Analysts optimistic on steel makers, despite rising costs

By V. Phani Kumar, MarketWatch

HONG KONG (MarketWatch) -- Japanese steel makers' willingness to pay a 55% increase in price to buy coking coal from BHP Billiton is leading a new wave of optimism for Asia's steel industry, with analysts hopeful that the steel mills may in turn be able to raise prices to cover most of the increase in costs.

Under a new pricing agreement signed with BHP on Monday, leading Japanese steel producers, including JFE Holdings and Nippon Steel Corp., agreed to pay the Anglo-Australian miner $200 a ton for coking coal during the April-to-June period, compared with around $129 a ton during the current financial year ending March 31. The latest agreement will reset prices every quarter, unlike previous contracts where prices were reset annually.

Although a number of other steel makers in the region have yet to sign similar agreements for key raw materials such as coking coal and iron ore, some analysts said the agreement partially lifts the uncertainty that surrounded steel makers' tough price negotiations with miners in recent times.

"While this doesn't mark a complete end to the uncertainty over this year's raw material contracts, we expect even a partial settlement to be seen positively by the markets," Goldman Sachs analysts wrote in a note to clients. "This will also provide an impetus for quicker and sharper recovery in Asian spot-steel prices, which have already been rising in anticipation of higher material costs."

Goldman Sachs estimates that Asian mills will need to raise steel prices by between 20% and 30% to be able to pass on the expected increase in the cost of procuring iron ore and coking coal.

At the same time, Japanese steel makers, which currently sign a large number of contracts with their own customers on an annual basis, will also need to reset prices in those contracts every quarter, the brokerage said.

Regional supply-demand trends were also likely to support an increase in steel prices.

"We expect Chinese spot prices for steel to begin rising in earnest on renewed demand following the Lunar New Year and the increase in key raw material prices," said J.P. Morgan analyst Akira Kishimoto.

"With demand for steel still booming in China and Southeast Asia, we think Japanese blast-furnace steel makers could also raise export prices high enough to offset the entire increase in raw material costs," Kishimoto said. "Within Japan, however, we think they may have to swallow some of the cost increase on sales to certain long-term contract customers."

In Tuesday's trading in Tokyo, steel makers were taking a breather after rising sharply in the past few days. Shares of JFE (JP:5411 2,758, -47.00, -1.68%) /quotes/comstock/11i!jfee.y (JFEEY 0.00, 0.00, 0.00%) dropped 1%, Nippon Steel (JP:5401 301.00, -5.00, -1.63%) /quotes/comstock/11i!nisty (NISTY 34.45, -0.20, -0.58%) shed 1.1% and Kobe Steel Ltd. (JP:5406 195.00, +7.00, +3.72%) /quotes/comstock/11i!kbsty (KBSTY 10.50, -0.03, -0.28%) dropped 1.1% in Tokyo afternoon trading.

Elsewhere in the region, Posco /quotes/comstock/13*!pkx/quotes/nls/pkx (PKX 106.83, +0.05, +0.05%) inched up 0.2% while Hyundai Steel Co. dropped 0.6% in Seoul, Angang Steel Co. /quotes/comstock/22h!e:347 (HK:347 11.84, 0.00, 0.00%) /quotes/comstock/11i!angg.y (ANGGY 56.59, +4.94, +9.56%) fell 1.2% in Hong Kong, Baoshan Iron & Steel Co. /quotes/comstock/28c!e:600019 (CN:600019 6.55, 0.00, 0.00%) slipped 0.1% in Shanghai, and Tata Steel Ltd. fell 1.1% in Mumbai.

Among miners, BHP /quotes/comstock/22x!e:bhp (AU:BHP 40.26, -0.20, -0.49%) /quotes/comstock/13*!bhp/quotes/nls/bhp (BHP 72.40, +0.32, +0.44%) fell 0.5%, while rival Rio Tinto Ltd. /quotes/comstock/13*!rtp/quotes/nls/rtp (RTP 52.38, -0.01, -0.02%) /quotes/comstock/22x!e:rio (AU:RIO 70.82, -0.68, -0.95%) dropped 1% in Sydney, and NMDC Ltd. tumbled 5.6% in Mumbai morning trading.

In wider market action, Japan's Nikkei 225 Average, South Korea's Kospi and India's Sensex gave up 0.1% each, with Australia's S&P/ASX 200 rising 0.3%, Hong Kong's Hang Seng Index advancing 0.3% and China's Shanghai Composite adding 0.4%.

Varahabhotla Phani Kumar is a reporter in MarketWatch's Hong Kong bureau.

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