Steel stocks are undervalued as sector fundamentals pick up

The Chinese steel industry’s fundamentals are improving from a very low base, but valuations for some stocks haven’t caught up with the pace as investors dismiss signs of a pick-up, analysts said.

An example of a steelmaker enjoying a resurgence in the current environment is Liaoning-based Angang Steel, according to a research report by Jefferies analysts Po Wei and Howard Lau.

They say the company, after reporting 94 per cent year-on-year net profit growth in the first half, will see earnings remain high in the third quarter.

“We think two fundamental fronts are improving for Angang,” Wei and Lau wrote. “First, although happening at a slow pace, China’s steel mill capacities are indeed shutting down especially in inland regions such as Shanxi and Sichuan where products could not be exported. The government’s plan is to close down 3 per cent of capacity every year.

“Second, iron ore suppliers are becoming more fragmented too, extracting less profitability out of the value chain.”

Additionally, Jefferies expects to see a stronger than normal seasonal rebound in construction demand in the fourth quarter after extreme weather conditions this summer disrupted most building activity in east and central China. Growth in steel demand in the second half may still slow to around 2 per cent year-on-year, down from 5 per cent in the first half, as China’s fixed-asset investment growth declines.

Jefferies reiterated its buy rating on Angang Steel, based on its cheap valuation, with a target price of HK$4.80.