Deep value in the SA steel industry, or a money pit?
The steel business, like most primary industries, is highly cyclical, and very vulnerable to swings in the economy. When GDP is booming, and capacity is expanding, the steel industry booms, but when a nation's animal spirits wane, steel companies can see dramatic falls in sales, prices, and value.
Right now, steel companies in South Africa are in a trough. With GDP falling into recession, and a long-term downturn in the construction industry, the steel business has been in a slump, and there's apparently little prospect of them emerging soon. However, in this interview with the CEO of the S.A. Institute of Steel Construction, we hear some reasons for optimism. Under the National Development Plan, there will be plenty of fresh infrastructure projects needed raw materials, which could boost the steel industry, and there's also reason to hope that projects in the rest of Africa will similarly offer opportunity for South African steel makers. – FD
GUGULETHU MFUPHI: Hello, and a warm welcome to Power Lunch on this Wednesday afternoon. I'm Gugulethu Mfuphi and the guy who's getting himself ready for action and adjusting his jacket…
ALEC HOGG: What's wrong with that? They take 15 minutes to get me all mucked up here.
GUGULETHU MFUPHI: They're making sure that you can hear the director too, Alec. TV is a tricky game.
ALEC HOGG: He says it's not omnidirectional. It's over directional. We don't know. He's all embarrassed now. He was on the start of the show – the launch. He was the man who said 'ten, nine, eight…' That's all he can say now. 'Ten, nine, eight – remember me?'
GUGULETHU MFUPHI: Luckily, he's not in our ear, otherwise he'd be disciplining us. Nonetheless, we have someone else in our ears to tell us.
ALEC HOGG: We have to compose ourselves because this is a business show, not a family show.
GUGULETHU MFUPHI: We never have fun on the business show, so let's get into the number, Alec. Numbers today: up, down, and all the way around…
ALEC HOGG: I'm not sure. Does it matter? Even if you keep talking like that, does anyone ever care?
GUGULETHU MFUPHI: You see, I can't control myself now.
ALEC HOGG: Just keep it in monosyllables.
GUGULETHU MFUPHI: Okay, monosyllables.
ALEC HOGG: Yes, all the way. I wrote this morning… I have this bugbear, this bee in my bonnet about being a pedestrian because I've never been a pedestrian. I was always a driver and now I realise the reason why the pavements are in such awful shape in Johannesburg and everywhere else, is because the people who make the rules are the drivers. In the Apartheid era, who were the people in the hokkie? It certainly wasn't the guys making the rules. Who are the people in the hokkie now? It's still not the guys making the rules. Just open your eyes when you walk around your area – your city – and you'll see how the pavements have just been commandeered.
GUGULETHU MFUPHI: I walk through the Balalaika Hotel quite often and that's right next to what used to be… Oh, I'm not allowed to say.
ALEC HOGG: It's my secret.
GUGULETHU MFUPHI: But the security guards know now.
ALEC HOGG: Look at this. When you walk down the pavement, you will see how many homeowners have actually taken over parts of the pavement, so if you're a pedestrian you can walk part of the way and then you have to go into the road – if you're lucky – and go back again. It's crazy. That pavement doesn't belong to the homeowners, the taxi drivers, or to the people in the construction industry etcetera. It belongs to the public and we should demand.
GUGULETHU MFUPHI: You're not wearing your red tie for nothing today.
ALEC HOGG: No, it's just crazy, though. It's drift. You turn a blind eye to – what do they call it – the 'broken window syndrome'. Who cares if the poor pedestrians have to walk in the roads? A couple more of them will be killed every year.
GUGULETHU MFUPHI: Maybe that's a potential interview. Anyone else who has gripes about a lack of focus on pedestrians…
ALEC HOGG: Just keep your eyes open. That's what we're going to be talking about, and the reason I'm making these points is we're going to be talking to a gentleman called Petrus de Kock – he's the Research Manager at Brand South Africa – later in the show. Petrus says 'become an active citizen' and that's what I'm trying to suggest. Keep your eyes open. Active citizenry is the way you build great nations. Bobby Godsell has been saying the same thing for ages and he is of course, one of the great business leaders in South Africa, and he's now pushing for active citizenry. That's what we're going to be speaking to Petrus de Kock about. We'll be talking about the Rand – quite a lot of lawyers today here on our program – and then of course, the strikes that are going on in the steel industry. Lots coming up.
GUGULETHU MFUPHI: Let's go to the news now.
TSHEPISO BAKWADI: Gugu, good afternoon. Reserve Bank Governor Gill Marcus says despite recent negative and disappointing economic data, South Africa is not heading for a recession. She further stated that while the Bank is very concerned about weak economic growth, very dramatic deep QC's and other economic data would have to occur to signal a recession.
Eskom's Senior Executives will not take their annual bonuses in light of the R225bn revenue shortfall experienced over the five-year period between 2013 and 2018. The Interim Chief Executive, Colin Matjila says top executives at the group have acknowledged the financial constraints by agreeing to forego their annual performance bonuses as one of the efforts to cut costs.
In company results, Brait recorded a 20 percent increase in full-year net asset value per share. The group invested R1.8bn during the period, including a 37 percent acquisition of Southern View Finance.
In other earnings, Sibanye expects headline earnings per share for the six months ending June, to be at least 20 percent lower. The miner also released a production update with an increased gold forecast of six-hundred-and-ninety-thousand ounces, which includes one month of production from the recently acquired Cook operation. Sibanye also forecasts an all-in cash cost of three-hundred-and-sixty-five-thousand Rands per kilogram.
French cement-maker Lafarge is planning to consolidate some of its African operations under a new entity. This entity will be listed on the Nigerian Stock Exchange. Assets in Nigeria and South Africa will be transferred to the newly created Lafarge Africa, which will be the sixth-largest company on the Nigerian Stock Exchange.
Finally, South Africa's private sector kept shrinking in May as a five-month strike at the country's platinum mines depressed output and new orders. HSBC's PMI rose to 49.7 in May from 49.4 as output and new orders decreased. This goes against the Kagiso PMI data, which came out earlier this week and showed a fall to 44.3 points from 47.4 previously.
All those are your top stories. It's back to Gugu and Alec at the JSE.
GUGULETHU MFUPHI: Thank you so much, Tshepiso. Checking in with the market performance in mid-day trading, we do see that the wall around me looks a lot more positive than negative, with only the industrial sector actually with a negative bias, but significantly flat today. Banks, resources, and financials managing to push up the Alsi performance so far today. Companies that are also in focus today: Sibanye Gold out with a trading update, expecting declined earnings, but production expected to be up. The share price today up as well – just over one percent.
African Oxygen, also known as Afrox – it's a very small company, but it does seem as though management there is quite busy with recent contracts and agreements with companies just recently signing one worth R25m. That share price also up so far today.
Telkom is continuing its run, and it does seem to be on the money there. They're looking at Brait as well, out with results so far today.
Moving on to the JSE All Share Index, on net performers today so far, we are rather flat, but pushing toward that fifty thousand point mark – once again, sitting at forty-nine-thousand-nine-hundred-and-seventy-seven points. Something else that's of concern is the local unit (the Rand). Looking at that again, weakening significantly at 10.75 to the U.S. Dollar. As far as I understand, we're at an eight or ten-week low against the Greenback.
ALEC HOGG: Gugu's made many people down in the South of Johannesburg most distressed. Afrox is a R7bn company, not really that small, but I suppose when you deal in the billions, what's seven?
GUGULETHU MFUPHI: What's seven?
ALEC HOGG: Anyway, we're going to have a look at the steel industry now. Paolo Trinchero is the Chief Executive of the S.A. Institute of Steel Constructions. One of the reasons why we're keen on this chat with you – quite apart from everything that's happening on the strike front, and I'm sure we'll touch on that – is that our dear friend Piet Viljoen, from RECM has made his top stock of the moment ArcelorMittal. When you get a deep value investor going into a particular share, it's because things are not going that well in the industry because they see value there. I think it's trading at point-three percent of book at the moment. Is it really that bad in the steel sector in South Africa?
PAOLO TRINCHERO: Well, the steel sector is really a barometer of the economy. If we have a negative growth rate of point-six GDP, it has quite a large impact on the steel market. The steel industry essentially talks to the mining industry, the construction industry, transport, and of course, manufacturing.
ALEC HOGG: What's happened to demand?
PAOLO TRINCHERO: Well, the demand has fallen off.
ALEC HOGG: Year-on-year…
PAOLO TRINCHERO: Year-on-year: I can't quote exact numbers, but I'd say around five to ten percent.
ALEC HOGG: Down.
PAOLO TRINCHERO: Down, primarily due to the platinum strike, which has had a big impact not only on the platinum mines but on the sectors that service the platinum mines as well. That has been a cause for concern in the industry and we think, going into the second half of the year, that that certainly will improve. We expect the strike – certainly, on the platinum side – to come to an end, demand to start picking up, and going into 2015 we expect that growth to improve dramatically. If we have the implementation of the National Development Plan; that certainly will talk to steel consumption.
GUGULETHU MFUPHI: How do you substantiate such a positive outlook then, when the fundamentals of the country just aren't there?
PAOLO TRINCHERO: You're correct. The fundamentals aren't there, but you tend to find that infrastructural projects have a massive impact on the steel industry. If we have only some of the National Development Plan projects coming online, it will have a substantial impact. If you go back to the past large projects like Mossgas or Mozal, Medupi and Kusile have all had a positive impact on the steel industry. If we have some of those projects going forward, it will have a positive impact and of course, we need to look to Africa as well.
ALEC HOGG: What's in the pipeline? You've mentioned Kusile and Medupi.
PAOLO TRINCHERO: Well, Kusile and Medupi are coming to an end in terms of steel consumption, but we do have Coal 3 and Eskom is working very hard.
ALEC HOGG: Coal 3? What is Coal 3?
PAOLO TRINCHERO: Essentially, it's a third power station, but of course, between Eskom and government partners they are deciding as to whether they're going to invest in Oil & Gas, nuclear, or coal. All three, or any of the three, would have a positive impact on the steel industry.
GUGULETHU MFUPHI: Then what's your view on the current legislation on the table regarding the 20 percent free carry stake?
PAOLO TRINCHERO: Well, the 20 percent free carry stake we hope, would be negotiated with some of the Oil & Gas companies but of course, that's not our place as the Steel Institute, to comment on that.
GUGULETHU MFUPHI: But you would be impacted by it?
PAOLO TRINCHERO: We would be impacted, yes, and if those projects go ahead, it has a major positive spinoff for our industry.
ALEC HOGG: And if they don't, it continues to be sluggish.
PAOLO TRINCHERO: If they don't, we continue in a sluggish environment.
ALEC HOGG: You did say that you couldn't really talk about the strike because there are negotiations beginning again. Just by way of background, it's the end of a three-year agreement that is causing the concerns amongst the rest of us because my goodness, we see what the platinum strike has done to us. If you were to have a similar thing in your sector – in the steel sector – would it have as big an impact?
PAOLO TRINCHERO: It certainly would. Just to calm the waters, industry, unions, and labour are working very hard at the moment. There are currently negotiations underway. There are very good and experienced teams that have been talking already since last year. Although it is not the Steel Institute's view/mandate to comment, we currently do not have a strike. There is essentially, a dispute and they are currently negotiating.
ALEC HOGG: That's good news, Gugu. They are – or have been – talking for the past year, or since last year already, rather than getting to the end day and you get to brinkmanship, which then forces people into positions.
PAOLO TRINCHERO: Yes. As I say, the feedback coming back from SEFSA is that they are talking, they are negotiating, and we should wait and see before we jump to conclusions.
ALEC HOGG: Getting back to how I opened this up, which was Piet Viljoen's investment into ArcelorMittal South Africa. If you take the view of a value investor, it can be many years before you realise the underlying investment. Do you think that it's going to take that long for this industry to turn around?
PAOLO TRINCHERO: I would think we would start seeing positive growth in 2015 already. We will see certain projects going ahead in Africa and there have been some projects going through on our National Development Plan, particularly when we speak about renewable energy projects and the square kilometre array. There have been school build programs. We have some universities that are going to be built in the next year or so and that will be positive for the industry. I do feel that from a value-investing point of view, the steel industry will pick up. Generally, steel is a volume industry. You need volume in order to make good returns.
ALEC HOGG: To get volume, you need infrastructure.
PAOLO TRINCHERO: To get volume, infrastructure is one of the primary drivers of that volume.
ALEC HOGG: Well, thanks for giving us some hope. We can go and buy those shares now.
GUGULETHU MFUPHI: Indeed, go and buy those shares (and a little bit more optimism). Alec was saying that he is an optimist.
ALEC HOGG: It's so cheap. That's the point. They're priced for disaster. They're priced almost as though they're going to close the company down. That's when you hear any bit of optimism. Even in 2020, it would put smiles on the faces of value investors.
GUGULETHU MFUPHI: Indeed. Well, thank you so much to Paolo Trinchero. He's the Chief Executive of the South African Institute of Steel Construction.
After the break, we chat to David Shapiro – a latecomer – to get an update on the market so far today. Don't go anywhere.