global mining and steel primer - ubs (2008)

UBS Investment Research Mining and Steel Primer Hard rock to heavy metal amid scarcity  Mining and Steel Primer updated Mining and steel continue to be among the best performing global equity sectors, but conflicting issues – from ‘pricing bubbles, ‘imminent recessions’, ‘demand destruction’ to ‘resource scarcity’ – can confound investors. This primer details the issues, indicators, commodities and companies in one easy reference.  China continues to change perspectives The most significant change since our 2005 edition is the take-off in commodit y p rices and equity performances that mark this materials cycle as the strongest i n the past 50 years. Most of this can be pegged to China’s emergence as the dominant global materials consumer. Lead indicators have to increasingly focus o n China.  Crude oil leads and poses questions about future materials direction We have also seen a ‘growth in scarcity’. Crude oil exemplifies the broad issues that drive commodity, mining and steel equity valuations. Peak production, ‘buy’ rather than ‘build’, ongoing consolidation, energy and environmental challenges, and demand responses are also shaping future differentiated outcomes.  Mining and steel equities to be re-rated Comparative valuation multiples are a product of history. The continued unfolding of secular growth and systemic supply constraints question whether the ne w conditions will lead to a re-rating of undervalued (difficult to replace) assets. We are buyers of large-cap, high-quality mining and steel equities. Global Equity Research Global Mining & Metals Sector Comment 10 June 2008 www.ubs.com/investmentresearch Global Mining Team daniel.brebner@ubs.com +44-20-7568 3451 Global Steel Team timna.tanners@ubs.com andrew.snowdowne@ubs.com +44-20-7568 1823 This report has been prepared by UBS Limited ANALYST CERTIFICATION AND REQUIRED DISCLOSURES BEGIN ON PAGE 222. UBS does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. ab Mining and Steel Primer 10 June 2008 UBS 2 How to use this primer This 2008 edition of the introduction to the mining and steel sectors is a guide to the industry, its processes, its markets and its participants in a single source: Q The industry’s context, major drivers and key indicators are covered in the first two sections, which highlight the impact of China and the developing world demand amid continuing supply constraints. Q The underlying commodity markets, producers, end uses, cost structures and price trends are detailed in a standardised fact sheet in section 3; this is complementary to our quarterly Commodity Connections updates. Q Exploration, mining and metal and steel production processes and emerging social, political and environmental constraints are addressed in section 4. Q All major mining and steel companies researched by UBS are referenced in standard fact sheets in Sections 5 and 6. Q A glossary of commonly used terms, a list of important places and projects in the world of mining and metals, regional data on the distribution of mineral reserves, a short discussion on metals trading, chemical symbols, conversion factors and a list of other useful sources of information are included in the Appendices. We acknowledge the contribution by Matt Fernley in the original 2005 edition of the Mining and Steel Primer. While there has been significant revision reflected by three years of change and development in the collective global mining and steel teams, listed below, we have followed the original format of the previous edition. We specially thank our Hyderabad basic materials team led by Amit Gupta for their dedication and professionalism in compiling this primer. Table 1: UBS global mining and steel teams Peter Hickson Basic Materials Strategist Global +44-20-7568 4165 Olof Cederholm Mining & Steel Scandinavia +46-8-453 7306 Daniel Brebner Commodities/Global Mining Strategist Global +44-20-7568 3451 Andrew Snowdowne Steel Europe +44-20-7568 1823 Andrew Snowdowne Co-Global Steel Strategist Europe +44-20-7568 1823 Marcelo Zilberberg* Steel Europe +44-20-7568 4029 Timna Tanners Co-Global Steel Strategist United States +1-212-713 2927 Paul Galloway Mining Europe +44-20-7568 4117 Grant Sporre Mining Europe +44-20-7568 2247 Roger Bell* Mining Europe +44-20-7568 8347 Brian MacArthur Mining &Metals North America +1-416-350 2229 Chris Lichtenheldt* Mining &Metals North America +1-416-8143 719 Onno Rutten Mining Canada +1 416 814 3663 Atsushi Yamaguchi Steel & Other Metals Japan +81-3-5208 6250 Dan Rollins Mining mid/small cap Canada +1-416-814 3694 Katsuya Takeuchi* Steel & Other Metals Japan +81-3-5208 6237 Timna Tanners Building Materials/Steel United States +1-212-713 2927 Sunita Sachdev Mining & Basic Materials India +91-22-2286-2059 PT Luther* Building Materials/Steel United States +1-212-713 2481 Yong-Suk Son Steel Asia +82-2-3702 8804 Shneur Z Gershuni US Coal United States +1-212-713 2927 Athaporn Arayasantiparb Mining Thailand +662-651 3770 Ronald J Barone US Energy United States +1-212-713 3848 Andreas Bokkenheuser Mining Indonesia +62-21-2554 7033 Glyn Lawcock Diversified Mining Australasia +61-2-9324 3675 Mark Busuttil Steel Australasia +61-2-9324 3623 Edmo Chagas Mining & Metals Latin America +55-21-3262-9226 Joe (Jonathan) Battershill Gold and Base Metals Australasia +61-2-9324 2834 Carlos Vasques* Mining & Metals Latin America +55-21-3262-9670 Ghee Peh Mining & Metals China +852-2971-6448 Denis Evstratenko Steels / Mining & Metals Russia +7-495-648-2368 Hubert Tang Steel China +86-21-6103-3158 Alexei Morozov Head of Research, Mining & Steel Russia +7-495-648-2369 Chi Wei Tan Steel Malaysia +60-32-781-1111 James Bennett Diversified Mining South Africa +27-11-322 7302 Amit Gupta BM Leader Hyderabad India +91-40-3051-6093 Simon Kendall Gold, PGMs South Africa +27-11-322 7319 Chirag Saglani Basic Materials Hyderabad India +91-40-3051-0000 * Associate analyst Emerging Markets Global Europe North America Asia Pacific Source: UBS A guide to industry processes, markets and participants Mining and Steel Primer 10 June 2008 UBS 3 Contents page How to use this primer 2 Introduction 5 — Global demand continues to surprise 5 — Global supply delayed response 11 — Geopolitical and environmental constraints 13 Section 1: Sector drivers and valuation 16 — Consolidation 19 — Industry structure and pricing power 24 — Changing industry cost structures 25 — Declining reserves 29 — Cyclicality 32 — Long-term demand trends and intensity of use 35 — Speculative demand a continuing driver 38 — Stocking and de-stocking affects cycles 40 — China and other emerging economies 41 — Exchange rate effects 44 — Impact of infrastructure development 45 — Valuation methodology and trends 46 Section 2: Major indicators 51 — Key indicators of global mining and steel equity performance 52 — Crude oil price 53 — Metals prices (MGMI) 54 — Chinese steel prices 55 — Chinese trade flows 56 — US dollar and exchange rates 57 — Bulk freight rates 58 — US ISM indices 59 — Industrial production 60 Section 3: Metals and commodities markets 61 — Prices 62 — Treatment and refining charges 62 — Metal exchanges 64 — Other materials 82 Section 4: Hard rock to heavy metal 91 — How did it get there and how do you get it out? 92 — Mine development and mining methods 102 — Minerals processing (beneficiation) 106 — Steel – a major subset of the metals industry 111 — Stainless steel 115 — Environmental impact of mining and steel 117 Section 5: Major mining companies 119 — Companies not covered by UBS 173 Section 6: Major Steel companies 175 — Other important steel producers 205 Appendices 206 Global Mining Team daniel.brebner@ubs.com +44-20-7568 3451 Global Steel Team timna.tanners@ubs.com andrew.snowdowne@ubs.com +44-20-7568 1823 Mining and Steel Primer 10 June 2008 UBS 4 — Definitions of common terms 207 — Common abbreviations 215 — Metals trading – an introduction 216 — Other useful sources of information 218 Mining and Steel Primer 10 June 2008 UBS 5 Introduction The importance of mining to the world has become very apparent in recent years, as commodity and equity prices have exceeded most expectations. Chart 1: Metals, gold and steel prices for past 10 years Chart 2: Mining, steel and global equity absolute performance 0 100 200 300 400 500 600 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Aluminium Copper Gold Steel 0 100 200 300 400 500 600 700 800 900 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Global Mining Global Seel World Market Source: Thomson Datastream Source: Thomson Datastream The stellar relative performance of the sectors is prompting the following questions among investors: Q Are we in a pricing bubble? Q When will supply respond to these higher prices? Q Will a recession and demand weakness break the secular rise in prices? Q Who are the winners in a resource-scarce world? Global demand continues to surprise Chart 3: US global share of steel, copper and oil since 1960 Chart 4: China global share of steel, copper and oil since 1960 5% 10% 15% 20% 25% 30% 35% 40% 45% 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 Steel Copper Oil 5% 10% 15% 20% 25% 30% 35% 40% 45% 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 Steel Copper Oil Source: IISI, ICSG, WBM Source: IISI, WMD, China Customs Statistics Stellar price performance… …prompts a number of questions Mining and Steel Primer 10 June 2008 UBS 6 The debate on whether we are in a pricing bubble is confronted, on the one hand, by the natural suspicion of markets and their ability to ‘correct back to a mean’ after long periods of elevated prices and demand destruction. On the other hand, the emergence of China as a dominant consumer of materials suggests that the secular trends of rising prices may continue. China has assumed the mantle from the US as the world’s largest consumer in most commodities. However, there are some materials, such as oil, where the US remains dominant but China’s future growth rate and impact on global market balances are yet to be fully felt. Increasingly, we see China’s emergence as the dominant materials consumer as being a ‘1 in 50 to 100 year’ event that eclipses our paradigms set in the past 30 years of declining prices in real terms. The intensity of use (IoU) of steel, seen below as a proxy for metals, expressed as per unit of global GDP, reflects major materials consumption patterns of the past 60 years. The IoU doubled in the 30 years to the 1970s, driven by post war reconstruction and the Japanese economic miracle, only to nearly halve in the following 30 years as the developed economies matured into post-industrial growth. The rise in steel IoU per unit of global GDP in the past five years has been driven primarily by the rapid industrial growth in China, augmented by other developing world demand. It is our belief that these secular patterns of demand are the main reason for the current booming price conditions. Our modelling of China, India and the Next Billion over the next 10-20 years, at around 8% pa growth, suggests this pattern of rising steel (metals) intensity could continue in the manner of the past five years and this should support more secular growth. Cyclical events, such as recessions, have interrupted these secular patterns in the past, as shown in Chart 5, but only temporarily. Over the next couple of years we forecast softer world growth in the face of rising energy and other prices, but we still believe the 5-10 year growth trends in the developing world should remain robust. Chart 5: Intensity of use of steel per unit of global GDP in kg/US$ since 1945* 0.015 0.017 0.019 0.021 0.023 0.025 0.027 0.029 0.031 0.033 0.035 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010E 2015E Source: IISI, World Bank, UBS estimates Note: * Bars show periods of recession. Developing world consumption varies across materials. It is particularly strong in infrastructure-related demand, such as steel and cement, but less so in consumer-related sectors, such as paper. We project other key industrial metals, The emergence of China as a dominant consumer of materials suggests that the secular trends of rising prices may continue Our modelling of China, India and the Next Billion over the next 10-20 years, at c8% pa growth, suggests this pattern of rising metals intensity could continue Recessions have interrupted these secular patterns in the past, but only temporarily Mining and Steel Primer 10 June 2008 UBS 7 such as copper and aluminium, to grow from their current 50% share to nearly 70% of global demand over the next 15 years. By contrast, we project the global share of commodities associated with the more mature, latter stages of economic development, such as oil and paper, to be more modest for the developing world. Chart 6: Materials global share of consumption from China, India and the Next Billion 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% Steel Cement Copper Aluminium Crude Oil Paper& Board 2002 2008E 2012E 2022E Source: IISI, Cembureau, ICSG, WBMS, BP, RISI, AFPA, UBS estimates Another key factor contributing to the broad commodity price rises has been the surging crude oil price. Crude oil is by far the biggest commodity market, estimated at US$2.1 trillion in 2007, rising to US$3.5 trillion in 2008, based on the UBS forecast of US$115/bbl WTI oil price (assuming 100% traded). By comparison, the crude steel market is estimated at US$780 billion, rising to nearly US$1.1 trillion in 2008, while production of the combined LME metals (aluminium, copper, nickel, tin, lead and zinc) was valued at US$350 billion in 2007, with copper and aluminium making up two-thirds of the metals market value. Bulk commodities (coal and iron ore) seaborne trade and associated freight markets expect to see rises in 2008 of over 50% to take them close to US$300bn in 2008E. The 2008E-07 increment in the oil market is bigger than the combined value of steel, LME metals, seaborne bulks and freight markets in 2007. Infrastructure-related demand is particularly strong (steel and cement), but demand from consumer-related sectors is less so (paper) The surging crude oil price has also contributed to the broad commodity price rises Mining and Steel Primer 10 June 2008 UBS 8 Chart 7: Relative size of key commodity markets in 2007 and 2008E* (US$bn) 0 500 1000 1500 2000 2500 3000 3500 4000 Crude oil Carbon Steel LME metals Copper Aluminium Seaborne Bulks Freight 2007 2008E Source: Thomson Datastream, BP, Clarkson, Tex Report Note: * UBS forecasts for commodity prices. The high oil prices have boosted the global accumulation of the so-called ‘petrodollars’. From 2003 to 2007, the accumulated net oil revenue of the world’s oil exporter totalled US$3,300 billion; in 2008 we estimate (using our oil forecast price of US$115/bbl) that net export revenue should clear US$1,350 billion. This quantum of money is impacting the demand for materials through increased expenditure on infrastructure and energy-related investment as well as commodity investment. Chart 8: Crude oil prices and metals prices since 1996 Chart 9: Crude oil and BM equity prices since 1996 0 100 200 300 400 500 600 700 1996 1998 2000 2002 2004 2006 2008 0 20 40 60 80 100 120 140 Metals price index lhs Oil price rhs 400 700 1000 1300 1600 1900 2200 2500 1996 1998 2000 2002 2004 2006 2008 0 20 40 60 80 100 120 140 Global BM equity index lhs Oil price rhs Source: Thomson Datastream Source: Thomson Datastream The threat of demand destruction from higher energy and metals prices in the developed world is somewhat offset by the more materials-intensive demand in the oil-rich developing world. But the broad risk of demand destruction, through the diminution of purchasing power or through thrifting or conservation, is real and unknown, given the rise in prices over recent years. The following charts highlight the relationship between copper and steel demand and world industrial production, and copper The global accumulation of petrodollars is affecting demand for materials through increased expenditure on infrastructure, for example Somewhat offsetting any threat of demand destruction in the developed world But the broad risk of demand destruction is still real and unknown Mining and Steel Primer 10 June 2008 UBS 9 and steel demand and copper and steel prices. The only comparable period of rapid price increases resulting in falling demand was in the 1970s. Chart 10: Copper demand growth and world industrial production, 1961-2010E -4% -2% 0% 2% 4% 6% 8% 10% 12% 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 -15% -10% -5% 0% 5% 10% 15% 20% World IP y/y % World Copper Demand y/y Source: ICSG, Thomson Datastream, UBS estimates Chart 11: Copper demand growth and world copper prices, 1961-2010E 0 1000 2000 3000 4000 5000 6000 7000 8000 9000 10000 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 -15% -10% -5% 0% 5% 10% 15% 20% Copper US$/t 2005$ World Copper Demand y/y Source: ICSG, Thomson Datastream, UBS estimates Mining and Steel Primer 10 June 2008 UBS 10 Chart 12: Copper and steel demand growth compared, 1961-2010E -10% -5% 0% 5% 10% 15% 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 World Steel Demand y/y % World Copper Demand y/y Source: ICSG, Thomson Datastream, UBS estimates Chart 13: World steel demand growth and world Industrial Production, 1961-2010E -10% -5% 0% 5% 10% 15% 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 -10% -5% 0% 5% 10% 15% World IP y/y % World Steel Demand y/y % Source: IISI, Thomson Datastream, UBS estimates Chart 14: Steel slab prices in US$ (2005 real) and world steel demand, 1961-2010E 100 150 200 250 300 350 400 450 500 550 600 650 700 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 -10% -5% 0% 5% 10% 15% Steel slab US$/t 2005$ World Steel Demand y/y % Source: IISI, Thomson Datastream, UBS estimates [...]... Source: Thomson Datastream UBS 14 Mining and Steel Primer 10 June 2008 This page is left intentionally blank UBS 15 Mining and Steel Primer 10 June 2008 Section 1: Sector drivers and valuation UBS 16 Mining and Steel Primer 10 June 2008 The mining and metals sector tends to be more complex to analyse in the number of drivers that can affect company performance and hence, profitability and stock performance... Clarksons Sth Africa to Europe Jan-08 Jan-07 Jan-06 Jan-05 Jan-04 Jan-03 Jan-02 Jan-08 Jan-07 Jan-06 Jan-05 Jan-04 Jan-03 Jan-02 Jan-01 Jan-00 0 Jan-01 Jan-00 0 20 Coal fob US$/t Source: Tex Report, Clarksons The split of costs into material, labour, energy and other are listed in Table 4 Table 4: Cash cost composition by materials, 2007E Alumina Aluminium Copper Zinc Steel Raw materials 39% 49% 27%... (POSCO, Nippon Steel) And Asia the laggard in consolidation Chart 27: M&A activity among key global steel companies, 200 2-0 8 Source: Company sources, UBS UBS 22 Mining and Steel Primer 10 June 2008 Table 3: Top 25 transacted deals in global steel since 2005 Bidder Target Commodity Size (US$bn) Year ArcelorMittal Arcelor Global steel 38.2 2006 Nippon Steel Oji steel Japanese steel 13.4 2007 Tata Steel Corus... Company sources, UBS UBS 20 Mining and Steel Primer 10 June 2008 The top 25 deals in global mining have totalled US$250 billion since 2005; global steel deals, by contrast, have totalled more than US$130 billion Global mining deals have been twice the size of global steel deals since 2005 Chart 25: M&A activity among key global mining diversified companies, 200 2-0 8 Source: Company sources, UBS Chart 26:... production has broken down UBS 32 Mining and Steel Primer 10 June 2008 Chart 44: Global mining index and ISM to 2004 Chart 45: Global mining index and ISM to 2008 3500 65 900 800 60 700 150 3000 130 2500 55 ISM manu index rhs Mining Index lhs Source: Thomson Datastream Chart 46: Global mining and a China-modified ISM index Mining Index rhs 2008 So while the mining and other materials sectors are still... cash flows by mining the higher grade first Demand-based drivers Cyclicality: The mining and steel sectors, in common with all basic materials sectors, have been correlated to the global industrial production cycle, both in terms of earnings and hence, in terms of stock performance; although stocks tend to pre-empt it UBS 17 Mining and Steel Primer 10 June 2008 Long-term demand trends and intensity... impact physical demand Stocking and de-stocking impacts: Many investors underestimate the impact of stocking and de-stocking cycles on industry demand outcomes Often demand trends at the beginning or end of a cycle can be intensified by these effects In many materials, China’s dominant size and its own stocking and restocking cycle can impact global markets, such as copper Supply- and demand-based drivers... expenditure more than halve between 1997 and 2002, but that the number of major deposit discoveries has substantially dropped off since the late-1980s and early-1990s The efficiency of exploration efforts has declined over the past 10 years The number of major deposit discoveries has fallen substantially since the late-1980s and early-1990s UBS 29 Mining and Steel Primer 10 June 2008 The return to higher... Algoma Steel US steel 1.9 2007 Essar Minnesota Steel US steel 1.8 2007 United States Steel Stelco Nth Am steel 1.8 2007 Nucor Shv North America US steel 1.4 2008 Nucor Corp Harris Steel Group Inc Steel- Specialty 1.2 2007 Source: Company sources, UBS Chart 28: Top 30 steel companies market capitalisation and 2007 revenue (US$bn) Revenue 2007 US$bn 120 ArcelorMittal 100 80 ThyssenKrupp 60 40 Nippon Steel. .. Eregli Demir Ve Celik Fabrik Turkish steel 3.0 2006 Angang Steel Angang New Steel And Iron Co China consolidation 2.8 2006 Techint Argentina Hylsamex Sa-Cl B LatAm steel 2.6 2006 Severstal Lucchini Spa European steel 2.3 2005 Evraz Group Oregon Steel US steel, pipe 2.3 2007 Evraz Group Multiple Targets EM steel 2.2 2008 Tenaris Hydril LatAm steel 2.0 2007 Onesteel Smorgon Steel Group Australian long 2.0 . +85 2-2 97 1-6 448 Denis Evstratenko Steels / Mining & Metals Russia + 7-4 9 5-6 4 8-2 368 Hubert Tang Steel China +8 6-2 1-6 10 3-3 158 Alexei Morozov Head of Research, Mining & Steel Russia + 7-4 9 5-6 4 8-2 369. +4 4-2 0-7 568 4029 Timna Tanners Co -Global Steel Strategist United States + 1-2 1 2-7 13 2927 Paul Galloway Mining Europe +4 4-2 0-7 568 4117 Grant Sporre Mining Europe +4 4-2 0-7 568 2247 Roger Bell* Mining. Commodities /Global Mining Strategist Global +4 4-2 0-7 568 3451 Andrew Snowdowne Steel Europe +4 4-2 0-7 568 1823 Andrew Snowdowne Co -Global Steel Strategist Europe +4 4-2 0-7 568 1823 Marcelo Zilberberg* Steel