Industrials

Chris Bryant is a Bloomberg Gadfly columnist covering industrial companies. He previously worked for the Financial Times.

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

When China creates a new corporate behemoth, it's typically a signal for overseas competitors to watch out.

On the Up
ArcelorMittal's shares have almost trebled since February
Source: Bloomberg

Yet news that China wants to create two new domestic steel giants should be a helpful development for ArcelorMittal, the world's biggest steel maker. That's because the deal should, eventually, curtail overcapacity as well as the wave of cheap Chinese steel exports that plagued the industry in recent years.

Challenging Number One
Chinese consolidationn would close the gap with ArcelorMittal, the world's largest steelmaker
Source: World Steel Association

Northern and southern China will each get their own steel champion under the plans being discussed. Hebei Iron & Steel Group, China's largest steelmaker by output, could be combined with Shougang Group, according to Bloomberg News. Meanwhile Shanghai Baosteel Group Corp., the second-biggest, may combine with Wuhan Iron & Steel Group Corp. 

Consolidating China's steel industry will be easier said than done. The government wants the market share of the top 10 producers to be no less than 60 percent by 2025, according to Bloomberg Intelligence's Kenneth Hoffman. In practice, the measure slipped to 39 percent in 2013 from 49 percent in 2010.

Spot the Production Cuts
China's crude steel production has surged over the past year despite planned capacity reductions
Source: Bloomberg Intelligence
Note: "North" is Hebei, Shandong, Liaoning, Tianjin, Inner Mongolia, Jilin, Heilongjiang provinces. "Central" is Shanxi, Hubei, Henan, Jiangxi, Sichuan, Hunan, Shaanxi, and Chongqing. "East" is Jiangsu, Anhui, Shanghai, and Zhejiang. "South" is Guandong, Guangxi, Fujian, Yunnan, Guizhou, and Hainan. "West" is Xinjiang, Gansu, Ningxia and Qinghai. Other provinces don't produce steel.

Chinese Premier Li Keqiang promised in January to cut steel production capacity by as much as 150 million metric tons -- but, so far, nothing of the sort has happened.

No surprise then that ArcelorMittal CEO Lakshmi Mittal reiterated on Friday that "China remains a threat" as the steelmaker posted an otherwise stellar set of earnings. Second-quarter Ebitda almost doubled on the previous three months and net debt fell by more than 25 percent after the company's $3 billion rights offering in March.

Importantly, ArcelorMittal hasn't yet reaped the full benefit from a recovery in global steel prices -- the improvement in earnings owed much both to cost-cutting and restrained capital expenditure.

ArcelorMittal shares have surged almost threefold since their February low. But their recovery is still vulnerable: Ford's profit miss last week suggests a rough patch for U.S. car sales. Automotive account for about 40 percent of ArcelorMittal's shipments in North America. Meanwhile, the steel price rally has petered out in recent weeks.

If Chinese capacity cuts help support steel prices in the medium term, ArcelorMittal's earnings should benefit. There's even a chance the company could end up with the best of both worlds -- a decline in Chinese steel exports as well as a decline in pricing competition as U.S. and European tariffs start to bite.

Cutting Debt
A capital increase and asset sales have helped ArcelorMittal trim an enormous debt pile
Source: Bloomberg

ArcelorMittal suspended shareholder payouts in November and the board has promised to discuss them again once its net debt to falls to less than twice Ebitda. The measure stood at 2.5 times Ebitda at the end of the second quarter.

Chinese steel mergers could, therefore, literally pay dividends for ArcelorMittal investors.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the authors of this story:
Chris Bryant in Frankfurt at cbryant32@bloomberg.net
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Edward Evans at eevans3@bloomberg.net