The profit outlook for the mainland's steel sector is showing signs of improvement as capacity expansion slows and inventories and raw material costs fall, but iron ore miners, battling a flood of overseas imports, have yet to see light at the end of the tunnel.
But for years to come, the two overcapacity-plagued industries are unlikely to see the kind of profits they were making during the mainland's fixed-asset construction boom and iron ore shortage between 2005 and 2008, with a gradual shift from an investment-led economic model to a consumption-led one slowing growth in demand for steel.
The China Iron and Steel Association, which represents the nation's largest steel mills, says its members' pre-tax profits rose 51.6 per cent in the first 11 months of last year to 24.4 billion yuan (HK$30.3 billion).
The combined net profit of Hebei Iron and Steel, Baoshan Iron & Steel and Angang Steel, three of the nation's largest steelmakers, is forecast to have climbed 31 per cent last year to 8.8 billion yuan and might rise a further 23 per cent this year to 10.9 billion yuan, according to analysts polled by Thomson Reuters.
Baoshan alone accounted for 36 per cent of the total profits made by medium-sized to large steel mills, despite having only 5 per cent of the industry's revenue, according to a JP Morgan report.
The improvement in steel producers' performance after a couple of years of weak profit and losses was primarily driven by lower raw material prices.
The spot market price of ore delivered to Qingdao port dropped 46.4 per cent last year to US$71 a tonne, while coking coal futures in Dalian fell 16.5 per cent to 808 yuan a tonne.
Iron ore accounts for about 45 per cent of a steel mill's production cost, an analyst says, while coking coal accounts for about 30 per cent.
However, analysts say the sector's growth prospects remain constrained by weak demand and tight state control over capacity expansion.
"We remain neutral on China's steel sector on concerns of little improvement in supply-demand dynamics, and thus low profit margins for the steel mills generally over the next three to five years," Daiwa Securities analyst Joey Chen said in a note.
The mainland's apparent crude steel consumption - deliveries minus net exports - dropped 3.4 per cent last year to 738.3 million tonnes, according to the China Iron and Steel Association.
With exports jumping 64.5 per cent to 84.4 million tonnes, the figures suggested that actual domestic demand was flat or had declined slightly, the association said.
Prices of low-end construction products such as reinforcement bars and wire rods, and those of higher value-added products including hot-rolled and cold-rolled sheets have fallen to their lowest in more than 12 years. Mainland iron ore prices are trading at a 51/2-year low.
Chen's note cited projections by the China Metallurgical Industry Planning and Research Institute that the country's steel demand - about half the world's total - would grow only 1.4 per cent this year, with output tipped to increase 1.7 per cent. Crude steel output grew 0.9 per cent last year.
Those figures contrast sharply with average output growth of 8.5 per cent between 2009 and 2013 and 20 per cent between 2001 and 2007, and are only slightly better than the 1 per cent growth recorded in 2008.
Citi analysts said in a report last year's fixed-asset investment growth of 15.7 per cent - down from 19.7 per cent in 2013 and an average of 27.2 per cent between 2002 and 2012 - signalled "the end of investment-led growth" and might lead to high single-digit growth rates in the years ahead.
The sharp deceleration in steel demand and the ramping up of output by overseas miners explained last year's 49 per cent fall in the price of iron ore, which made it the worse performing exchange-traded metal.
More gloom is predicted.
"Super-high profits enjoyed in the iron ore sector appear to be over," Mark Pervan, the head of commodity research at Australia and New Zealand Banking Group, said in a report after visiting mainland steel mills and ore traders in November. "A combination of tough government reform, weak housing market and increasing supply mean most see little upside in iron ore prices over the next two years."
Property construction accounts for 45 per cent of the mainland's steel consumption.
Unlike giant overseas rivals Vale, Rio Tinto and BHP Billiton, which together control 70 per cent of the global seaborne iron ore supply - of which China is the largest buyer - mainland miners tend to work deposits with much lower ore content and are smaller and less cost-efficient.
Pervan said 60 per cent of mainland iron ore output was not profitable at US$80 a tonne.
But mines have been slow to shut down because half the supply comes from state-owned pits controlled by steel mills that can afford to prop them up to maintain employment.
Pervan forecast ore prices would average US$78 a tonne this year, while Citi analyst Ivan Szpakowski tipped a more bearish US$65. They traded at about US$63 last Thursday.
Szpakowski said in a report sustained prices in the US$60s were needed to drive significant output cutbacks outside China, and even lower prices would be required to cause cutbacks on the mainland. He forecast mainland output would fall by more than 200 million tonnes, or 50 per cent, between 2013 and 2016.
Iron ore's oversupply situation is reminiscent of the surplus predicament in the crude oil market, where the Opec cartel has refused to cut output despite tepid demand, aiming to maintain market share by forcing fast-growing producers in North America to shut high-cost projects.
"The world's largest producers - Rio Tinto, BHP Billiton and Vale - have judged it rational to flood a market already in surplus … clearly, the majors have adopted a strategy to push prices down in order to cut out high-cost competitors, especially the Chinese producers and gain market share," Sanford Bernstein senior analyst Paul Gait said in a research report.
The report noted that the three had expanded output in the first three quarters of last year by between 6 and 19 per cent, and that BHP and Rio had announced further output expansion plans for the next few years.
Three Hong Kong-listed mainland iron ore miners are facing more tough times.
China Hanking Holdings said in December it expected net profit to fall about 90 per cent last year from the 192.7 million yuan recorded in 2013, citing lower product prices and higher output costs. First-half profit plunged 49 per cent to 49 million yuan, implying it was 29.7 million yuan in the red in the second half.
An analyst polled by Thomson Reuters expected Hengshi Mining Investments to post a 19 per cent fall in net profit HK$406.7 million last year, followed by a 48 per cent drop to HK$212 million this year.
China Zhongsheng Resources Holdings said in December it expected to report a loss for last year, compared with a profit in 2013, partly because of lower iron ore prices.
Source: South China Morning Post