>PAN ASIA : STEEL (GOLDMAN SACHS)

■ Coal price settlement marks the end of some uncertainty
JFE Holdings announced that it has accepted a 55% increase in the price of coking coal starting 1Q FY3/11, and in a departure from the past, it has agreed for coal prices to be reset every quarter, rather than on an
annual basis. The quarterly-reset price will cover half of the coal shipments for the year. For the other half, which will still have an annual contract price, the prices are yet to be settled, though they will likely be higher than the price settled for quarterly contracts.

While this does not mark a complete end to the uncertainty over this year’s raw material contracts (and iron ore prices are yet to be settled), we expect even a partial settlement to be seen positively by the markets. 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.

Our calculations suggest that Asian steelmakers will need anywhere between a 20%-30% increase in average steel prices this year to pass on the expected cost of iron ore and coal price increases. This means an average benchmark price of US$593/t-US$642/t (up from the average of US$494/t in 2009). Note that the current spot price is already close to US$600/t, and rising sharply. Some steelmakers will be able to pass it on; others may not. Another important point to note, particularly for Japanese steelmakers, is that while variable costs are rising, their fixed costs should fall, given the rise in utilization this year.

Japanese steel pricing mechanism likely to change. We believe that, under the current system, Japanese steelmakers are at a relative disadvantage to their Asian peers, as they have a large portion of their customer contracts on annual pricing terms. We believe that as they start accepting quarterly contract prices for coal, they will need to reset their prices to their customers also on a quarterly basis. This may not happen from FY3/11 itself, though we expect this to happen at least by FY3/12.

Our best ideas: Buy JFE, POSCO, Kobe Steel
We expect Asian steel stocks to react positively to the coal settlement, as it ends some uncertainty; US steel stocks were up on Friday, including POSCO ADRs, which were up more than 3%. We maintain our Buy (Conviction List) on JFE, POSCO, and our Buy ratings on Kobe Steel, Nippon Steel and Hyundai Steel.

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