The outlook for the Asia-Pacific metals and mining sector in 2012 is changing even though evidence of industry weakening is just beginning to appear in corporate performance. It will be difficult for mining companies in the region to repeat the profitability seen in 2010 and 2011, when they were at the top of the commodity pricing cycle.
While most companies that Standard & Poor's Ratings Services rates posted good results in the second and third quarters of 2011, there have been some reversals in the third quarter and lower profitability is expected in the fourth quarter and early 2012.
Still, we expect economic growth in the Asia-Pacific region to remain positive and considerably higher than in Europe and the US. Standard & Poor's base-case scenario for China is a soft landing with real GDP growth of more than 8 per cent over the next few years, based on a near-term slowdown, followed by the government's remedial actions and a recovery to varying degree.
The overall market sentiment has turned markedly negative.The growing signs of weaker economic conditions in Europe and the US will dampen demand for some commodities in the next six months. The steel industry could face the most difficulties partly because it is so vulnerable to reductions in capacity utilisation and margin squeeze.
We believe the proportion of negative rating outlooks and negative rating actions on Asia-Pacific's metals and mining companies could increase during the next several quarters. Still, many of our rated entities are diversified with solid cash flow and strong current capitalisation. Even some of the smaller, more concentrated companies have ample liquidity to withstand the next trough in the commodity cycle.
Ssteel, nickel, aluminium and, possibly coking coal, are expected to exhibit negative trends, but the outlook for thermal coal, iron ore, gold, and mineral sands will be more stable.
Prices for iron ore and mineral sands will remain resilient due to supply-side constraints. Although prices can still fall, the constraints may set a floor price for these commodities when demand declines. As gold is perceived a safe haven, its price is not expected to face a precipitous decline.
All Eyes On China
China's demand for metals and minerals is influenced more by domestic consumption and government investment than by the direction of the export sector. Recent industry reports of increased copper inventories, reduction in aluminium product imports, growing receivables, softer end-user demand in real-estate construction, infrastructure (especially railroads), and shipping industries, and the closure of small steel mills due to declining orders will have a negative effect on commodity prices and producers' profitability.
Over the next three years, the underlying strong fundamentals for increased demand for metals in China are expected to continue, but the proportion of demand from domestic consumption is likely to grow. Nonetheless, China's producers and importers of metals and minerals could suffer, particularly those marginal-cost producers or producers with transportation disadvantages.
Steel less solid
Steel companies in Asia-Pacific are less stable due to falling demand from certain sectors in China and lower growth in steel demand in developed countries.
If demand from China declines, steel producers in Japan and Korea, as well as iron ore and coking coal producers in Australia. In addition, some producers with still-high capital expenditures may have little free cash to reduce debt.
India's steel industry is different. First, steel demand is expected to be more stable, based on the ongoing need for infrastructure investments and the demand from the automotive and heavy vehicle sector.
Second, integrated steel producers in India, are faring better because they don't face the iron ore shortages experienced by India now. Karnataka has banned iron ore mining and that is hurting non-integrated steel producers; JSW Steel , for example, can't access iron ore for its newly commissioned blast furnace. In the case of iron ore producer , it means lower EBITDA contribution from iron ore in 2011 until the ban is lifted.
Accessing capital
Access to capital in the high-yield market is becoming less assured. The dearth of the US dollar bond issuances in the third quarter, combined with recent declines in equity prices for metals and mining companies and the crisis among European banks, is making new debt and equity issuances harder. If these volatile capital market conditions continue, rolling over 2012 and 2013 debt maturities would be more difficult for high-yield issuers with significant maturities coming due, such as Vedanta.
Production costs are rising throughout the metals and mining industry due to inflation, rising labour costs and, in some cases, appreciating currencies. While we expect higher production costs for steel companies for the remainder of 2011, this trend could ease in 2012 if economies experience slower growth overall and steel demand softens in certain sectors.
The level of capital expenditure and mergers and acquisitions (M&A) will be lower in 2012. Some companies have completed or are near completing major expansion projects. Others have reined in capital expenditure plans to strengthen their financial position or due to lack of funding. Still, projects underway are expected to continue. Given that M&A by companies in India and China tend to hinge on gaining access to coal and iron ore, this activity will continue.
(The author is Managing Director and Analytical Manager, Corporate Ratings —Commodities, Asia-Pacific, Standard & Poor’s.)