEL OJSC 1121 THYSSENKRUPP AG 3121 CSN - COMPANHIA SIDERURGICA NACIONAL 4122 HYUNDAI STEEL COMPANY 2121 ANGANG STEEL COMPANY LTD 1121 Source: Credit Suisse HOLT

The HOLT rankings for valuation for ArcelorMittal, Voestalpine, Reliance, Ternium are all supportive of our analyst Outperform views. 2nd quartile rankings for CSN support the Underperform stance of our Brazilian team. Although ThyssenKrupp screens poorly, HOLT does not take into account the returns and balance sheet changes that could occur from a successful disposal of the Americas plants. The above ranking is based on HOLT Valuation Metrics with the following weightage: HOLT Percent to Best (50%), Economic P/E Ratio (30%), Dividend Yield (10%), Value Cost Ratio (10%). Ranking relative to World Stocks.

Global Steel Equities 23 06 September 2012 China (c700mt output 2012E) Fundamentals Supply/Production Trina Chen 852 2101 7031 Figure 42: China steel production and growth [email protected] Frankie Zhu 852 2101 7426 [email protected]

Source: WSA Chinese crude steel output was 61.7 mn tonnes in July, up 4% YoY and up 2% MoM. Daily output reported by CISA July was 1.97 mn tonnes/day, and remained stable at 1.93mn tonnes (or 704 mn tonnes on annualised basis) as of second ten days of August. Over-production remains an issue. Despite poor industry profitability, we see deteriorating supply discipline versus past years, partly due to fixed costs such as financing cost, and the struggle to maintain market shares in a poor demand environment. While there are maintenance cuts, these remain mild at this stage. Demand

Figure 43: China apparent demand and growth

Source: WSA, ISSB

Global Steel Equities 24 06 September 2012

Apparent consumption in 7M12 was 677 mn tonnes (annualised), up 1% YoY. Demand has been stagnant across the board. We expect a mild seasonal recovery in the construction market in 4Q12, yet effective stimulus policy remains absent. A slow growth outlook remains for 2013E, in our view. Inventory

Figure 44: Steel inventory—warehouse and mills Steel inventory level (mn tonnes) 30 25 20 15 10 5 0 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13

Warehouse Large/med steel mills

Source: CEIC, Mysteel

Steel trader/Warehouse inventory is lower than a year ago, but our channel checks suggest finished steel product inventory is higher than usual for selected mills. Steel inventory at large and medium mills is over 12 mn tonnes, 45% higher yoy. Costs/currencies The domestic iron ore price in Hebei fell 4% MoM to US$138/t; the import spot CFR fell 20% to US$99/t. Domestic Kailuan coking coal is US$198/t, down 2% MoM, while semi- coking coal fell 17% from the peak. Falling costs led to a decline in steel prices. We estimate the average rebar producer will still be just about breakeven on a cash basis, based on spot raw material cost, and further downside risk remains in both steel and IO pricing. Pricing

Figure 45: HRC prices—China spot, Baosteel contract HRC Price (US$/tonne) 1000 US 800

600

Baosteel Eastern-China spot 400 contract

200 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13

Source: Mysteel, CRU, Company data

Global Steel Equities 25 06 September 2012

The Chinese current spot HRC price is US$481/t, down 7% MoM and prices for rebar and CRC are US$467/t and US$608/t, down 2% and 3% MoM, respectively. In the near term, poor seasonality and over-production in steel should continue to put pressure on pricing until negative margin emerges in steel at a “floored” IO price.

Figure 46: Chinese imports/exports—steel products Net exports of total steel (incl FS and semis, annualised) (mn tonnes) 120

90

60

30

0

-30 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Sep-07 Sep-08 Sep-09 Sep-10 Sep-11 Sep-12 May-07 May-08 May-09 May-10 May-11 May-12

Imports Exports Net exports

Source: CEIC, Mysteel, Credit Suisse estimates Earnings outlook The Chinese steel producers have reported poor earnings, with 1H12 losses of between Rmb2bn-3bn, for Angang and Maanshan. Baosteel was alone in reporting recurring profit of Rmb2.8bn for the period. We expect to see depressed margins persisting in the steel sector due to deteriorating supply discipline and a flat cost curve, combined with structurally excessive capacity, in the context of slow demand. Stocks Valuation Chinese steel stocks are trading between 0.4-0.6x P/B, factoring in persistent poor fundamentals. Yet continued depressed margin will further derate the sector in our view— potentially to 0.3-0.4x P/B. Catalysts Poor 1H12 results and negative earnings momentum. Balance sheet and other risks A persistent poor operating environment has led to rising A/R days in general for the industry. A/P days is also on the rise. Gearings are moving up as well. EBITDA/financial costs at this stage is more than 2x, although bank lends seemed essential for mills to keep the cash flow. Favoured stocks Baosteel (600019.SS, Rmb4.35, NEUTRAL, TP Rmb5.20) Least favoured Angang Steel Company Ltd. (0347.HK, HK$3.79, UNDERPERFORM, TP HK$2.30) Maanshan Iron & Steel Co Ltd. (0323.HK, HK$1.57, UNDERPERFORM, TP HK$1.00)

Global Steel Equities 26 06 September 2012 Europe (c180mt output 2012E) Fundamentals

Figure 47: EU IP versus steel output growth all yoy % Michael Shillaker 44 20 7888 3270 0.5 0.25 michael.shillaker@credit- 0.4 0.2 suisse.com 0.3 0.15 Nihal Shah 0.2 0.1 44 20 7888 3270 [email protected] 0.1 0.05 James Gurry 0 0 01/08/2003 01/10/2004 01/12/2005 01/02/2007 01/04/2008 01/06/2009 01/08/2010 01/10/2011 44 20 7883 7083 -0.1 -0.05 [email protected] -0.2 -0.1 Liam Fitzpatrick -0.3 -0.15 44 20 7888 7888 [email protected] -0.4 -0.2

-0.5 -0.25

Steel Output IP

Source: WSA; Credit Suisse research Demand

Figure 48: EU IP vs. IP growth % 115 15%

110 10%

5% 105 0% 100 -5% 95 -10% 90 -15%

85 -20%

80 -25% Jun-2003 Jul-2004 Aug-2005 Sep-2006 Oct-2007 Nov-2008 Dec-2009 Jan-2011 Feb-2012

EU IP EU IP growth

Source: Credit Suisse Research

Demand growth peaked in Europe in 2010 and absolute demand a year later in mid-2011. Since then we have been in a significant slowdown phase driven by fears of the “European Crisis”, and its impact on confidence and end demand. Regardless of the slowdown it is clear that absolute demand remains a way off the pre-crisis highs and is broadly back a decade to the last recession of 2001-2003.

Global Steel Equities 27 06 September 2012

Supply/Production

Figure 49: EC-15 steel output (kt) vs. Y/y growth %

17000 30%

15000 20%

13000 10%

11000 0%

9000 -10%

7000 -20%

5000 -30% Jan-96 Aug-97 Mar-99 Oct-00 May-02 Dec-03 Jul-05 Feb-07 Sep-08 Apr-10 Nov-11

EC 15 % y/y Poly. (% y/y)

Source: WSA, Credit Suisse research

Steel apparent demand (as highlighted above with production) remained stubbornly high in Europe in 2010/2011 against the backdrop of weakening end demand as inventory was built through the system , most notably in Germany. Since the summer of 2011 however, apparent demand and production rates have fallen sharply and we are now at a run rate of growth significantly below the long-term trend. This is normally a prerequisite for some kind of up cycle. Inventory

Figure 50: Europe Flat carbon inventories (Kt) vs. I/S ratio (rhs) (Kt) (months in hand) 1,600 5.8

5.3 1,400 4.8 1,200 4.3

1,000 3.8

3.3 800 2.8 600 2.3

400 1.8 Jul-97 Jul-98 Jul-99 Jul-00 Jul-01 Jul-02 Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Flat CarbonJan-02 InventoriesJan-03 Jan-04 Jan-05 I/SJan-06 Ratio (RHS)Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

Source: CRU, Credit Suisse research

Inventory, especially in Germany, has been rapidly built in the post crisis period and entering the summer of 2012, was at record highs. We think inventory will work its way lower through the end of the year – as end users destock and steel mills cut output in reaction to this.

Global Steel Equities 28 06 September 2012

Trade flows

Figure 51: EU net imports/exports vs. USDEUR

1500 1.7

1000 1.6

500 1.5

0 Jan Aug Mar Oct May Dec Jul Feb Sep Apr Nov Jun Jan Aug Mar 1.4 2004 2004 2005 2005 2006 2006 2007 2008 2008 2009 2009 2010 2011 2011 2012 -500

1.3 -1000

1.2 -1500

-2000 1.1

EU net imports /exports USD EUR

Source: Eurostat; Thomson Reuters

Although longer term Europe tends to be a marginal net exporter, this trend has accelerated post crisis against a backdrop of weak domestic demand and a weakening euro, making European steel more competitive to export. YTD in 2012 the run rate of EU exports has been around 12mtpa, around 7% of the total market size of the EU 27 steel market. Pricing

Figure 52: Germany Flat & Long prices Figure 53: Italy Flat & Long prices 1600 1600

1400 1400

1200 1200

1000 1000

800 800

600 600

400 400

200 200

0 0 Jul-95 Jul-96 Jul-97 Jul-98 Jul-99 Jul-00 Jul-01 Jul-02 Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-95 Jul-96 Jul-97 Jul-98 Jul-99 Jul-00 Jul-01 Jul-02 Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

HRC CRC HDG Rebar HRC CRC HDG Rebar

Source: CRU, Credit Suisse research Source: CRU, Credit Suisse research

Pricing in Europe peaked in Q2 2011 and apart from a brief spike in early 2012, it has been on a steady downward trend since, and is now back to late 2009/early 2010 levels. Given the output cuts we noted above, and that steel prices are broadly on cash cost for the European mills, the steel price slide appears to have stopped – prices are now stabilising at current levels.

Global Steel Equities 29 06 September 2012

Earnings outlook The earnings outlook for H2 as a consequence of the above remains relatively tough. Prices are low and at cash cost levels, and output cuts are driving up average cost. It appears however that barring a further demand shock event, we should see steel prices begin to recover, perhaps in late 2012 or early 2013. In turn volumes should cyclically start to recover suggesting earnings momentum reverses upwards from Q4 2012E. The potential strength of the earnings recovery depends primarily on European demand (relative to output cuts), where the outlook is far from bullish, as well as the speed with which inventory is worked down. Beyond the initial phase of earnings recovery however, global fundamentals will kick in—namely the strength of global markets and the consequent trade flow effects on the supply side. We think the cycle should remain relatively short-lived, without any form of strong global demand recovery. However visibility is poor and will likely remain so through the back end of 2012E. Stocks Valuation While a thorough comps table is provided at the back of this note for all regions (see Appendix, Equity performance and comps, starting on page 70), we would highlight that European names trade at or near 2012E P/B lows in most cases. Taking balance sheets into account, all the names we cover are at EV/IC lows with the exceptions of Voestalpine and Tenaris. The latter is an OCTG name, and we exclude analysis here. Figure 54: P/B European steels (High Low now) Figure 55: EV:IC range (High Low now)

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates Relative to returns both Voestalpine and Thyssen look cheap and in part this explains on the face of it a superior valuation on balance sheet metrics. Figure 56: P/B vs ROE 2012

20%

15% Tenaris

Voestalpine 10%

5% SSAB ThyssenKrupp ArcelorMittal Vallourec Acerinox 0% Salzgitter 0.0 0.5 1.0 1.5 2.0 2.5 Aperam OutoKumpu -5% Kloeckner

-10%

Source: Credit Suisse estimates

Global Steel Equities 30 06 September 2012

Balance sheet and other risks Deleveraging in the steel industry is as much a focus now as it was in the 2002-2005 period. Corporates such as Mittal and TKAG are selling assets to deleverage balance sheet excess which was built up during the boom period of 2006-2009. Favoured stocks Within the steel names we continue to recommend self-help catalyst investments (Thyssen) and also ArcelorMittal for the eventual recovery. Of the mid-cap steel names our most preferred is Voestalpine for its strategic focus. Our least preferred exposures remain Outokumpu and Salzgitter, both rated Neutral. TKAG remains our favoured stock given its ‘special situation’ nature from the proposed asset sales in the Americas and the likely completion of the stainless deal (Inoxum to Outokumpu). Competition authority decision is expected at the end of October 2012, and should the deal go through, TK would receive $1bn in cash, $900m by the way of Outokumpu loan note and a stake in new Outo of 29.9%. Catalysts Key catalysts are as follows Thyssen: 1) EU approval of stainless deal likely on or before 24 October. 2) Ultimate sale of the Americas steel assets which should reduce net debt to zero and will have a significant impact on TKAG’s earnings stream of TKAG (given the deep loss making nature of the asset up for sale). ArcelorMittal 1) Ongoing growth in iron ore, which should add some US$500m structurally to earnings over the next 12 months, on our estimates. 2) Major restructuring of steel facilities in Europe which should structurally reduce costs by some US$1bn. 3) Asset sales with a management aim of reducing net debt by around US$7bn (from US22bn to c US$15bn)– with management’s stated aim of regaining its former investment grade rating. While we continue to believe AM has the potential for a large material asset sale, the more time passes before this happens the longer the market is likely to perceive a risk of a rights issue in order to delever We believe there is a 6 to 12 month window to allow for an option value of a major asset sale, beyond this the time value of that option will in effect fade as the risk of a rights issue becomes more likely should deleveraging not accelerate through asset sales. Least favoured Our least favoured stocks are the smaller Euro-centric producers such as Salzgitter, rated Neutral, which in our view lacks any type of catalyst away from the steel cycle. We are also relatively cautious on SSAB, also Neutral, given its poor earnings track record since the crisis and its significant debt levels, which it is likely to find harder than peers MT.NA and TKAG to reduce.

Global Steel Equities 31 06 September 2012 Japan (c110 mt output 2012E) Fundamentals

Figure 57: Japan IP versus steel output growth all yoy Shinya Yamada 813 4550 9910 80 (%) [email protected] 60 Kazumasa Okumoto 813 4550 7266 40 kazumasa.okumoto@credit- suisse.com 20

0

-20

-40

-60 '03/1 '04/1 '05/1 '06/1 '07/1 '08/1 '09/1 '10/1 '11/1 '12/1 Crude Steel Production, YoY IP, YoY

Source: JISF, METI Demand

Figure 58: Japan I/P trend 120 40 (%) 110 30

100 20

90 10

80 0

70 -10

60 -20

50 -30

40 -40 '03/1 '04/1 '05/1 '06/1 '07/1 '08/1 '09/1 '10/1 '11/1 '12/1 JPN IP IP, YoY

Source: METI Steel demand flagged in 2011, owing to the Great East Japan Earthquake of 11 March and the adverse impact on exports from autumn floods in Thailand. In 2012, though, steel demand has bounced back amid a steady recovery in domestic construction demand, in turn a reflection of post-quake rebuilding coupled with a nationwide need to refurbish aging structures. While demand for automotive steel is also rebounding, we expect a reactive decline from autumn when eco-car subsidies end.

Global Steel Equities 32 06 September 2012

Supply/Production

Figure 59: Japan steel output vs. Y/y growth 12,000 60 (kt) (%) 10,000 40

8,000 20

6,000 0

4,000 -20

2,000 -40

0 -60 '96/1 '97/1 '98/1 '99/1 '00/1 '01/1 '02/1 '03/1 '04/1 '05/1 '06/1 '07/1 '08/1 '09/1 '10/1 '11/1 '12/1 Crude Steel Production YoY

Source: WSA, Credit Suisse research Steel production is recovering as well, but as yet is only around 90% of the average level for 2007, prior to Lehman Brothers’ collapse. While we think it likely that domestic demand will continue to pick up gradually, especially in the construction market, it seems probable that overall output will be dragged down by a fall in export demand driven by yen strength and market stagnation in Asia. Inventory

Figure 60: Japan steel inventories 7,000 1.8 (kt) (months) 6,000 1.6

5,000 1.4

4,000 1.2

3,000 1

2,000 0.8

1,000 0.6

0 0.4 '97/1 '98/1 '99/1 '00/1 '01/1 '02/1 '03/1 '04/1 '05/1 '06/1 '07/1 '08/1 '09/1 '10/1 '11/1 '12/1 Ordinary Steel Product, Domestic Inventories (LHS) I/S Ratio (RHS)

Source: JISF Inventory remains at high levels, yet improvement is evident in terms of both absolute levels and months of inventory. With negligible prospects of steep growth in demand, production cuts appear necessary if inventory is to fall further. In the near term, though, it is conceivable that expectations of a rebound in steel prices will cause demand to spike as buyers set aside restraint, and use up some inventory.

Global Steel Equities 33 06 September 2012

Trade flows

Figure 61: Japan steel net export vs. fx rate 4,500 140 (kt) 4,000 120 3,500 100 3,000 2,500 80

2,000 60 1,500 40 1,000 20 500 0 0 '04/1 '05/1 '06/1 '07/1 '08/1 '09/1 '10/1 '11/1 '12/1 Net Export (LHS) JPY/USD (RHS)

Source: MoF, Thomson Reuters Export volume has risen consistently since 2007, despite ongoing yen appreciation. The reality is, though, that steelmakers have been exporting at a loss as a means of maintaining operating rates against a backdrop of weak domestic demand. Exports fell after the Thai floods in autumn 2011, but had largely recovered by spring 2012. More recently, however, exports look to be slowing again, on account of yen strength and lacklustre Asian prices. Pricing

Figure 62: Japan steel product prices 140,000 (JPY/t) 120,000

100,000

80,000

60,000

40,000

20,000

0 '95/1 '97/1 '99/1 '01/1 '03/1 '05/1 '07/1 '09/1 '11/1

HRC CRC HDG Rebar

Source: Japan Metal Daily Wholesale prices for steel peaked in spring 2012 and have been softening through summer. Prices could well rebound, though, in response to the increase in scrap prices from mid-August. It seems likely that steel prices will continue rising modestly through next spring, as the normal pattern is for demand to trend upward in spring and autumn.

Global Steel Equities 34 06 September 2012

Earnings outlook Assuming wholesale prices rebound as outlined above, we think it more than likely that sector earnings will bottom in Jul–Sep 2012, and recover in Oct–Dec. In price negotiations with large-lot buyers from the auto sector, Nippon Steel and the other leading blast furnace steelmakers apparently have agreed to a small (¥2,000/ton) HoH price cut on steel sheets for 1H FY12 (Apr–Sep). Steelmakers' spreads had worsened considerably over the past three years but now look to be widening again. Blast furnace steelmakers' 1H FY12 profits will be squeezed by valuation losses on raw material inventories, but in 2H (Oct–Mar) we think any such impact will be minimal, in view of which we see profit bouncing back strongly. As of 1 October, Nippon Steel and Sumitomo Metal Industries will merge to form Nippon Steel & Sumitomo Metal Corporation (NSSMC). We await the announcement of a medium-term plan for the new company, and will be focusing in particular on plans for cost synergies, cash flow improvement, and profit. Stocks Balance sheet and other risks Nippon Steel and Sumitomo Metal have ample cash flow and at this stage look to have minimal balance sheet risk. However if ongoing yen strength keeps exports in the red, there could be increased risk of asset impairment. Favoured stocks

Figure 63: Stock price performances of major Japanese steel companies 200

180

160

140

120

100

80

60

40 '09/2 '09/8 '10/2 '10/8 '11/2 '11/8 '12/2 '12/8

Nippon Steel SMI Kobe Steel JFE

Source: Thomson Reuters

From a medium-term perspective we prefer Nippon Steel and Sumitomo Metal Industries (both Outperform). In this era of global economic stagnation, steelmakers cannot expect to greatly increase sales or prices and cost cutting will be key to restoring profits. We think NSSMC will have more scope for cost cutting than rivals, due to synergies arising from the merger.

Global Steel Equities 35 06 September 2012

Catalysts Key catalysts are as follows Nippon Steel, Sumitomo Metal Industries: 3) New medium-term business plan expected in October or November 4) Possibility that new medium-term plan will include additional announcements concerning consolidation of facilities and synergies 5) Possibility that new medium-term plan will include strategies for greatly improving working capital and cash flow Least favoured Kobe Steel (Neutral) is harbouring balance sheet risk, as it expects negative FCF of ¥120bn in FY12. At its current share price we think the company will find equity financing difficult, and must continue relying on banks for support.

Global Steel Equities 36 06 September 2012 US (c90mt production 2012E) Fundamentals

Overall we continue to view US steel supply/demand fundamentals as relatively better Richard Garchitorena, CFA balanced than most regions globally, with imports as the key swing factor deciding the 212 325 5809 over/undersupplied nature of the region. We see domestic demand remaining resilient, richard.garchitorena@credit- with no clear signs of a sharp demand decline coming either from the data or our channel suisse.com checks. While non-residential construction remains challenging, it appears to have found a bottom, with the timing of the next cyclical upswing the key question still left unanswered. Riya Bhattacharya On domestic supply, the bankruptcy of RG Steel and the pending sale of Thyssen’s 212 325 2132 Alabama rolling mill have effectively reduced supply by at least 3 to 4 million tons, with no riya.bhattacharya@credit- near-term likelihood of that supply coming back within at least the next 6 months. This suisse.com brings us to imports, which according to the August import license data looks to be flat relative to July, but could pick up given the significant deterioration in global prices and the resulting widening of the spread vs. US prices. Thus, ignoring the rest of the world, US fundamentals look relatively better, but unfortunately the import arbitrage trade will likely bring US prices back to where global prices settle over time. Supply/Production Steel Production: U.S. US production remains relatively disciplined, with capacity utilisation rates moving around a tight range of 73-78% over the past few months. U.S. raw steel output in July was 1.88m tons, -1.2% seq and down 0.6% y/y. We believe the bankruptcy of RG Steel coupled with reduced production rates at Thyssen’s Alabama mill should continue to cap production levels through at least the rest of 2012.

Figure 64: US production Figure 65: US capacity utilisation

US Steel production (m tonnes) 100%

10,000 90%

9,000 80% 8,000 70% 7,000 60% 6,000 5,000 50%

4,000 40%

3,000 30% 2,000 20% 1,000 - 1/1/2006 1/1/2007 1/1/2008 1/1/2009 1/1/2010 1/1/2011 1/1/2012

Source: AISI Source: AISI Demand The primary data points we look at to track US demand are: 1) monthly MSCI service centre shipments, 2) the ISM buyers survey, 3) our monthly proprietary survey of private service centres and 4) company commentary on end market activity. We believe recent shipment data is still supportive of current prices, with August typically showing a strong uptick in shipments sequentially. Recent channel checks and commentary from service centres indicate no signs of a significant drop off in demand in the second half yet.

■ MSCI Shipment data: Total MSCI shipments in July decreased 6.3% seq. on a daily avg basis to 156.6 m tons. The largest decreases were seen in flat rolled (-7.4%), plates (-6.4%), pipe and tubing (-7.0%), stainless (-4.2%), Bars (-1.5%).

Global Steel Equities 37 06 September 2012

■ ISM Survey Highlights: Demand Expectations Rising: 27% expect orders to be up in the next 3 months, vs. 25% last month. 36% expect orders to be down in the next 3 months, vs. 17% in last month. 27% reported shipments were up vs. three months ago, vs. 25% last month. 27% reported shipments were below three months ago, vs. 25% last month. Economic Activity – 27% expect sales and production to be up over the next 6 months, vs. 25% last month. 27% expect sales and production to be down, vs. 17% in last month. 36% indicated they plan to build or buy new manufacturing facilities within the next year, vs. 42% last month.

Figure 66: Y/Y shipment growth since 2003 Figure 67: US monthly steel shipments 6,000 35.0%

25.0% 5,000 15.0% 4,000 5.0% -5.0% 3,000 -15.0% 2,000 -25.0% -35.0% 1,000 -45.0% YoY ShipmentsGrowth 0 -55.0% 2 MSCI shipments ul-1

Jul-04 Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 J Source: MSCI Source: MSCI Inventory The primary datapoints we look at to track current inventories and future expectations are 1) monthly MSCI service centre inventory data, 2) the ISM buyers survey and 3) our monthly proprietary survey of private service centres. Current inventories are only slightly above normal (at 2.7 MOS), but are expected to come down to normal levels of 2.5 MOS in August as they typically do. Thus, we believe inventories remain supportive of current price levels, although there is still no interest in restocking given the lack of visibility in pricing and demand.

■ MSCI Inventory data: July Months of Supply (MOS) were up at 2.7 vs 2.6 in June. Actual tons held at the service centres decreased 1% sequentially to 8.9m tons. Largest decreases were seen in structurals (6.8%), bars (3.6%) and flat rolled (-1%), while increases were seen in plate (1.6%), pipe & tubing inventories (0.1%) and stainless (3.1%) sequentially.

■ ISM Survey Highlights: Inventory Expectations: 27% plan to decrease inventories over the next 6 months, vs. 50% last month. 18% indicated they will increase inventories, vs 8% last month. Inventories vs. Demand – 36% indicated inventories were too high relative to demand, vs. 33% last month. 0% indicated inventories were too low, vs. 8% last month.

Global Steel Equities 38 06 September 2012

Figure 68: Inventories—months of supply Figure 69: Inventories—tons held at service centres

4.0 15,000

14,000

3.5 13,000

12,000

3.0 11,000

10,000

2.5 9,000 Months of Supply of Months Inventories (in 000 tons) (in Inventories

8,000

7,000 2.0

6,000

5,000 1.5 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Source: MSCI Source: MSCI Source: MSCI, Source: ; MSCI, Pricing US HRC Prices: Steel price hikes pushed by the steel mills have been sticking, having increased from the lows of $617/ton at the end of July to $665/ton, albeit still below the previous peak of $680/ton at the beginning of May. We would not be surprised to see some easing in prices in the near term as price differentials have widened (Chinese steel prices have dropped $50/ton since the end of July), with the spread between the US and China now at $126/ton, while US/Germany prices are at $84/ton, suggesting the risk of another influx of imports by 4Q if the widening of the spread continues.

Figure 70: Regional prices Figure 71: Regional spreads

$1,200 $180 Since Jan., China vs. U.S. price spread $160 dropped by $100/ton but have increased $1,100 again (now at nearly ~100/ton) compared to ~115/ton in Feb $1,000 $140 $900 $120 $800 $100

US$/ton $700 $80 $600 $60 $500 $40 $400 $20 $300 $0 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 -$20

North America Europe China China Germany Japan Average Source: CRU; Source: CRU, Imports We continue to monitor import data as we believe it poses the single largest risk to domestic steel prices in the coming months. July steel imports into the US were down 15.4% sequentially on a daily avg basis (-4.2% y/y) to 2.35m tonnes, while US Import Admin license data implies full month imports slightly higher vs. July (up ~0.3% seq.). Thus, while near-term imports have been easing, recent trends in regional price spreads suggests this trend will reverse, possibly as soon as October.

Global Steel Equities 39 06 September 2012

Figure 72: US steel imports (total) Figure 73: US steel imports (by country) 4,500 Imports by Country 4,000

3,500

3,000 ROW Canada 2,500 20% 19% 2,000 Taiwan 3% 1,500 China Korea 1,000 7% 11%

500 Germany 5% - Japan Brazil Russia Turkey 7% Mexico 12% 4% 3% 9%

Source: Source: US Department of Commerce Source: US Department of Commerce Earnings outlook While seasonality will likely result in softening steel prices in the coming months (Sept./Oct), we believe the longer-term outlook for US steel producer earnings will depend on the relative strength of US steel prices relative to global prices, and the resulting shifts in trade flows. Thus, while we are more encouraged about the outlook for US steel demand than global demand heading into 2013 (with Q3’12 expected to be the trough for US Industrial production), in our view rising imports pose the greatest risk to steel prices and in turn, steel producer margins. However we do think it is worth highlighting the benefits from lower raw materials, with iron ore, met coal and scrap prices down 10% to 40% year over year. We believe that lower input costs should provide some margin relief as soon as Q4’12 and into 2013, especially if recent spot prices hold. Ironically, this trend should help those steel producers with a less vertically integrated supply chain, which historically has been hurt by rising raw material costs, minimising the near-term impact of slightly softening steel prices. Conversely, if an influx of imports comes into the US in Q4 taking US prices back down well below $600/ton, we believe earnings for the service centres have the least exposure to the downside, given our view that volumes continue to remain stable. Within this backdrop, our preference remains for the steel service centres, which offer investors more stable margins in both up and down pricing cycles than the steel producers, especially considering our current steel price forecast assumes pricing remains relatively range bound through 2012/2013. Stocks Valuation The US steel producers continue to look relatively cheap on an absolute basis, trading at 5.3x 2013E EBITDA, but this is largely driven by the lack of visibility on the near-term and longer-term outlook for prices. The group does look attractive vs. historical valuations, trading on average at a 6% discount to their historical EV/EBITDA multiples. Given the more defensive nature of the steel service centres, as a group they are trading at much higher multiples than the steel producers (at 7.4x 2013E EBITDA), but still at a 17% discount to their historical one year forward EBITDA multiple.

Global Steel Equities 40 06 September 2012

Catalysts ArcelorMittal strike threat – Aug. 31st (new contract structure yet to be resolved) Pickup in Architectural Billings Index above 50 (proxy for non-residential construction) US Steel Imports Mid-quarter updates (NUE, X, AKS) MSCI Inventory data Balance sheet and other risks Both X and AKS have significant underfunded pensions, with AKS and X both near the top of the list in terms of pension underfunding as a percentage of market cap, as well as a percentage of pension in equities relative to market cap. We have also highlighted the company’s exposure to multiemployer pensions (Steelworkers Pension Trust) which also remains materially underfunded. NUE has no significant pension obligations. The good news is that these issues are well known, and so are arguably already priced into the shares. Additionally the recent Senate highway bill passed by the US Congress provided the steel companies with significant pension funding relief as they increased the discount rate to calculate the pension liabilities. Although the lower requirements reduce the risk of a near-term liquidity event, it does not change the fact that both X and AKS still have significant underfunded pension liabilities which remain on the balance sheet. Additionally, the reduced funding requirements could also result in larger pension contributions and more pension risk in the long-term. Favoured stocks RS (Reliance Steel) We recommend investors look at the service centre stocks as a more defensive way to play an uptick in the steel demand cycle, supported by view that the strength in U.S. demand continues through 2012E and into 2013E, and pricing remains relatively stable. We continue to view RS as the best positioned company in a challenged industry. The majority of RS’s end markets remain strong, with no major drop-off in demand or pricing expected in 2H. Management’s confidence in the business is further confirmed by the company’s 2012 dividend increase to $1.00 per share, which we believe investors will appreciate. The company continues to grow through acquisitions, with two in the quarter and over $845m in liquidity for more. Finally, while RS’s current earnings run rate of +$5 in EPS is impressive given the weak macro environment, we believe normalised earnings are at least 20% higher, with further upside if non-res. recovers. RS remains our top pick in the steel sector. Reiterate Outperform. Nucor (NUE), AKS (AK Steel) We prefer NUE as a best in class name with the industry leading balance sheet, attractive, sustainable dividend yield (3-4%), an improving cost base with the DRI plant completion in 2013 and leverage to a non-residential construction recovery. Our Outperform rating on AKS is supported by our view that AKS stands to benefit the most from lower raw material input costs (AKS is fully exposed to both iron ore and met coal prices) and relatively stable steel prices. Additionally, trading at less than 5.0x 2013E EBITDA, we believe the downside is largely priced in, with bankruptcy concerns largely overdone.

Global Steel Equities 41 06 September 2012

Least favoured US Steel (X), Olympic Steel (ZEUS) Relative to the other US names under coverage, we believe US Steel is the most exposed to a drop in global steel prices due to its European segment, which is our primary reason for the relative preference for other steel producers. X also has more exposure to the OCTG market through its tubular segment, which we believe may be close to peaking near-term if rig counts start to decline in 4Q. Finally, while vertical integration is a positive when raw material inputs are increasing, it does not help when the opposite is the case. Thus, X’s fully integrated iron ore needs in the US mean they benefit less relative to AKS in a lower iron ore price environment. On ZEUS, while we continue to like the steel service centres, ZEUS is the service centre most levered to carbon steel, with almost 80% of volumes tied to various carbon steel products. Thus, if steel prices start to decline in the US, we would expect ZEUS shares to be most impacted among the service centres. We rate both stocks Neutral.

Global Steel Equities 42 06 September 2012 India (c75mt output 2012E) Fundamentals: Low local supply offset by imports

Our earlier held view that India would become a net exporter by end-FY13 now looks Neelkanth Mishra unlikely to play out. The shortage of iron ore locally, caused by the sharp slowdown in 9122 6777 3716 mining output, has caused the smaller mills to shut down. DRI capacity, which at ~25mt neelkanth.mishra@credit- was about one-third of supply, has been severely impacted by the sharp surge in the suisse.com spread between lumps and fines (Figure 74). Ishan Mahajan Figure 74: Lumps fines spread has increased largely due to regulatory measures 9122 6777 3894 Rs. Rs. [email protected] 6000 3000

5000 2500

4000 2000

3000 1500

2000 1000

1000 500

0 0 Jan-10 Jun-10 Nov-10 Apr-11 Sep-11 Feb-12

Lumps (Rs/t) Fines (Rs/t) Spread

Source: Thomson Reuters Supply/Production Thus, the growth in Indian production, though still 5%-plus y/y (Figure 75), has been much below expectations, as large capacities like Essar’s have not come on line as expected.

Figure 75: Despite ore supply constraints, production growth still 5%-plus y/y

30% Ex-China Production y/y% India Production y/y% 25%

20%

15%

10%

5%

0%

-5%

-10%

-15%

-20% Jan-94 Jan-97 Jan-00 Jan-03 Jan-06 Jan-09 Jan-12

Source: Worldsteel, Credit Suisse research

Global Steel Equities 43 06 September 2012

As the year progresses, and Tata Steel, Bhushan, and to some extent SAIL increase their supplies, the smelting profit margins are likely to get squeezed further. The surge in imports from Japan and Korea, which under the FTA are now no longer subject to the 7.5% import duty, is driving a slower than expected ramp up, as companies seem to be reluctant to commission new capacities when smelting margins are low, and inventory is building up at producers. Demand Contrary to consensus views driven by using GDP-based multipliers that growth will be in high single digits at worst, and possibly in the low teens every year, for more than a year we have flagged the sharp slowdown in investment activity in India, and pointed to the 2.6% CAGR demand growth seen in the 1997-2005 period when the investment cycle was weak in India. Over the next couple of years we expect demand to stay weak.

Figure 76: From 1997-2005, despite ~6% GDP growth, Indian steel demand grew at 2.6%

80 mn t 5% again? 70

60

50 14% CAGR

40 2.6% CAGR 30

20 1997 1999 2001 2003 2005 2007 2009 2011

Growth in Apparent Steel Demand in India Y/Y (%)

Source: JPC, Credit Suisse estimates The one driver of growth that was holding up until 3-4 months back was auto sales; in the last quarter this too has slowed substantially, further pressuring the oversupplied flat rolled market. Long product demand has held up so far, but the growth in rural construction is unlikely to be strong enough to offset the slowdown elsewhere.

Global Steel Equities 44 06 September 2012

Inventory

Figure 77: Inventory changes at producers are worrying

1,400 kt 1,200

1,000

800

600

400

200

0 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 (200)

JSPL JSW SAIL Tata Steel Total

Source: Company data There is no comprehensive data available on distributor inventories in India, and anecdotally it seems these inventories are low, partly driven by the constraints on liquidity and the high cost of working capital financing. On the other hand, inventories at producers picked up quite sharply in 1QFY13 (Figure 77) – some of this is seasonal, but even after adjusting for that overstates the apparent demand growth reported by JPC. The apparent demand calculation formula of production + imports – exports overstates apparent demand if producers are building inventory. Costs/currencies The steep fall in iron ore prices is a concern for Indian firms, as even those that were not vertically integrated benefited from ore that was available locally, and thus saved on freight costs. The decline in steel prices driven by the sharp fall in ore and coal prices will only be partly offset by Indian companies, especially because the fall in ore has been more extreme. Companies like SAIL and Tata, which are effectively mining companies getting steel multiples, are likely to be the most impacted. Pricing Given the sharp fall in the currency, rupee prices held up well until recently. Though in the last week or so, prices have now started to come off – companies acknowledge a Rs1000- 1500/t decline, but in reality the declines are likely to be substantially higher. Earnings outlook Consensus earnings estimates for steel companies have been trending down (Figure 78, Figure 79), but we expect further declines as steel prices chase down the raw material prices.

Global Steel Equities 45 06 September 2012

Figure 78: FY13 consensus EBITDA Figure 79: FY14 consensus EBITDA

3,500 3,500

3,000 3,000

2,500 2,500

2,000 2,000

1,500 1,500

1,000 1,000

500 500 FY13 EBITDA est. (US$) FY14 EBITDA est. (US$) 0 0 1-Jan-12 1-Mar-12 1-May-12 1-Jul-12 1-Jan-12 1-Mar-12 1-May-12 1-Jul-12

Tata Steel SAIL JSW Tata Steel SAIL JSW

Source: IBES Source: IBES Stocks Valuation

Figure 80: Stocks look expensive on EV/EBITDA valuations

25 Fwd EV/EBITDA

20

15

10

5

0 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

Tata Steel JSW SAIL

Source: IBES Consensus On EV/EBITDA the names continue to look expensive despite the declines in stock prices, as earnings estimates continue to get revised down. While on P/B a sub-book value valuation is considered attractive, we continue to believe that with returns similar to those seen in the 1990s (Figure 81), the P/B multiples are likely to be in similar territory.

Figure 81: ROCE for steel firms Figure 82: P/B multiples for steel firms

5.0 0.7 P/B fwd. 4.5 0.6 4.0 0.5 3.5 0.4 3.0 0.3 2.5 2.0 0.2 1.5 0.1 1.0 0 0.5 FY94 FY97 FY00 FY03 FY06 FY09 FY12 -0.1 0.0 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12 -0.2 Tata Steel JSW SAIL Tata Steel SAIL

Source: Company data, Credit Suisse research Source: Company data, Credit Suisse estimates

Global Steel Equities 46 06 September 2012

Balance sheet and other risks All the companies under our Indian steels coverage now have high leverage. SAIL has the best balance sheet, but is unlikely to stay that way given low operating cash flow generation (and likely losses), and continuing high capex, with commissioning continuing to get significantly pushed out. Companies have also been using acceptances to reduce working capital financing, which means that the effective debt for the likes of JSW and Tata Steel is higher than the reported net debt. While in our valuation models we still take the reported net debt, for the sake of global comparisons, as well as in assessing the true financial health of the company, we believe the adjusted debt is a better indicator. Favoured stock: Jindal Steel & Power We like JSPL mainly for its exposure to the power business, as well as the continuing high spread between pellet prices and fines prices—JSPL is the only large merchant pellet supplier, and returns continue to surprise us. The stock has been among the worst performers (The JSPL stock is 48% below its YTD and LTM high of Rs645.1 It has underperformed the BSE Metal Index by 28% YTD) due to fears around regulations capping their returns on the merchant power business, and some coal blocks potentially get de-allocated. In our valuation we only take the operating mines, which were all allocated pre-2004, and thus are unlikely to be touched. We believe the stock is cheap, but given the overhangs, will require patience. We rate it Outperform. Catalysts As regulatory changes continue to play out in India’s coal and power industry, and the market gets convinced that JSPL’s profits are unlikely to change meaningfully, the stock could see a valuation re-rating. Further, commissioning of its expansions on time—e.g. the DRI plant, the 2400MW Tamnar-II power plant, etc would give much needed comfort to investors, in our view. Least favoured: SAIL, Tata SAIL loses money on every tonne of steel that it smelts. If not for vertical ownership on iron ore, it would be making heavy losses even at the EBITDA level. Our concerns arise from the sharp decline in iron ore prices, the potential increase in wage costs, and continuing rise in interest costs due to rising leverage, there is meaningful downside to SAIL’s price target and we rate it Underperform. For Tata Steel as well, the increase in EBITDA/t in the local operations post 2004 was mainly due to the increase in iron ore and coking coal prices. With these correcting, the sustainable profitability is likely to be much lower than the US$300/t that is currently assumed by consensus. Given the high leverage and the problematic European operations, we believe there is meaningful downside to the stock—rated Underperform. Technically, Tata has the been the preferred play for investors wanting some exposure to the metals space. As these positions unwind, any declines can get exaggerated.

Global Steel Equities 47 06 September 2012 Korea (c72mt output 2012E) Fundamentals

Figure 83: Korea- crude steel production and IP growth Minseok Sinn 822 3707 8898 [email protected] Hayoung Chung 822 3707 3795 hayoung.chung@credit- suisse.com

Source: KOSA, Thomson Reuters Supply/Production Steel production in Korea has been sharply growing in recent years, despite weak demand growth. Whereas POSCO’s production growth has been relatively slow among Korea’s two integrated steelmakers, Hyundai Steel’s aggressive capacity expansions with construction of two blast furnaces (crude steel production capacity of 8mn tonnes per annum on aggregate) have driven the steel production growth in Korea in recent years. Hyundai Steel currently constructs its 3rd blast furnace with crude steel production capacity of 4mn tonnes per annum, which will be completed by September 2013.

Figure 84: Korea - crude steel production

Source: KOSA

Global Steel Equities 48 06 September 2012

Demand Steel demand growth in Korea has been substantially decelerating over the past couple of years since the sharp recovery in 2010 from the impact of the 2009 global credit crisis. Concerns on the Eurozone crisis and global macro outlook have impacted confidence and end demand. While the global macro concerns remain a key depressing factor on Korea’s IP and GDP growth, which relies heavily on the global economy, a quick recovery of steel demand growth is less likely in the absence of improvement in the global macro environment.

Figure 85: Korea – Crude steel production and IP growth

Source: KOSA, Thomson Reuters Inventory Steel inventory in Korea has been steady in recent years. Despite the higher production growth and weak demand growth, sharp increase of net exports (increase of gross exports and decrease of gross imports) has contributed to the stabilisation of the inventories.

Figure 86: Korea – CRC, HRC inventory and I/S ratio

Source: KOSA

Global Steel Equities 49 06 September 2012

Trade flows Korea has turned from a net importer of steel products to a net exporter over the past couple of years. Considering most of additional crude steels from Hyundai Steel’s 3rd blast furnace (which will begin production of crude steels from late 2013) are likely to be consumed for replacement of imported steels and export to overseas markets, Korea will be a bigger net exporter of steel products in 2014E.

Figure 87: Korea – Steel product exports and imports

Source: NSO Pricing The domestic steel price in Korea is highly affected by imported steel price currently, which is driven by the China spot price. While the China spot price has been continuously weakened since mid-2011 by fall in raw material prices and weak demand growth, the domestic steel price has also been weakened. The influence of POSCO’s pricing on the domestic market is no longer that dominant, whereas POSCO had been effectively a price setter in the domestic market until a few years ago.

Figure 88: Korea – HRC price

Source: KMJ

Global Steel Equities 50 06 September 2012

Earnings outlook The greater uncertainties in the earnings outlook in 2H12 had been the key depressing factor on the steelmakers in recent months, in our view, even after the strong earnings rebound in 2Q12 from the bottom in 1Q12. Under the circumstances, we believe the recent steady raw material prices imply reduced fluctuation in their margin outlook and improved earnings visibility for 2H12E. We also see limited room for a further squeeze in steelmaking margins from current levels, given several major Asian steelmakers’ current close-to-break-even margin levels, although a quick expansion in the margins seems less likely considering weak demand outlook under continuing over-capacity, which is unlikely to be resolved within the next few years. Even if steelmaking margins deteriorate further (i.e. due to impact of macro turmoil on steel demands), we would anticipate these to be short-lived given the current low base and steelmakers’ additional margin protection efforts (i.e. production cuts).

Figure 89: Iron ore/coking coal cost per pig iron of 1t Figure 90: Major steelmakers in East Asia—OP margin versus spread between HRC price and the iron ore/coking coal cost

Source: Company data, Credit Suisse estimates Source: Company data

Figure 91: POSCO – EBITDA/t and EBITDA margin Figure 92: Hyundai Steel – EBITDA/t and EBITDA margin

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

Global Steel Equities 51 06 September 2012

Stocks We believe both POSCO and Hyundai Steel currently have appealing risk-averse return profiles, even though we do not expect a notable improvement in steelmaking margins within the next few years considering the ongoing over-supplies and weak demand outlook. While we like POSCO’s efficient cost structure and higher-end product mix that allow it to maintain higher capacity utilisation and relatively steady earnings, we also like Hyundai Steel’s ongoing organic growth story with the capacity expansion and captive customers (i.e., Hyundai Hysco, Hyundai Motors, Kia Motors). In terms of valuation, both POSCO and Hyundai Steel currently trade on slight discount to other major steelmakers in the region and the world. We rate both stocks Outperform.

Figure 93: POSCO – P/B to ROE Figure 94: Hyundai Steel – P/B to ROE

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

Figure 95: Global major steelmakers’ P/B to ROE (2012E) Figure 96: Global major steelmakers’ EV/t to EBITDA/t (2012E)

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

Global Steel Equities 52 06 September 2012 Latam (c70mt output 2012E) Fundamentals In our view, LatAm supply/demand fundamentals are relatively better balanced than in Ivano Westin most other regions, although the sector may continue to struggle in the short term given 55 11 3841 6318 lower steel demand (CSe Brazil 2012 GPD growth of 1.5%), continuous pressure from [email protected] direct and indirect steel imports, and fierce competition in the domestic flat steel market. Marina Melemendjian The main risks for domestic steel prices are continuous battles for market share between 55 11 3841 6341 CSN, Usiminas and Arcelor Mittal, while all steel companies are under pressure from marina.melemendjian@credit- increased imports whenever the price parity (international vs. domestic steel prices) are suisse.com over 12%. The industry may evolve in 2013 (CSe Brazil 2013 GDP growth of 4.0%), through a combination of public and private efforts, infrastructure investments (sporting Viccenzo Paternostro events), and an infrastructure investment package of US$66bn over a five-year period. 55 11 3841 6043 LatAm demand is expected to pick up, driven mainly by Mexico, while weaker demand in viccenzo.paternostro@credit- other regions may negatively impact earnings in the short term. suisse.com As we ride out the commodities cycle, we offer these main reasons for the lower competitiveness of the industry: required reforms (tax, legal and labor) never occurred; Brazil’s economy improved, resulting in lower sovereign risk and appreciation of the Brazilian real; higher competition from direct and indirect steel imports (including automobiles, machinery, and white goods); lack of changes in the Brazilian energy matrix; few investments in steel technology improvements, COGS/t increases driven by higher labor costs and iron ore cargoes being sold at full market price. Supply/Production

Figure 97: Latam crude steel production (Mt) Figure 98: Brazil crude steel production (Mt) 80 0.2 40 0.3 % y/y % y/y 70 0.2 35 0.2 0.1 60 30 0.1 0.1 50 25 0.0 40 20 0.0 -0.1 30 15 Latin America -0.1 -0.1 Brazil Crude 20 Crude Steel 10 -0.2 Production Steel Production -0.2 10 (Mt) -0.2 5 (Mt) 0 -0.3 0 -0.3 1999 2001 2003 2005 2007 2009 2011 1999 2001 2003 2005 2007 2009 2011

Source: WSA, Credit Suisse research Source: WSA, Credit Suisse research Demand LatAm steel consumption has remained relative stable in the past four years (ex 2009), while Brazil faced a decline in 2011. Since the slowdown of the Brazilian economy earlier this year, coupled with the global economic slowdown, delays and postponement of local investments, expected GDP growth and subsequently steel demand did not materialise. We expect a challenging second half in 2012 and stable-to-moderate growth in 2013.

Global Steel Equities 53 06 September 2012

Figure 99: Latam Apparent Steel Consumption (Mt) Figure 100: Brazil Apparent Steel Consumption (Mt)

68.9 69.5 71.1 29.8 66.2 27.1 28.2 60.8 25.0 54.3 53.5 52.7 21.5 49.8 19.9 20.2 20.3 46.7 46.4 18.5 18.6 18.8

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Source: WSA, Credit Suisse research Source: WSA Credit Suisse research Inventory Inventories, especially in Brazil, have been relatively stable at three months of shipments. Inventories dropped in Q2 2012 but started to recover in Q3 driven by a lower demand for flat products. We estimate inventories will remain flattish throughout the year, as output and demand should not vary significantly.

Figure 101: Brazil Steel Inventories (Kt) 1,400 7.0 I/S (months) - RHS 1,200 6.0

1,000 5.0

800 4.0

600 3.0 Average I/S (months) - 400 RHS 2.0

200 1.0 Inventories (kt) 0 0.0 Jan/08 Jul/08 Jan/09 Jul/09 Jan/10 Jul/10 Jan/11 Jul/11 Jan/12

Source: IABR, Credit Suisse research Pricing LatAm steel prices had peaked by the end of 2011 and were on a continuous downtrend until the end of 2Q12, when flat and long steel makers increased prices. On the other hand, prices are expected to stay stable q/q in Q4, with downside risks to such estimates if the macro global scenario deteriorates. LatAm steel prices are under pressure in some regions, especially in Argentina, and the outlook remains weak for the coming quarters. The most sensitive point for the Brazilian industry is the price parity between international and steel prices, which could boost imports if international steel prices decrease.

Global Steel Equities 54 06 September 2012

Figure 102: Latam Steel Prices (US$/t) 1,400

Plate 1,200 HRC 1,000 CRC 800

600

400

200 Jan-07 Oct-07 Jul-08 Apr-09 Feb-10 Nov-10 Aug-11 May-12

Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse estimates

Figure 103: Domestic vs. Imported Steel Price Parity Long Steel Import FOB Price (US$/t) 570.0 International Maritime Freight 60.0 Insurance 2.9 C&F Price - Brazil 632.9 II - Import Tax 75.9 Working Capital 29.0 Port Expenses 20.0 Stocking 10.0 Domestic Freight 40.0 C&F Price - Brazil 807.8 Exchange Rate (R$ / US$) 2.02 Imported Steel Price (R$/t) 1631.7

Domestic Price (R$/t) 1824

Domestic Premium 11.8% Source: Credit Suisse estimates

Global Steel Equities 55 06 September 2012

Trade Flows

Figure 104: Latam Net Imports / Exports (Mt) Figure 105: Brazil Net Imports / Exports

7.7 Brazil Net Imports / Exports (Mt) 3.1 3.1 2.9 2.9 2.9 2.9 BRL / USD 3.2 3.7 2.4 2.4 2.4 2.4 2.2 2.2 1.9 2.0 1.9 2.0 1.8 1.8 -0.1 1.8 1.7 1.8 1.7 -1.0 -2.2 -3.1

-5.1 -6.6 -6.3 -7.0 Net Imports / Exports (Mt) -8.2 -8.8 -11.0 -10.7 -9.2 BRL / USD -11.4 -11.8 -9.9 -9.8 -9.6 -12.4

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Source: WSA, Credit Suisse research Source: WSA, Credit Suisse research

Earnings outlook The earnings outlook for 2H12 as a consequence of the above should be positive in 3Q12, although we anticipate a challenging 4Q12. Steel prices increased in the Brazilian steel market for both flat and long steel products in mid-2012; cash cost levels are stable; and cost reductions will be posted by some domestic players. It appears, though, that the end of the year may reflect deteriorating earnings and margins if the macro scenario remains depressed. The potential strength of the earnings recovery depends primarily on demand in China (to boost steel prices, decreasing international vs. Brazilian steel price parity), where the outlook is far more bearish as demand remains weak. Beyond those changes in the macro scenario, long steel producers in Brazil could benefit from infrastructure investments in 2013-14, while flat steel makers are likely to face stronger competition from imports. The next phase of robust earnings recovery would be further depreciation of the Brazilian currency, which would shield local industry. What is clear is that equity investors may find it challenging to find value in the sector in the short term, although 2013 looks more positive. Stocks We believe most Latam steel stocks look relatively expensive on an comparative basis with global peers, but Ternium is the most attractive name on a valuation basis in our coverage universe at 3.6x 2013E EV/EBITDA. Catalysts Usiminas Positive: steel capacity utilisation improvements, COGS/t reduction, lower capex, and indebtedness improvements from the all-time high of 5.1x Net Debt/EBITDA 2012 (CSe) to 2.7x in 2013E and 2.5x in 2014E, divestments of non core business, potential ~ US$ 630Mn of earn outs to be received from Sumitomo. Negative: weaker steel outlook and mining expansion delays. Rated Neutral.

Global Steel Equities 56 06 September 2012

CSN Positive: start-up of new 0.5Mt long steel plant. Negative: lower iron ore volume and prices, additional capex increases for both mining and rail (Transnordestina) divisions, domestic steel prices under pressure, delays in the mining division expansion and increasing indebtedness. Rated Underperform. Gerdau Positive: continuous robust demand for long steel products driven by infrastructure investments, higher volume sales and realised prices in North America, monetisation of its Brazilian iron ore asset. Negative: weaker demand in LatAm and Specialty Steels division, stronger competition from imports driven by lower international steel prices. Rated Outperform. Ternium Positive: steel prices and recovery in the USA, Mexico and Argentina; Brownfield steel expansions; and development of the mining business. Negative: deteriorating demand in Argentina and anticipated weaker steel prices. Rated Outperform. Balance sheet and other risks The balance sheet of most LatAm steel mills started to deteriorate since the boom period of 2007/2008. Ternium remains the stock in our coverage universe with the healthiest debt position, while Usiminas is the one with the most sensitive momentum, at 5.1x Net Debt/EBITDA (CSe YE2012). We estimate CSN will face a challenging environment due to lower iron sales volumes and compressed prices, which could result in substantial earnings revisions, increasing the company’s leverage. We estimate Net Debt/EBITDA to increase to levels close to 4.0x in 2012E, declining to ~3.1x after EBITDA recovery in 2013E. Gerdau and Ternium remain at healthier levels of 1.6x and 1.0x 2013E Net Debt/EBITDA, respectively. Favoured stocks Our top picks in the sector are Gerdau in Brazil and Ternium in LatAm. We recommend that investors have exposure to the Brazilian steel sector through GGBR4, given its exposure to the more resilient long steel markets in Brazil and the US, two regions that seem to be lower risk compared with the Asian market. We continue to view Gerdau as the best-positioned company given higher margins, better capital allocation, a positive track record in project deliveries and lower exposure to steel imports. We prefer TX over CSNA3 and USIM5 given its attractive valuation (3.6x 2013E EV/EBITDA), natural hedge through exposure to North America and LatAm markets, cost controls and better capital allocation. Least favoured Our least favourite stock is CSNA3 and we rate it Underperform. We believe the full value of CSN’s mining business is unwarranted, given worldwide macro uncertainties and execution risks of mining projects. Additionally, likely downside risks include lower iron ore volume and prices, capex increases in the mining and steel divisions, and the domestic steel price under pressure due to fierce competition.

Global Steel Equities 57 06 September 2012 EEMEA: Russia, Turkey, South Africa (c110mt output 2012E) Fundamentals—Russia Demand—construction is a driving force Semyon Mironov 7 495 662 8510 Russian steel demand growth has been slowing in line with recent IP momentum—every semyon.mironov@credit- 1% move in IP leads to a c3% move in steel demand growth on average. Our economists suisse.com expect c3.5% a year IP growth in Russia in 2013-14E, which would lead to c10% steel consumption growth over this period, on our calculations. Dmitry Glushakov 7 495 662 8512 Figure 106: Steel consumption versus IP growth dmitry.glushakov@credit- 120% 30.0% suisse.com

100% 25.0%

80% 20.0%

60% 15.0%

40% 10.0%

20% 5.0%

0% 0.0% Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 -20% -5.0%

-40% -10.0%

-60% -15.0%

-80% -20.0% Steel demand growth, y-o-y IP growth, y-o-y

Source: WSA; Credit Suisse research At the same time, our bottom-up analysis suggests Russian steel demand should grow at a faster rate of 5-7% a year in 2012-14E driven primarily by construction, which, in turn, should grow in Russia by 13% and 7% over 2012-13E, respectively according to Credit Suisse estimates. This growth would compensate for the decline in demand from pipe producers, which were important for steel demand in 2010-11A. We expect demand from the pipe industry to fall by 12% this year as LDP producers cut production given the lack of orders from Gazprom. Overall, we expect the construction segment to remain the main contributor to steel demand growth with its share increasing from 50% in 2011A to 55% in 2015E.

Global Steel Equities 58 06 September 2012

Figure 107: Russian steel demand structure by segment 2011A 2015E

Metalware Metalware Other Engineering production Engineering production Other 2% Pipe producers industry 11% industry 11% 1% Pipe producers 12% 25% 11% 22%

Construction Construction and traders and traders 50% 55%

Source: Company data, Credit Suisse estimates Product-wise, we see strong demand for higher value-added flat products: in 1H’12A cold- rolled steel consumption was 14% up y-o-y, galvanised steel demand grew 19% y-o-y and pre-painted steel demand went up 35% y-o-y. We believe demand growth was driven by strong demand from the construction sector, by growing demand from Russian plants of foreign car producers and partial substitution of lower quality hot-rolled sheet in the consumption mix by higher grades of steel. We expect this trend to continue with a higher proportion of rebar and high grade flat steel in the demand structure.

Figure 108: Russian steel demand structure by product 2011A 2015E

Pipe billet Wire rod Other Other Rails 8% HR Sheet Rails Wire rod Pipe billet Sections 5% 7% 6% HR Sheet 2% 20% Sections 3% 5% 7% 10% 9% 17%

Rebar Rebar 16% 19% HR Plate 9%

HR Plate 12% CR products CR products Pre-painted Galvanised Pre-painted Galvanised 9% 9% 4% 7% 7% 9%

Source: Company data, Credit Suisse estimates Supply We do not expect any significant expansion of steel capacity in Russia in 2013-15E. In Crude steel, we expect a further ramp-up of NLMK’s 3.4mtpa blast furnace, which the company launched in the end of 2011A, and two mini mills by NLMK and Severstal (1.5mtpa and 1mtpa), which should be launched in 2013-14E. In finished steel production, we do not expect any capacity expansion in hot-rolling, while the only project in cold-rolling and galvanising is MMK’s Mill-2000, which was launched last year and should be ramped up in the next two years to fulfil the growing demand for high grade flat steel. In long steel we expect significant growth in finishing capacity – both NLMK’s and Severstal’s mini-mills (a combined 2.5mtpa) will be able to produce wide range of construction steel (rebar and sections), while Evraz’s and Mechel’s universal rolling mills (additional 1.8mtpa) should be able to produce high quality 100m long rails as well as construction sections. At the same time we expect this capacity growth to be taken up by the construction market, which we expect to grow 13% this year and another 5-7% a year in the next 3 years.

Global Steel Equities 59 06 September 2012

Figure 109: Russian steel industry supply/demand (Kt) FINISHED STEEL SUPPLY/DEMAND 2006A 2007A 2008A 2009A 2010A 2011A 2012E 2013E 2014E 2015E production 59,832 62,021 59,982 53,314 58,789 59,569 63,448 65,331 67,885 69,447 growth 4% -3% -11% 10% 1% 7% 3% 4% 2% apparent consumption 35,815 40,174 37,326 26,600 35,983 40,548 42,978 45,185 48,196 50,240 growth 12% -7% -29% 35% 13% 6% 5% 7% 4% GDP growth 8.5% 5.2% -7.8% 4.0% 4.2% 3.8% 4.9% 4.0% 4.0% net export 24,033 21,850 22,668 26,721 22,160 18,326 19,480 19,126 18,662 17,332 export 13,432 12,872 11,410 14,598 12,517 11,857 11,197 10,541 9,985 9,016 import 4,669 6,263 4,932 3,317 5,140 6,710 7,237 7,482 7,248 7,462

Semi-finished products production 18,806 18,825 19,412 17,956 17,909 16,367 18,973 19,600 19,600 19,600 apparent consumption 3,546 3,591 3,226 2,518 3,130 3,259 3,398 3,534 3,675 3,822 growth 1% -10% -22% 24% 4% 4% 4% 4% 4% net export 15,258 15,237 16,188 15,439 14,775 13,155 15,518 16,066 15,925 15,778 export 15,270 15,241 16,190 15,440 14,783 13,179 15,520 16,066 15,925 15,778 import 12 4 2 1 8 24 2 - - -

Flat products production 24,618 25,442 23,409 22,229 25,648 26,343 27,089 27,231 28,185 28,547 apparent consumption 17,458 19,346 18,039 13,688 19,203 21,218 22,255 23,778 25,949 27,113 growth 11% -7% -24% 40% 10% 5% 7% 9% 4% net export 7,157 6,093 5,369 8,539 5,790 4,356 3,971 3,321 2,573 1,454 export 10,144 9,676 8,395 10,898 9,259 8,730 8,591 8,177 7,518 6,810 import 2,987 3,583 3,026 2,359 3,469 4,374 4,620 4,856 4,945 5,356

Long products production 16,408 17,754 17,161 13,129 15,232 16,859 17,387 18,500 20,100 21,300 apparent consumption 14,811 17,237 16,061 10,394 13,650 16,071 17,326 17,873 18,572 19,305 growth 16% -7% -35% 31% 18% 8% 3% 4% 4% net export 1,606 516 1,109 2,742 1,587 791 -11 -262 163 100 export 3,276 3,192 3,013 3,699 3,250 3,103 2,604 2,364 2,467 2,206 import 1,670 2,676 1,904 957 1,663 2,312 2,615 2,626 2,303 2,106 Source: Company data, Credit Suisse estimates Costs Russian steelmakers’ competitiveness stemmed from their vertical integration into raw materials, with Severstal the most integrated and MMK the least integrated. As a result Russian steelmakers were always placed in the 1st quartile of the cash cost curve. However there are two trends that are having an impact on competitiveness (and as a result margins) and are likely to continue to affect Russian steelmakers:

■ Mining cost inflation goes ahead of general inflation level

■ There is risk of further raw materials price decline. Our current base case assumption for 2013E is US$145/t for iron ore and US$210/t for coking coal versus spot prices of US$100/t and US$175/t respectively. As a result of these two factors, the benefit of vertical integration has been squeezed from the middle of last year and with falling raw materials prices we expect it to continue to deteriorate. Figure 110 and Figure 111 represent dynamics of vertical integration benefit of Severstal and Evraz, two the most vertically integrated Russian steel producers

Global Steel Equities 60 06 September 2012

Figure 110: Dynamics of Evraz’s benefits of vertical integration Iron ore Coking coal

140 200 120 forecast forecast 100 150 80 100 60 40 50 US$/tonne 20 US$/tonne 0 1Q'09A 2Q'09A 3Q'09A 4Q'09A 1Q'10A 2Q'10A 3Q'10A 4Q'10A 1Q'11A 2Q'11A 3Q'11A 4Q'11A 1Q'12A 2Q'12A 3Q'12E 4Q'12E 2013E 2014E 0 -20 -40 2013E 2014E 1Q'09A 2Q'09A 3Q'09A 4Q'09A 1Q'10A 2Q'10A 3Q'10A 4Q'10A 1Q'11A 2Q'11A 3Q'11A 4Q'11A 1Q'12A 2Q'12A 3Q'12E 4Q'12E

integration benefit ($/t of steel) cash cost market price integration benefit ($/t of steel) cash cost market price

Source: Company data, Credit Suisse estimates

Figure 111: Dynamics of Severstal’s benefits of vertical integration Iron Ore Coking coal

140 forecast 250 120 forecast 200 100 80 150 60 100 40 50 US$/tonne US$/tonne 20 0 0 1Q'10A 2Q'10A 3Q'10A 4Q'10A 1Q'11A 2Q'11A 3Q'11A 4Q'11A 1Q'12A 2Q'12A 3Q'12E 4Q'12E 2013E 2014E 1Q'10A 2Q'10A 3Q'10A 4Q'10A 1Q'11A 2Q'11A 3Q'11A 4Q'11A 1Q'12A 2Q'12A 3Q'12E 4Q'12E 2013E 2014E

integration benefit ($/t of steel) cash cost market price integration benefit ($/t of steel) cash cost market price

Source: Company data, Credit Suisse estimates Pricing Russian prices have historically been more volatile than European or Chinese benchmarks, outperforming the latter in bull markets and underperforming in the down cycle (Figure 112). On average, the Russian export price is between Chinese and European domestic prices.

Figure 112: HRC prices, Russian export versus Chinese and European domestic

1400

1200

1000

800

US$/t 600

400

200

0 Jan.07 Jun.07 Nov.07 Apr.08 Sep.08 Feb.09 Jul.09 Dec.09 May.10 Oct.10 Mar.11 Aug.11 Jan.12 Jun.12

HRC, China domestic HRC, Europe domestic HRC, Russia export

Source: CRU, Our view remains unchanged: we believe the demand/supply position of the global steel industry will not allow steelmakers to improve margins in the next several years.

Global Steel Equities 61 06 September 2012

We expect European overcapacity (c60-80mtpa) to continue as the driving factor for the weak pricing power of steelmakers in the region. For this situation to improve we need either significant excessive capacity shutdowns or significant recovery in European steel demand – we see none of these scenarios as likely. At the same, in our view, steelmaking margin has already reached its historical support level of US$200/t (HRC fob price minus raw materials cost per tonne of steel) as shown in Figure 113. Recent history suggests that this is the level at which marginal producers start closing plants, and the market stabilises.

Figure 113: Gross steelmaking margin versus Global capacity utilisation

800 95%

700 90% 600 85% 500 80% 400 75% US$/tonne 300 70% 200 Global steel capacity utilisation, % utilisation, steel capacity Global 100 65%

0 60% 2013E 2014E 2015E 3Q'05A 4Q'05A 1Q'06A 2Q'06A 3Q'06A 4Q'06A 1Q'07A 2Q'07A 3Q'07A 4Q'07A 1Q'08A 2Q'08A 3Q'08A 4Q'08A 1Q'09A 2Q'09A 3Q'09A 4Q'09A 1Q'10A 2Q'10A 3Q'10A 4Q'10A 1Q'11A 2Q'11A 3Q'11A 4Q'11A 1Q'12A 2Q'12A 3Q'12E 4Q'12E

HRC fob Black Sea price - Raw materials cost base Global steel capacity utilisation

Source: CRU; Thomson Reuters, Credit Suisse estimates In absolute terms we expect steel prices to be determined by the cost of production, with zero margin for marginal producers on the cash cost curve. Assuming no significant improvement in prices for raw materials, the cost of steel production and steel prices would be flat to down y-o-y in 2013-15E, in our view. Fundamentals—Turkey Supply/demand Turkey’s steel consumption saw c7% CAGR in 2001-11A to reach c27mt in 2011A (Figure 114). We expect Turkish steel demand to continue growing slightly above IP growth level at 5-7% annually. On the supply side we do not expect any major capacity additions in the next several years: the growth in capacity in 2010-11A was driven by flat steel producers with EAF technology: Colakoglu added c3mt, MMK built 2.2mtpa plant and Tosyali added 1.1mtpa. Overall, Turkey remains a net exporter of steel with c5mtpa export, which should decline with the growth of domestic consumption.

Global Steel Equities 62 06 September 2012

Figure 114: Turkish supply/demand for steel 40.0

35.0

30.0

25.0

20.0 mtpa 15.0

10.0

5.0

0.0 2000A 2001A 2002A 2003A 2004A 2005A 2006A 2007A 2008A 2009A 2010A 2011A 6M12A (an-d) Total steel production Total steel consumption

Source: TIPSA, Credit Suisse research While Turkey remains a net exporter of steel, it has a different balance of trade in flat and long steel products – it is a net exporter of lower-value-added long steel and a net importer of flat steel (see charts below). The pick-up in production of flat steel in 2010-11A was driven by introduction of aforementioned capacity by MMK and Cokacoglu. At the same time Turkey will remain short flat steel in foreseeable future even if all new capacity is fully utilised.

Figure 115: Turkey is a net exporter of long steel Figure 116: …but net importer of flat steel 30.0 14.0 25.0 12.0 10.0 20.0 8.0 15.0 mtpa mtpa 6.0 10.0 4.0

5.0 2.0

0.0 0.0 2000A 2002A 2004A 2006A 2008A 2010A 6M12A 2000A 2002A 2004A 2006A 2008A 2010A 6M12A (an-d) (an-d) Long - Production Long - Consumption Flat - Production Flat - Consumption

Source: TIPSA, Credit Suisse research Source: TIPSA, Credit Suisse research Prices Turkish prices broadly track Russian export prices as Russian exporters are the main competitors to the domestic producers (Figure 117). The difference in prices is coming from cUS$30/t freight cost and c10% import tariff, which allows domestic producers to price their steel with premium to importers.

Global Steel Equities 63 06 September 2012

Figure 117: Turkish domestic HRC price versus Russian export price

900

850

800

750

700

US$/tonne 650

600

550

500 07/01/2011 11/03/2011 13/05/2011 15/07/2011 16/09/2011 18/11/2011 20/01/2012 23/03/2012 25/05/2012 27/07/2012

HRC, Turkey domestic HRC, Turkey import HRC, Russian export

Source: MetalExpert, Credit Suisse estimates Fundamentals—South Africa Supply/demand Domestic demand was relatively stagnant in 20010-11A at 5mtpa after peak consumption of 6mtpa in 2006-08A driven by construction for Football World Cup 2010. We do not expect any significant demand growth with the lack of infrastructure spending in the country. From the supply side ArcelorMittal South Africa remains a dominant player with c70% market share; however recently competition from importers has been intensifying. While the government from time to time offers to build a new steel producer[, we believe the balance should remain rather unchanged over the next 3-5 years.

Figure 118: SA domestic shipments: flat/long Figure 119: SA steel consumption by sector 6000 7300 5500 6300 5000 5300 4500 4000 4300 kt kt 3500 3300 3000 2300 2500 1300 2000 1500 300 2003 2004 2005 2006 2007 2008 2009 2010 2011 2003 2004 2005 2006 2007 2008 2009 2010 2011

Long Flat Construction Mining and agriculture Automotive & assembly Metal products

Source: Company data Source: Company data Prices As historically ArcelorMittal South Africa was a dominant producer in the South African market, it charged price to domestic customers based on import net back parity. As a result steel has been trading with premium to benchmark prices (Figure 120).

Global Steel Equities 64 06 September 2012

Figure 120: Flat steel price dynamics of South African producers vs HRC fob Black Sea 10,000

9,000

8,000

7,000

6,000

Rand/tonne 5,000

4,000

3,000

2,000 2Q'07A 4Q'07A 2Q'08A 4Q'08A 2Q'09A 4Q'09A 2Q'10A 4Q'10A 2Q'11A 4Q'11A 2Q'12A

AMSA's flat steel average realised price Highveld's flat steel average realised price HRC FOB Black Sea

Source: Company data The premium currently stands at an all-time high for both flat steel and long steel (Figure 121 and Figure 122). We believe this premium should persist as AMSA is close to break- even on EBITDA line and should make everything possible to keep the price in South Africa flat even given falling benchmarks.

Figure 121: AMSA’s price premium – flat steel Figure 122: AMSA’s price premium - long steel

250 226 350 215 214 288 300 285 200 183 248 172 232 164 250 219 197 150 200 103 141 92 150 130 100 110 US$/tonne US$/tonne 50 100 50 50

0 0 2005A 2006A 2007A 2008A 2009A 2010A 2011A 2012E 2013E 2005A 2006A 2007A 2008A 2009A 2010A 2011A 2012E 2013E

Flat steel ACL average realised price - HRC fob Black Sea premium Long steel ACL average realised price - Rebar fob Black Sea premium

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates Earnings outlook Our earnings outlook is based on two assumptions:

■ iron ore and coking coal prices are set to fall in 2012-14E relative to 2011A, however floating above current spot levels.

■ steelmaking margin has reached its trough and should remain relatively flat in real terms over the next several years. As a result we expect profitability of vertically integrated steelmakers to contract considerably in 2012-14E relative to 2011A, while non-integrated producers should maintain flat profits. In EEMEA we have only two non-vertically integrated steel names— MMK and Erdemir—we expect MMK’s earnings momentum to outperform peers due to increasing volumes and improving product mix (ramping up both Mill-2000 and Turkish plant).

Global Steel Equities 65 06 September 2012

Figure 123: EBITDA dynamics – base case Figure 124: EBITDA dynamics – conservative scenario

1.40 1.20 1.10 1.20 1.00 1.00 0.90 0.80 0.80 0.70 0.60 0.60 0.50 0.40 0.40 2011A 2012E 2013E 2014E 2011A 2012E 2013E 2014E

Evraz MMK Severstal Evraz MMK Severstal EBITDA growth index, 2011A = 2011A = index, 100% growth EBITDA EBITDA growth index, 2011A = 2011A = index, 100% growth EBITDA NLMK Mechel ArcelorMittal SA NLMK Mechel ArcelorMittal SA Erdemir Erdemir

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates Stocks Valuation Whether Russian steel stocks are attractive at current levels depends on iron ore and coking coal price assumptions. Below we present our calculation of both EBITDA and EV/EBITDA multiples for the whole EEEMA Steel sector under our coverage for 2012-13E under 1) our in-house, more optimistic scenario and 2) a more conservative one. Our conclusion is that MMK currently looks the most attractively valued.

Figure 125: Valuation of EEMEA steel stocks in two scenarios 2012E 2013E 2014E 2011A Raw materials scenarios Optimistic Conservative Optimistic Conservative Optimistic Conservative iron ore, fob Australia, US$/t 160 131 125 135 115 118 115 coking coal, fob Australia, US$/t 306 214 209 210 200 205 200 implied scrap price, China dom., US$/t 486 429 416 433 394 402 394 implied HRC fob CIS price, US$/t 700 600 580 610 570 590 590 345678910 EBITDA Severstal US$m 13,448 3,564 2,129 1,887 2,240 1,639 1,851 1,797 NLMK US$m 15,410 2,239 1,854 1,790 1,937 1,629 2,042 1,911 MMK US$m 6,608 1,260 1,108 1,108 1,221 1,221 1,368 1,368 Evraz US$m 11,353 2,898 1,925 1,627 2,039 1,427 1,573 1,332 Erdemir Lm 9,100 2,034 1,292 1,285 1,340 1,333 1,206 1,213 AMSA Rm 15,187 1,714 1,309 691 1,019 -85 642 405

2012E 2013E 2014E Current EV/EBITDA 2011A Optimistic Conservative Optimistic Conservative Optimistic Conservative Severstal 3.8 6.3 7.1 6.0 8.2 7.3 7.5 NLMK 6.9 8.3 8.6 8.0 9.5 7.5 8.1 MMK 5.2 6.0 6.0 5.4 5.4 4.8 4.8 Evraz 3.9 5.9 7.0 5.6 8.0 7.2 8.5 Erdemir 4.5 7.0 7.1 6.8 6.8 7.5 7.5 ArcelorMittal SA 8.9 11.6 22.0 14.9 -178.3 23.7 37.5 Source: Company data, Credit Suisse estimates Catalysts Russian steelmakers should start reporting Q3 results in November. Overall we expect negative earnings dynamics, especially for vertically integrated companies, and a less than encouraging outlook. Balance sheet We expect the majority of EEMEA steelmakers to be FCF neutral or negative in 2013-14E even under our base-case scenario (Figure 126) with a weaker outlook in a conservative case. The only exceptions are non-integrated MMK and Erdemir, which should sustain their 3-5% in both cases, on our numbers.

Global Steel Equities 66 06 September 2012

Figure 126: FCF generation of EEMEA steelmakers in 2012-14E under different scenarios 2012E 2013E 2014E 2011A Raw materials scenarios Optimistic Conservative Optimistic Conservative Optimistic Conservative iron ore, fob Australia, US$/t 160 131 125 135 115 118 115 coking coal, fob Australia, US$/t 306 214 209 210 200 205 200 implied scrap price, China dom., US$/t 486 429 416 433 394 402 394 implied HRC fob CIS price, US$/t 700 600 580 610 570 590 590

FCF Severstal US$m 10,543 743 836 686 121 -360 618 480 NLMK US$m 11,567 -64 -355 -246 -189 -360 584 348 MMK US$m 3,563 -886 467 414 227 97 494 459 Evraz US$m 3,587 1,423 -181 -412 -106 -638 -327 -617 Erdemir Lm 6,273 485 868 1,065 241 297 466 274 ArcelorMittal SA Rm 18,220 2,964 237 -494 -808 -1,889 -2,949 -2,780

FCF yield Severstal US$m 7% 8% 7% 1% -3% 6% 5% NLMK US$m -1% -3% -2% -2% -3% 5% 3% MMK US$m -25% 13% 12% 6% 3% 14% 13% Evraz US$m 40% -5% -11% -3% -18% -9% -17% Erdemir Lm 8% 14% 17% 4% 5% 7% 4% ArcelorMittal SA Rm 16% 1% -3% -4% -10% -16% -15% Source: Company data, Credit Suisse estimates As a result we do not expect any significant balance sheet improvement from the Russian steelmakers, with Mechel being the most leveraged (Figure 127).

Figure 127: Net debt/EBITDA of Russian steelmakers (base-case scenario) 8.0 6.9 7.0 5.5 6.0 5.2 5.0 4.2 3.7 3.5 4.0 3.2 3.4 3.2 2.7 3.0 2.3 2.2 2.0 2.1 2.0 1.6 1.5 1.6 1.8 Net debt/ EBITDA, x EBITDA, Net debt/ 2.0 1.2 1.0 0.0 2011A 2012E 2013E 2014E

Evraz MMK Severstal NLMK Mechel

Source: Company data, Credit Suisse estimates Stock preferences We believe the market is in a transition period regarding its view on Russian steelmakers: while we have already seen signs of non-integrated steels operationally outperforming integrated ones, this has not been reflected in stock performance so far. We expect Q3 and Q4 results to show the market different EBITDA dynamics for the two groups of steelmakers, with further deterioration of integration benefits of integrated steel producers. As a result non-integrated MMK (Outperform, US$5.9/sh TP) and Erdemir (Neutral, TRY2.1/sh TP) remain our preferred steel producers. EVRAZ and Severstal are both rated Neutral, with target prices of 310p and $13.10, respectively. Mechel (Underperform, US$6/sh TP), ArcelorMittal SA (Underperform, R33/sh TP) and NLMK (Underperform, US$16/GDR TP) are our least favoured stocks.

Global Steel Equities 67 06 September 2012 Australia (c6mt output) Fundamentals Supply/Production Michael Slifirski 61 3 9280 1845 Australia has only two steel producers: BlueScope Steel, produces flat products michael.slifirski@credit- exclusively through the operation on a single 2.5Mtpa blast furnace, and Arrium suisse.com (OneSteel) a long product producer that operates one small blast furnace and 3 electric arc furnaces with total capacity of 2.7Mtpa. Sam Webb Domestic steel production capacity is broadly aligned with mid-cycle domestic steel 61 3 9280 1716 demand, allowing for ~20% imports. Peak of domestic cycle demand has historically seen [email protected] demand exceed domestic capacity, requiring an increase in imports. Demand Domestic steel demand has not recovered significantly from trough levels post-2008, with very subdued construction activity limiting demand to ~80% on more normal levels. This has resulted in BlueScope exporting ~400ktpa surplus flat product production as HRC at loss making margins. This production would more normally be sold as a downstream product (metallic coated, painted and possibly roll formed) into the domestic construction market. Arrium continue to operate their small blast furnace a near full capacity but their EAFs are being operated at ~70% of capacity. Current demand levels are at historically low levels. Inventory There are no inventory statistics available but the supply chain appears to have de- stocked to be balanced with current subdued demand levels. With surplus unutilised steel- making capacity, delivery performance does not required normal stock levels to be carried. However, strong growth in the steel distribution industry at the peak of the cycle has resulted in excess distribution capacity and generally negative margins from this industry. This is precipitating a significant consolidation of capacity and numerous distribution centres closing. Costs/currencies Australian steel producers have seen a material deterioration in their historical globally competitive position due to the strong AUD and secondly constrained production. The AUD has doubled from 0.50 to 1.04 relative to the USD, doubling conversion costs in USD terms, relocating the domestic steel industry from a globally low cost steel producer to a higher cost producer, despite flat conversion costs in AUD terms. Arrium’s cost advantage of low captive iron ore proximate to its blast furnace is being undermined by the decline of iron ore prices, reducing this cost advantage. Its niche scale and broad product mix places puts at a disadvantage to mass producers of similar commodity products, in our view. BlueScope’s competitive position is enhanced by proximity to high quality coking coal and very low transport cost. However, its conversion costs have been adversely impacted by a halving of historical production rates through the planned exit of the historically large export business that accounted for over half of their production. Thus has increased cost per tonne but substantially improved revenue per tonne. Both companies are adversely impacted by low volumes which are materially impacting unit costs through low utilisation rates of facilities. Pricing Domestic steel prices are priced relative to import party while limited exports are priced by landed parity meaning that the domestic producers must pay the freight to land steel in export markets, delivering materially negative margins. Domestic prices typically lag Asian

Global Steel Equities 68 06 September 2012 steel prices by ~3 months, due to freight times, and attract a domestic premium of 5 – 10% for product quality, yield, just in time delivery and technical service. The domestic premium has been materially eroded by readily available imported steel dumped into the domestic market at $140-$200/t below the price that the same steel is sold for in its home market. A recent customs investigation has confirmed the existence of dumping and anti-dumping penalties may be instituted (Sydney Morning Herald). Earnings outlook Australia’s two steel producers’ earnings are highly dependent on: the global steel making spread, which remains at bottom of cycle levels; depressed domestic demand, at the bottom of cycle levels; and a high AUD which has doubled the conversion costs in USD. An improvement in any of these three drivers would materially improve earnings from current levels. Arrium (long products) is materially challenged by its strong positive leverage to rising iron ore prices. In the current falling iron ore price environment, its steel making margins are likely to turn negative and the earnings from its 6mtpa (increasing to 11Mtpa) iron ore export business could see a sharp decline. BlueScope is largely a spread business with no near term recovery in spread visible, but good quality and scale businesses are in good shape to leverage any improvement in the 3 drivers of earnings. Stocks In Australia, there are three steel cycle companies: SimsMetal Management (SGM.AX) – the world’s largest scrap aggregator, BlueScope Steel (BSL.AX) and Arrium ARI.AX). Valuation Arrium has been generating strong earnings from its iron ore export business and from its Grinding Media business, but breakeven to loss contributions from steel manufacturing, distribution and scrap. The current environment suggests risk of further losses from these challenged segments and a sharp decline in earnings from their iron ore export business. Arrium has delivered less challenging earnings multiples but a more constrained NPV upside and balance sheet risk with debt ~2.5x current market capitalisation SimsMetal Management lacks near term earnings support but is a call on what a mid-cycle scrap margin may be. We assume that material structural change in the industry will prevent historical mid-cycle margins of ~$30/t from being restored. Our DCF-derived target price of $11/share assumes that current margins of <$2/t increase to $15/t. Catalysts Improvement on bottom of cycle global steel making spreads. Domestic demand recovery. AUD depreciation. Balance sheet and other risks Arrium’s $2.1bn net debt ($2.4bn gross debt) is likely to increase as capital is deployed to deliver a doubling in iron ore production. 12 month rolling backward looking debt covenants appear satisfactory until June 2013, unless iron ore were to average below $80/t for the current half. SimsMetal continues to generate satisfactory free cash and has ample balance sheet capacity to fund working capital gyrations and corporate opportunities. Stock calls We remain cautious on Arrium near term (although remain OP) in a falling iron ore price environment due to strong negative earnings leveraged to falling iron ore prices and consequent balance sheet risk. Our preference is Sims.

Global Steel Equities 69 06 September 2012 Appendix: Equity performance and comps

Figure 128: Performance of equities Performance YTD 1 wk 1 mnth 3 mnths 6 mnths 1 year 2 year 5 year Europe Acerinox Michael Shillaker -15.1% -3.8% -3.8% -2.9% -18.2% -7.7% -34.7% -55.2% ArcelorMittal Michael Shillaker -19.2% -2.5% -2.5% 5.8% -22.3% -26.3% -53.4% -77.7% Aperam Michael Shillaker -5.0% -5.1% -5.1% 14.2% -28.3% -7.1% Kloeckner & Co. Michael Shillaker -27.2% -1.7% -1.7% -4.7% -30.5% -27.1% -50.8% -79.3% Outokumpu Michael Shillaker -46.7% -4.2% -4.2% -6.7% -44.9% -55.8% -80.4% -87.8% Salzgitter Michael Shillaker -24.7% -5.3% -5.3% -15.6% -27.1% -24.0% -42.1% -79.9% SSAB Michael Shillaker -17.5% -2.0% -2.0% -7.8% -21.3% -10.3% -53.4% -78.3% Tenaris Michael Shillaker 17.9% 2.4% 2.4% 36.1% 15.1% 61.8% 20.4% 1.4% Thyssen Krupp AG Michael Shillaker -10.0% -3.7% -3.7% 25.4% -14.5% -21.9% -29.2% -61.8% Vallourec Michael Shillaker -25.2% 0.6% 0.6% 31.1% -24.6% -33.9% -47.4% -60.4% Voestalpine Michael Shillaker 6.0% -0.9% -0.9% 14.2% -7.2% -2.9% -8.2% -62.2% Average -15.2% -2.4% -2.4% 8.1% -20.4% -14.1% -37.9% -64.1%

E.Euope/Africa ArcelorMittal South Africa Semyon Mironov -40.9% -7.7% -7.7% -20.8% -35.7% -31.0% -50.5% ERDEMIR Semyon Mironov -10.6% 1.0% 1.0% -1.9% -26.3% -12.7% -14.2% -28.9% Evraz Semyon Mironov -39.4% -3.0% -3.0% -19.3% -40.3% Magnitogorsk Steel Semyon Mironov -21.7% -4.7% -4.7% 10.8% -36.0% -49.0% -67.2% -72.8% Novolipetsk Steel Semyon Mironov -10.7% -2.0% -2.0% 17.7% -22.0% -36.1% -43.7% -47.6% Severstal Semyon Mironov 3.2% -1.8% -1.8% 8.8% -14.7% -17.0% -8.9% -30.9% TMK Semyon Mironov 54.4% 0.4% 0.4% 13.6% 4.1% 7.8% -14.6% -65.2% Average -9.4% -2.6% -2.6% 1.3% -24.4% -23.0% -33.2% -49.1%

North America AK Steel Holding Corp. Richard Garchitorena -36.8% -0.2% -0.2% -10.8% -24.5% -36.3% -62.0% -87.4% Metals USA Holdings Corp. Richard Garchitorena 22.6% 0.0% 0.0% 0.6% 11.1% 22.0% 11.9% Nucor Richard Garchitorena -4.9% -1.7% -1.7% 5.4% -8.9% 10.5% -2.7% -32.1% Olympic Steel Richard Garchitorena -32.4% -0.3% -0.3% -2.7% -27.6% -17.0% -32.9% -35.6% Reliance Steel & Aluminum Richard Garchitorena 5.6% -1.7% -1.7% 11.2% -2.8% 32.6% 26.8% -4.8% United States Steel Group Richard Garchitorena -26.5% -4.8% -4.8% 1.1% -23.0% -29.7% -57.7% -79.7% Worthington Industries Richard Garchitorena 27.6% -1.6% -1.6% 30.4% 24.0% 40.8% 33.6% 0.1% Average -6.4% -1.5% -1.5% 5.0% -7.4% 3.3% -11.8% -39.9%

China Angang Steel Company Ltd Trina Chen -34.7% -5.2% -5.2% -12.0% -28.7% -37.4% -69.0% -83.8% Baosteel Trina Chen -10.7% -3.3% -3.3% -9.8% -15.6% -15.8% -33.6% -77.9% Maanshan Iron & Steel Co Ltd Trina Chen -38.2% -3.1% -3.1% -9.9% -33.0% -40.1% -62.9% -77.3% Average -27.9% -3.9% -3.9% -10.6% -25.8% -31.1% -55.1% -79.7%

Japan Hitachi Metals Shinya Yamada -3.6% -4.8% -4.8% -7.2% -18.8% -3.2% -16.0% -39.7% JFE Holdings Inc Shinya Yamada -27.8% -3.7% -3.7% -17.7% -36.7% -41.7% -60.8% -86.6% Kobe Steel Shinya Yamada -48.7% -3.2% -3.2% -30.7% -52.0% -56.1% -65.9% -85.2% Nippon Steel Shinya Yamada -20.8% -7.9% -7.9% -7.9% -30.9% -32.4% -46.7% -81.3% Sumitomo Metal Industries Shinya Yamada -20.7% -8.3% -8.3% -7.5% -30.2% -29.3% -46.6% -81.0% Tokyo Steel Mfg. Shinya Yamada -59.1% -4.1% -4.1% -42.6% -60.4% -62.9% -72.8% -83.5% Average -30.1% -5.3% -5.3% -18.9% -38.2% -37.6% -51.5% -76.2%

Korea Hyundai Steel Co. Minseok Sinn -13.3% -4.4% -4.4% 1.2% -24.5% -17.0% -23.5% 8.4% POSCO Minseok Sinn -4.5% -4.2% -4.2% 1.5% -11.2% -8.3% -23.7% -39.1% Average -8.9% -4.3% -4.3% 1.4% -17.9% -12.7% -23.6% -15.4%

Taiwan Feng Hsin Iron & Steel Co Ltd -3.4% -1.2% -1.2% -5.1% -7.1% -14.6% -5.7% 3.6% Tung Ho Steel Enterprise Corp 3.6% -2.0% -2.0% -0.2% -7.7% -8.6% -2.7% -38.0% China Steel Randy Abrams -11.4% -3.3% -3.3% -9.0% -15.5% -14.9% -12.3% -32.8% Average -3.7% -2.1% -2.1% -4.8% -10.1% -12.7% -6.9% -22.4%

Brazil Companhia Siderurgica Nacional Ivano Westin -32.8% -2.6% -2.6% -19.8% -42.5% -31.8% -64.0% -47.8% Gerdau Ivano Westin 22.1% -4.9% -4.9% 11.0% 3.2% 35.2% -26.4% -24.2% Ternium Ivano Westin 3.1% -1.8% -1.8% 3.3% -17.1% -22.5% -44.6% -38.1% Usiminas Ivano Westin -19.2% 0.1% 0.1% 5.4% -32.5% -27.0% -63.1% -67.6% Average -6.7% -2.3% -2.3% 0.0% -22.2% -11.5% -49.5% -44.4%

India Jindal Steel & Power Ltd Neelkanth Mishra -24.0% -4.0% -4.0% -16.6% -36.9% -35.6% -49.6% 161.8% JSW Steel Ltd Neelkanth Mishra 32.1% -5.6% -5.6% 10.9% -5.7% -7.7% -42.4% -2.9% Steel Authority of India Ltd Neelkanth Mishra -5.5% -7.4% -7.4% -17.2% -17.2% -32.2% -59.9% -55.4% Tata Steel Ltd Neelkanth Mishra 6.8% -5.4% -5.4% -10.2% -16.0% -27.6% -33.7% -41.5% Average 2.3% -5.6% -5.6% -8.3% -18.9% -25.8% -46.4% 15.5%

Australasia BlueScope Steel Michael Slifirski -13.6% -6.7% -6.7% 20.7% -11.4% -46.3% -81.6% -95.0% Arrium Michael Slifirski -7.1% -18.2% -18.2% -31.9% -35.6% -54.5% -78.1% -89.1% Sims Metal Management Michael Slifirski -30.0% -3.8% -3.8% -13.6% -40.8% -39.0% -49.8% -70.5% Average -26.0% -11.2% -11.2% -16.2% -36.7% -51.3% -63.0% -67.1% Source: Thomson Reuters, Credit Suisse estimates

Global Steel Equities 70 06 September 2012

Figure 129: EBITDA margin EBITDA margin 2005 2006 2007 2008 2009 2010 2011 Europe Acerinox 10% 17% 11% 6% -6% 9% 7% ArcelorMittal 17% 17% 18% 20% 9% 11% 11% Aperam 13% 11% 5% 7% 6% Kloeckner & Co. 6% 7% 6% 9% -2% 5% 3% Outokumpu 9% 17% 11% 3% -8% 4% 2% Salzgitter 17% 25% 15% 11% 2% 6% 7% SSAB 24% 22% 25% 22% 3% 9% 11% Tenaris 35% 39% 35% 35% 28% 26% 25% Thyssen Krupp AG 9% 10% 10% 9% 0% 6% 8% Vallourec 25% 30% 29% 26% 22% 21% 18% Voestalpine 15% 17% 20% 18% 15% 12% 15%

E.Euope/Africa ArcelorMittal South Africa 34% 28% 30% 34% 6% 12% 5% ERDEMIR 16% 23% 21% 11% 6% 21% 23% Evraz 29% 31% 34% 31% 7% 18% 18% Magnitogorsk Steel 28% 30% 28% 20% 20% 19% 14% Novolipetsk Steel 49% 46% 44% 40% 23% 28% 19% Severstal 27% 23% 24% 24% 6% 24% 23% TMK 19% 24% 21% 15% 6% 17% 15%

North America AK Steel Holding Corp. 5% 4% 12% 3% 3% 1% 0% Metals USA Holdings Corp. 9% 8% 11% 0% 6% 8% Nucor 19% 20% 16% 14% 1% 6% 10% Olympic Steel 5% 6% 5% 10% -16% 2% 5% Reliance Steel & Aluminum 12% 12% 11% 11% 7% 8% 9% United States Steel Group 10% 15% -11% 3% 5% Worthington Industries 11% 7% 6% 6% -4% 4% 8%

China Angang Steel Company Ltd 15% 26% 24% 12% 12% 11% 5% Baosteel 24% 20% 17% 12% 15% 15% 10% Maanshan Iron & Steel Co Ltd 18% 16% 15% 10% 13% 11% 7%

Japan Hitachi Metals 12% 13% 8% 10% 14% JFE Holdings Inc 21% 21% 17% 12% 13% Kobe Steel 15% 15% 11% 10% 13% Nippon Steel 18% 16% 13% 9% 11% Sumitomo Metal Industries 24% 22% 18% 9% 13% Tokyo Steel Mfg. 20% 10% 23% 10% 4%

Korea Hyundai Steel Co. 14% 15% 12% 15% 11% 14% 13% POSCO 34% 27% 27% 28% 19% 23% 11%

Taiwan Feng Hsin Iron & Steel Co Ltd Tung Ho Steel Enterprise Corp China Steel 38% 27% 29% 18% 13% 21% 13%

Brazil Companhia Siderurgica Nacional 33% 44% 39% Gerdau 24% 15% 16% 13% Ternium 14% 19% 18% Usiminas 20% 11%

India Jindal Steel & Power Ltd 39% 39% 40% 40% 48% 53% 48% JSW Steel Ltd 34% 27% 32% 27% 18% 21% 19% Steel Authority of India Ltd 33% 21% 27% 27% 20% 23% 16% Tata Steel Ltd 39% 31% 30% 14% 12% 7% 12%

Australasia BlueScope Steel 16%5%7%3% Arrium 11% 9% 10% 9% Sims Metal Management 10%3%5%5% Source: Company data, Credit Suisse research

Global Steel Equities 71 06 September 2012

Figure 130: Global valuation comps Share MktCap EV Target Investment PE EV:EBITDA PB DY price USD USD Price Rating 2012E 2013E 2014E 2012E 2013E 2014E 2012E 2012E Europe (local) US$mn US$mn (local) Acerinox 8 2,628 3,996 8 NEUTRAL 31 14 12 10.0 7.4 6.7 1.2 1.2% ArcelorMittal 15 22,673 46,757 21 OUTPERFORM 16 8 6 5.9 4.7 4.0 0.4 5.1% Aperam 10 1,015 1,893 15 OUTPERFORM -11 -47 46 7.7 5.2 4.5 0.3 5.8% Kloeckner & Co. 7 891 1,758 10 OUTPERFORM -8 16 5 12.6 5.9 3.6 0.4 0.0% Outokumpu 1 1,267 3,564 1 NEUTRAL -7 169 6 12.9 7.6 4.4 0.3 0.0% Salzgitter 29 2,168 3,413 40 NEUTRAL 51 10 8 5.6 3.7 3.3 0.4 1.6% SSAB 49 1,745 4,497 75 NEUTRAL 18 13 9 6.8 5.6 4.6 0.5 4.5% Tenaris 16 24,384 24,288 15 UNDERPERFORM 13 13 11 8.1 7.4 6.5 2.1 2.5% Thyssen Krupp AG 16 10,001 24,438 25 OUTPERFORM 98 18 10 9.1 6.6 5.8 0.9 2.0% Vallourec 36 5,520 7,352 50 NEUTRAL 19 12 9 7.9 6.2 4.9 0.9 2.2% Voestalpine 23 4,837 11,106 33 OUTPERFORM 12 9 6 6.6 5.8 4.7 1.0 3.9%

E.Euope/Africa ArcelorMittal South Africa 40 1,911 1,543 33 UNDERPERFORM -41 -39 -23 10.0 12.8 20.3 0.7 0.0% ERDEMIR 2 3,444 4,943 2 NEUTRAL 11 8 8 8.3 6.4 6.7 0.9 5.7% Evraz 218 4,541 10,094 310 NEUTRAL -159 -351 -22 5.0 4.9 6.4 0.9 0.0% Magnitogorsk Steel 4 3,190 6,235 6 OUTPERFORM -184 23 14 5.7 4.6 4.2 0.3 2.0% Novolipetsk Steel 18 10,548 14,391 16 UNDERPERFORM 12 11 10 7.6 7.4 7.0 0.9 1.7% Severstal 12 7,818 10,722 13 NEUTRAL 13 12 21 4.8 4.6 5.8 1.4 2.0% TMK 14 3,033 6,531 19 OUTPERFORM 8 6 5 5.9 5.3 4.6 1.4 3.8%

North America AK Steel Holding Corp. 5 555 1,414 7 OUTPERFORM -22 6 5 5.8 4.2 3.9 1.4 2.0% Metals USA Holdings Corp. 14 512 991 20 OUTPERFORM 8 7 6 6.2 4.9 4.1 1.6 0.0% Nucor 37 11,765 14,847 45 OUTPERFORM 21 11 9 9.4 6.0 4.9 1.6 3.9% Olympic Steel 16 171 408 19 NEUTRAL 9 7 6 7.4 5.7 4.8 0.6 0.5% Reliance Steel & Aluminum 52 3,891 5,167 65 OUTPERFORM 10 9 8 6.4 5.3 4.5 1.1 1.5% United States Steel Group 19 2,710 6,530 24 NEUTRAL 11 6 5 6.4 3.7 3.2 0.8 1.1% Worthington Industries 21 1,486 1,813 22 NEUTRAL 12 11 10 7.5 6.3 5.3 2.1 2.1%

China Angang Steel Company Ltd 4 3,753 7,784 2 UNDERPERFORM -5 -10 -19 102.5 14.0 10.5 0.4 0.0% Baosteel 4 12,077 21,130 5 NEUTRAL 7 18 11 3.9 5.0 3.8 0.7 2.0% Maanshan Iron & Steel Co Ltd 2 1,489 4,579 1 UNDERPERFORM -2 -5 841 39.5 9.2 5.2 0.4 0.0%

Japan Hitachi Metals 781 3,512 5,232 900 NEUTRAL 15 10 9 5.8 5.1 4.6 1.2 1.8% JFE Holdings Inc 976 6,702 25,345 2,300 OUTPERFORM -14 6 3 7.3 6.6 5.2 0.4 2.0% Kobe Steel 60 2,297 10,919 70 NEUTRAL -13 -4 7 5.0 7.0 5.4 0.3 1.7% Nippon Steel 149 11,957 27,200 270 OUTPERFORM 16 -47 4 6.1 5.2 3.3 0.5 1.7% Sumitomo Metal Industries 109 6,446 20,391 200 OUTPERFORM -9 -7 4 8.3 7.7 4.9 0.7 1.8% Tokyo Steel Mfg. 257 488 366 250 NEUTRAL -3 -2 -3 5.5 -76.4 11.7 0.2 1.9%

Korea Hyundai Steel Co. 81,600 6,130 13,840 100,000 OUTPERFORM 9 7 6 8.8 7.9 6.2 0.7 0.6% POSCO 358,000 27,483 46,166 450,000 OUTPERFORM 9 7 7 8.2 7.2 6.9 0.6 2.7%

Taiwan China Steel 25 12,613 15,073 25 NEUTRAL 19 16 14.9 14.3 1.3 3.7%

Brazil Companhia Siderurgica Naciona 10 6,587 14,991 11 UNDERPERFORM 20 10 9 7.1 6.1 5.6 1.6 0.8% Gerdau 18 14,254 21,079 22 OUTPERFORM 15 13 10 8.2 6.6 5.2 1.2 2.6% Ternium 19 3,815 5,069 29 OUTPERFORM 6 6 5 3.3 3.1 2.5 0.6 3.5% Usiminas 8 4,426 6,905 9 NEUTRAL -23 -515 21 15.6 8.2 6.7 0.5 0.0%

India Jindal Steel & Power Ltd 336 5,619 8,054 500 OUTPERFORM 8 8 8 6.9 6.5 6.8 1.7 0.6% JSW Steel Ltd 654 2,611 5,854 400 UNDERPERFORM 27 24 12 5.3 7.4 7.7 0.9 1.6% Steel Authority of India Ltd 76 5,645 6,281 66 UNDERPERFORM 9 10 10 8.3 10.1 8.4 0.8 2.6% Tata Steel Ltd 351 6,093 15,897 340 UNDERPERFORM 6 8 7 7.1 6.7 6.2 0.8 4.0%

Australasia BlueScope Steel R R R R RESTRICTED -4 R R R R R R R Arrium 1 803 2,996 1 OUTPERFORM 4 4 2 5.0 4.5 2.5 0.2 10.4% Sims Metal Management 9 1,823 2,122 11 OUTPERFORM 23 14 12 8.2 6.7 5.8 0.7 2.3% Priced as of 04 September 2012, Source: Company data, Credit Suisse estimates

Global Steel Equities 72 06 September 2012 Appendix: Key regional snapshots

Figure 131: Global key charts Production Process in 2011 By Key countries/regions 2011 Oceania Eur ope From OHF 0% 1% Other Asia 12% 20% N.A meric a From EA F 8% 29% S.America 3%

CIS Other Eur ope 10%

From BOF 70% China 47%

Hot Rolled production by type 2010 Crude Steel Production (2000-2011) Other 1600 9% 1400

1200 Long 39% 1000

800

600

400 Flat 52% 200

0 20002001 20022003 20042005 20062007 20082009 20102011

Apparent Crude Steel consumption (2000-2010) Apparent Crude Steel Use per Capita (kg) (2000-2010)

1600 250

1400 200 1200

1000 150

800

100 600

400 50 200

0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: WSA

Global Steel Equities 73 06 September 2012

Figure 132: EU-27 key charts Production Process in 2011 By Key countries/regions 2011 Rest of EU From OHF 27 0.5% 17% Germany 25%

From EAF Other EU -15 43% 14%

From BOF 56% Belgium Italy 5% 16% UK 5% France Spain 9% 9%

Hot Rolled production by type 2010 Crude Steel Production (2000-2011) Other 1% 250

200

Long 40% 150

100 Flat 59% 50

0 20002001 200220032004 20052006 200720082009 20102011

Apparent Crude Steel consumption (2000-2010) Apparent Crude Steel Use per Capita (kg) (2000-2010)

250 500

450

200 400

350

150 300

250

100 200 150

50 100 50

0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: WSA

Global Steel Equities 74 06 September 2012

Figure 133: N. America key charts Production Process in 2010 By Key countries/regions 2011 Others From OHF Mexico 0% 0% 15%

From BOF Canada 40% 11%

From EAF 60%

USA 74%

Hot Rolled production by type 2010 Crude Steel Production (2000-2011) Other 3% 160

140 Long 30% 120

100

80

60

40

Flat 20 67% 0 20002001 200220032004 20052006 200720082009 20102011

Apparent Crude Steel consumption (2000-2010) Apparent Crude Steel Use per Capita (kg) (2000-2010)

200 400

180 350 160 300 140 250 120

100 200

80 150 60 100 40 50 20

0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: WSA

Global Steel Equities 75 06 September 2012

Figure 134: South America charts Production Process in 2011 By Key countries/regions 2011 From OHF Others 0% 11% Venezuela 6%

From EAF 37% Argentina 11%

From BOF 63% Brazil 72%

Hot Rolled production by type 2010 Crude Steel Production (2000-2011) Other 2% 60

50

40 Long 45% 30

Flat 53% 20

10

0 2001 2002 2003 2004 2005 20062007 2008 2009 2010 2011

Apparent Crude Steel consumption (2000-2010) Apparent Crude Steel Use per Capita (kg) (2000-2010)

60 140

120 50

100 40 80 30 60

20 40

10 20

0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: WSA

Global Steel Equities 76 06 September 2012

Figure 135: CIS & Other Europe key charts Production Process in 2011 By Key countries/regions 2011 From OHF Other Europe 0% 3% Turkey 23%

From EA F 38% Russ ia 45%

Other CIS 6% From BOF 62%

Ukraine 23%

Hot Rolled production by type 2009 Crude Steel Production (2000-2011) 180

160

140

Long 39% 120 100

80

60 Flat 61% 40

20

0 20002001 200220032004 20052006 200720082009 20102011

Apparent Crude Steel consumption (2000-2010) Apparent Crude Steel Use per Capita (kg) (2000-2010)

120 600

100 500

80 400

60 300

40 200

20 100

0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: WSA

Global Steel Equities 77 06 September 2012

Figure 136: China key charts Production Process in 2011 Net trade in Steel semis and finished From OHF 60 From EAF 0% 10% 50

40

30

20

10

0

-10

-20

-30

-40 From BOF 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 90%

Hot Rolled production by type 2010 Crude Steel Production (2000-2011) Other 3% 800

700

600

500 Long 46% 400

Flat 300 51% 200

100

0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Apparent Crude Steel consumption (2000-2010) Apparent Crude Steel Use per Capita (kg) (2000-2010)

700 500

450 600 400

500 350

300 400 250 300 200

200 150 100 100 50

0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: WSA

Global Steel Equities 78 06 September 2012

Figure 137: Other Asia key charts Production Process in 2011 By Key countries/regions 2011 (excl China) From OHF 7% 0%

Japan India 36% 25% From EAF 43%

From BOF 57%

Taiw an 8%

S Korea 24%

Hot Rolled production by type 2011 Crude Steel Production (2000-2011) 350 Other 9%

300

Long 250 37%

200

150

100

Flat 54% 50

0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Apparent Crude Steel consumption (2000-2010) Apparent Crude Steel Use per Capita (kg) (2000-2010)

300 140.0

120.0 250

100.0 200 80.0 150 60.0

100 40.0

50 20.0

0 0.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: WSA

Global Steel Equities 79 06 September 2012

Figure 138: Oceania key charts Production Process in 2011 By Key countries/regions 2011 New zealand From OHF 11% From EAF 0% 20%

From BOF Australia 80% 89%

Hot Rolled production by type 2010 Crude Steel Production (2000-2011) Other 0% 10 9 Long 8 30% 7

6

5

4

3

Flat 2 70% 1

0 2000 2001 2002 2003 2004 20052006 2007 2008 2009 2010 2011

Apparent Crude Steel consumption (2000-2010) Apparent Crude Steel Use per Capita (kg) (2000-2010)

12 400

350 10 300

8 250

6 200

150 4 100

2 50

0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: WSA

Global Steel Equities 80 06 September 2012 Analyst coverage

Figure 139: Analyst coverage Equity Research – Steel Austrailia Michael Slifirski +61 3 9280 1845 [email protected] Melbourne Sam Webb +61 3 9280 1716 [email protected] Melbourne

Brazil Ivano Westin +55 11 3841 6318 ivano,[email protected] Sao Paulo Viccenzo Paternostro +55 11 3841 6043 [email protected] Sao Paulo Marina Melemendjian +55 11 3841 6341 [email protected] Sao Paulo

China Trina Chen +852 2101 7031 [email protected] Hong Kong Frankie Zhu +852 2101 7426 [email protected] Hong Kong

Europe Michael Shillaker (Global Head) +44 20 7888 1344 [email protected] London Nihal Shah +44 20 7888 3270 [email protected] London James Gurry +44 20 7883 7083 [email protected] London Liam Fitzpatrick +44 20 7883 8350 [email protected] London

India Neelkanth Mishra +91 22 6777 3716 [email protected] Mum bai Ishan Mahajan +91 22 6777 3894 [email protected] Mum bai

Japan Shinya Yamada +813 4550 9910 [email protected] Tokyo Kazumasa Okumoto +813 4550 7266 [email protected] Tokyo

Korea Minseok Sinn +82 2 3707 8898 [email protected] Seoul Hayoung Chung +82 2 3707 3795 [email protected] Seoul

Russia Semyon Mironov +7 495 662 8510 [email protected] Mos cow Dmitry Glushakov +7 495 662 8512 [email protected] Mos cow

USA Richard Garchitorena +1 212 325 5809 [email protected] New York Riya Bhattacharya +1 212 325 2132 [email protected] New York Source: Company data

Global Steel Equities 81 06 September 2012

Companies Mentioned (Price as of 04 Sep 12) Acerinox (ACX.MC, Eu8.41, NEUTRAL, TP Eu8.00) AK Steel Holding Corp. (AKS, $5.02, OUTPERFORM [V], TP $7.00) Angang Steel Company Ltd. (0347.HK, HK$3.65, UNDERPERFORM [V], TP HK$2.30) Aperam (APAM.AS, Eu10.38, OUTPERFORM [V], TP Eu15.00) ArcelorMittal (MT.N, $14.64, OUTPERFORM, TP $21.00) ArcelorMittal South Africa (ACLJ.J, R40.05, UNDERPERFORM, TP R33) Arrium Ltd. (ARI.AX, A$0.65, OUTPERFORM [V], TP A$1.15) Baosteel (600019.SS, Rmb4.33, NEUTRAL, TP Rmb5.20) BlueScope Steel (BSL.AX, A$0.35, RESTRICTED [V]) China Steel (2002.TW, NT$25.15, NEUTRAL, TP NT$25.32) Companhia Siderurgica Nacional (CSNA3, R$9.56, UNDERPERFORM, TP R$10.50) ERDEMIR (EREGL.IS, TRY2.03, NEUTRAL, TP TRY2.10) Evraz (EVRE.L, 218 p, NEUTRAL, TP 310.00 p) Feng Hsin Iron & Steel Co Ltd. (2015.TW, NT$46.65) Gerdau (GGBR4, R$17.82, OUTPERFORM, TP R$21.50) Hitachi Metals (5486, ¥807, NEUTRAL, TP ¥900, OVERWEIGHT) Hyundai Steel Co. (004020.KS, W83,000, OUTPERFORM, TP W100,000) JFE Holdings, Inc. (5411, ¥1,007, OUTPERFORM, TP ¥2,300, OVERWEIGHT) Jindal Steel & Power Ltd. (JNSP.BO, Rs352.85, OUTPERFORM, TP Rs500.00) JSW Steel Ltd. (JSTL.BO, Rs676.75, UNDERPERFORM [V], TP Rs400.00) Kloeckner & Co. (KCOGn.DE, Eu7.13, OUTPERFORM [V], TP Eu10.00) Kobe Steel (5406, ¥61, NEUTRAL, TP ¥70, OVERWEIGHT) Maanshan Iron & Steel Co Ltd. (0323.HK, HK$1.54, UNDERPERFORM [V], TP HK$1.00) Magnitogorsk Steel (MAGNq.L, $3.78, OUTPERFORM [V], TP $5.90) Mechel (MTL.N, $5.74, UNDERPERFORM [V], TP $6.00) Metals USA Holdings Corp. (MUSA, $13.81, OUTPERFORM, TP $20.00) Nippon Steel (5401, ¥152, OUTPERFORM, TP ¥270, OVERWEIGHT) Novolipetsk Steel (NLMKq.L, $17.60, UNDERPERFORM [V], TP $16.00) Nucor (NUE, $37.11, OUTPERFORM, TP $45.00) Olympic Steel, Inc. (ZEUS, $15.67, NEUTRAL, TP $19.00) Outokumpu (OUT1V.HE, Eu0.69, NEUTRAL [V], TP Eu0.90) POSCO (005490.KS, W363,000, OUTPERFORM, TP W450,000) Reliance Steel & Aluminum (RS, $51.68, OUTPERFORM, TP $65.00) Salzgitter (SZGG.DE, Eu28.80, NEUTRAL, TP Eu40.00) Severstal (CHMFq.L, $11.62, NEUTRAL, TP $13.10) Sims Metal Management (SGM.AX, A$8.86, OUTPERFORM [V], TP A$11.00) SSAB (SSABa.ST, SKr48.82, NEUTRAL, TP SKr75.00) Steel Authority of India Ltd. (SAIL.BO, Rs77.20, UNDERPERFORM, TP Rs66.00) Sumitomo Metal Industries (5405, ¥111, OUTPERFORM, TP ¥200, OVERWEIGHT) Tata Steel Ltd. (TISC.BO, Rs363.10, UNDERPERFORM, TP Rs340.00) Tenaris (TENR.MI, Eu16.49, UNDERPERFORM, TP Eu15.00) Ternium (TX, $19.03, OUTPERFORM, TP $29.40) Thyssen Krupp AG (TKAG.F, Eu15.52, OUTPERFORM, TP Eu25.00) TMK (TRMKq.L, $14.01, OUTPERFORM [V], TP $19.00) Tokyo Steel Mfg. (5423, ¥256, NEUTRAL, TP ¥250, OVERWEIGHT) Tung Ho Steel Enterprise Corp. (2006.TW, NT$27.55) United States Steel Group (X, $18.78, NEUTRAL [V], TP $24.00) Usiminas (USIM5, R$8.07, NEUTRAL [V], TP R$8.60) Vallourec (VLLP.PA, Eu36.24, NEUTRAL [V], TP Eu50.00) Voestalpine (VOES.VI, Eu22.85, OUTPERFORM, TP Eu33.00) Worthington Industries (WOR, $21.42, NEUTRAL, TP $22.00)

Disclosure Appendix Important Global Disclosures The analysts identified in this report each certify, with respect to the companies or securities that the individual analyzes, that (1) the views expressed in this report accurately reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report. The analyst(s) responsible for preparing this research report received compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities.

Global Steel Equities 82 06 September 2012

Analysts’ stock ratings are defined as follows: Outperform (O): The stock’s total return is expected to outperform the relevant benchmark* by at least 10-15% (or more, depending on perceived risk) over the next 12 months. Neutral (N): The stock’s total return is expected to be in line with the relevant benchmark* (range of ±10-15%) over the next 12 months. Underperform (U): The stock’s total return is expected to underperform the relevant benchmark* by 10-15% or more over the next 12 months. *Relevant benchmark by region: As of 29th May 2009, Australia, New Zealand, U.S. and Canadian ratings are based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return potential within an analyst’s coverage universe**, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. Some U.S. and Canadian ratings may fall outside the absolute total return ranges defined above, depending on market conditions and industry factors. For Latin American, Japanese, and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; for European stocks, ratings are based on a stock’s total return relative to the analyst's coverage universe**. For Australian and New Zealand stocks, 12-month rolling yield is incorporated in the absolute total return calculation and a 15% and a 7.5% threshold replace the 10-15% level in the Outperform and Underperform stock rating definitions, respectively. The 15% and 7.5% thresholds replace the +10-15% and -10-15% levels in the Neutral stock rating definition, respectively. **An analyst's coverage universe consists of all companies covered by the analyst within the relevant sector. Restricted (R): In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances. Volatility Indicator [V]: A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward.

Analysts’ coverage universe weightings are distinct from analysts’ stock ratings and are based on the expected performance of an analyst’s coverage universe* versus the relevant broad market benchmark**: Overweight: Industry expected to outperform the relevant broad market benchmark over the next 12 months. Market Weight: Industry expected to perform in-line with the relevant broad market benchmark over the next 12 months. Underweight: Industry expected to underperform the relevant broad market benchmark over the next 12 months. *An analyst’s coverage universe consists of all companies covered by the analyst within the relevant sector. **The broad market benchmark is based on the expected return of the local market index (e.g., the S&P 500 in the U.S.) over the next 12 months.

Credit Suisse’s distribution of stock ratings (and banking clients) is: Global Ratings Distribution Outperform/Buy* 45% (52% banking clients) Neutral/Hold* 42% (49% banking clients) Underperform/Sell* 11% (39% banking clients) Restricted 2% *For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, and Underperform most closely correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis. (Please refer to definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdings, and other individual factors. Credit Suisse’s policy is to update research reports as it deems appropriate, based on developments with the subject company, the sector or the market that may have a material impact on the research views or opinions stated herein. Credit Suisse's policy is only to publish investment research that is impartial, independent, clear, fair and not misleading. For more detail please refer to Credit Suisse's Policies for Managing Conflicts of Interest in connection with Investment Research: http://www.csfb.com/research-and-analytics/disclaimer/managing_conflicts_disclaimer.html Credit Suisse does not provide any tax advice. Any statement herein regarding any US federal tax is not intended or written to be used, and cannot be used, by any taxpayer for the purposes of avoiding any penalties. Important Regional Disclosures Singapore recipients should contact a Singapore financial adviser for any matters arising from this research report. Restrictions on certain Canadian securities are indicated by the following abbreviations: NVS--Non-Voting shares; RVS--Restricted Voting Shares; SVS--Subordinate Voting Shares. Individuals receiving this report from a Canadian investment dealer that is not affiliated with Credit Suisse should be advised that this report may not contain regulatory disclosures the non-affiliated Canadian investment dealer would be required to make if this were its own report. For Credit Suisse Securities (Canada), Inc.'s policies and procedures regarding the dissemination of equity research, please visit http://www.csfb.com/legal_terms/canada_research_policy.shtml. Credit Suisse Securities (Europe) Limited acts as broker to EVRE.L. The following disclosed European company/ies have estimates that comply with IFRS: ACX.MC, MT.N, EVRE.L, KCOGn.DE, MTL.N, NLMKq.L, OUT1V.HE, SZGG.DE, SSABa.ST, TENR.MI, TKAG.F, TRMKq.L, VLLP.PA, VOES.VI. As of the date of this report, Credit Suisse acts as a market maker or liquidity provider in the equities securities that are the subject of this report. Principal is not guaranteed in the case of equities because equity prices are variable. Commission is the commission rate or the amount agreed with a customer when setting up an account or at anytime after that.

Global Steel Equities 83 06 September 2012

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Global Steel Equities 84 06 September 2012 Global Equity Research

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Recipients who are not market professional or institutional investor customers of CS should seek the advice of their independent financial advisor prior to taking any investment decision based on this report or for any necessary explanation of its contents. This research may relate to investments or services of a person outside of the UK or to other matters which are not regulated by the FSA or in respect of which the protections of the FSA for private customers and/or the UK compensation scheme may not be available, and further details as to where this may be the case are available upon request in respect of this report. Any Nielsen Media Research material contained in this report represents Nielsen Media Research's estimates and does not represent facts. NMR has neither reviewed nor approved this report and/or any of the statements made herein. 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