Diminished Chinese Demand Could Impact Glencore

We are reducing our long-term metallurgical coal price forecast based on a diminished outlook for Chinese steel demand

Daniel Rohr, CFA 6 October, 2014 | 8:00AM

We are reducing our long-term metallurgical coal price forecast to $130 from $160 based on a diminished outlook for Chinese steel demand. Amid weaker Chinese steel demand and lower domestic Chinese freight costs, we expect China's import needs to decline, eliminating what had been a key source of growth for the market. We expect global seaborne demand growth to slow considerably, with India the main source of incremental demand going forward.

We now expect Chinese steel production to peak at 800 million metric tons in 2014 and forecast output of 730 million metric tons in 2018 (a 9% drop). Our new outlook breaks from traditional methods as it focuses on the country's stock of steel in use, not its annual steel consumption. At 5.2 metric tons per capita, China's steel stock is nearly 3 times the norm for countries of comparable GDP per capita. China's additions to its steel stock slow over our forecast horizon.

Meanwhile, we expect improvements to the rail infrastructure linking China's coal-producing and coal-consuming regions to boost the competitiveness of domestic coal supplies. In recent years, China’s surging demand for steelmaking coal outstripped its ability to cost-effectively transport coal from mine to consumer. In the context of weaker demand growth, the ongoing railway build-out will drive down domestic costs and diminish import needs.

Because China's domestic met coal market (about 785 million metric tons) is so much larger than the seaborne market (about 250 million metric tons), small shifts in the domestic supply and demand balance have major implications for the seaborne trade. In our outlook, met coal loses its main source of demand growth. Outside China, demand growth has been weak over the past decade, a trend we mostly expect to continue. We assume modest demand growth from traditional buyers like Japan, Korea, Taiwan and the EU, and expect India to underpin a large share of demand growth going forward.

Our fair value estimate for Anglo American (AAL) remains 1,100p per share; our fair value estimate for Glencore (GLEN) remains 220p.

We expect weaker prices for most of Glencore's key commodities over the next several years, as Chinese demand weakens on slower GDP growth and diminished commodity intensity of GDP. Production growth and a more resilient marketing business provide a partial offset in our five-year explicit forecast horizon.

For Anglo American, we have assigned a high uncertainty rating to our fair value estimate. While we recognise the substantial uncertainty surrounding Anglo's future operating profits (mostly due to commodity price risk), we think a rating of high better captures the offset afforded by the company's modest balance sheet leverage than would a very high rating.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Anglo American PLC1,901.00 GBP0.00
Glencore PLC259.65 GBP0.00

About Author

Daniel Rohr, CFA  is a senior equity analyst at Morningstar.

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