Worst Dim Sum Baosteel Shows Smokestack Troubles

Baosteel Group Corp. was the worst-performing high-grade corporate Dim Sum bond in the past month as Premier Li Keqiang sacrifices economic growth during a shakeup of smokestack industries.

The yield on March 2017 debt of Baosteel, China’s third-largest steelmaker, rose 102 basis points and touched a record 4.87 percent on July 5, data compiled by Bloomberg show. That was the most among non-financial issuers on HSBC Holdings Plc’s investment-grade Dim Sum index, as average yields on the yuan debt sold offshore climbed 79 basis points to 4.01 percent. U.S. industrial companies pay 2.43 percent for three- to five-year debt, according to Bank of America Merrill Lynch indexes.

A record cash crunch has prompted Goldman Sachs Group Inc. to cut its 2013 growth forecast for China, as Nomura Holdings Inc. warns of defaults among companies with idle plants. Premier Li wants to bring forward a target of eliminating outdated capacity in steel, aluminum and cement to the end of 2014, the State Council said in a June 14 release.

“China has been restricting capital flows into high polluting and overcapacity industries,” said Mei Luwu, a Shenzhen-based fund manager at Lion Fund Management Co., which overseas more than 40 billion yuan ($6.5 billion). “We’re not optimistic on the steel industry’s fundamentals such as earnings and cash flow. It’s understandable that investors don’t like steel bonds in general.”

The yield on government 10-year debt was little changed at 3.52 percent on July 9 in Shanghai, after rising 7 basis points to 3.51 percent in June, ChinaBond data show. That on similar-maturity AAA corporate debt rose was 5.11 percent yesterday, after climbing 8 basis points last month to 5.12 percent. Yields on automaker bonds rose 43 basis points in June, while those on real-estate developers increased 18 basis points, according to Merrill indexes.

Halted Expansion

China’s economic planners have sought to rein in steel industry growth since at least 2004, when work on a 10.6 billion yuan project in the eastern province of Jiangsu was halted. Yet annual capacity has risen to 970 million metric tons, according to the steel association, exceeding the industry’s output of 716.5 million tons in 2012. Output is seven times larger than that of Japan, the No. 2 producer.

“Industries that face overcapacity problems will likely go through a tough restructuring in the second half and we expect these industries to experience corporate defaults,” Nomura economist Zhang Zhiwei wrote in a June 20 note.

Industry Crackdown

Vice Premier Zhang Gaoli said on May 15 that China would “strictly forbid” approval of steel, cement, aluminum-smelter and ship-building projects, according to the central government’s website. Severe punishment will be meted out to steel companies that sidestep regulations since they pollute the air “heavily,” the Economic Information Daily reported July 1, citing Liu Bingjiang, an official at the Ministry of Environmental Protection.

Investors are cautious toward steel bonds because of ratings downgrades, according to a spokesperson for China International Fund Management Co., a Shanghai-based money manager with 71.7 billion yuan of assets. Standard & Poor’s lowered Baosteel’s stand-alone credit profile to bbb- from bbb, while affirming its A- rating because of state support

“We believe continuing challenges in the Chinese steel industry and Baosteel’s significant capital spending will limit any major improvement in the company’s financial strength,” S&P said in a June 13 statement. “The intense competition in the steel industry in China constrains domestic steel prices.”

Rating Downgrades

Moody’s Investors Service on July 4 downgraded the senior unsecured rating of China Oriental Group Co., a Hong Kong-listed Chinese steel producer, to Ba3 from Ba2, with a negative outlook. The company’s August 2015 dollar-denominated notes fell 1.6 percent in the past month, based on prices from Trace, as the yield jumped 118 basis points to 8.74 percent.

The Chinese prices for hot-rolled coil, a benchmark steel product, have declined 16 percent to 3,533 yuan a metric ton on July 8 from 4,212 yuan on Feb. 18, according to Beijing Antaike Information Industry Co., amid an industry overcapacity, slowing demand and high inventories. Prices reached an eight-month low of 3,436 yuan on May 31.

Tracking the industry slowdown may be harder after China suspended the publication of industry-specific data from monthly surveys of manufacturing purchasing managers. Steel demand appeared to be “softening” with mills and traders reporting order declines, Macquarie Group Ltd. wrote in a report July 4.

Demand Forecasts

Demand for iron ore and steel from China may grow by 5 percent in coming months, compared with 10 percent in the first five months of this year, Jose Carlos Martins, executive director for ferrous and strategy for Vale SA, the world’s biggest iron ore producer, said June 14.

Five-year credit-default swaps insuring China’s sovereign debt against non-payment climbed four basis points this week to 122 on July 9 in New York, and touched a 17-month high of 147 on June 24, according to CMA prices. The contracts pay the buyer face value in exchange for underlying securities or the cash equivalent if a borrower fails to adhere to its debt agreements.

The yuan fell 0.06 percent to 6.1333 per dollar in Shanghai today after official data showed exports unexpectedly fell in June. Overseas sales declined 3.1 percent from a year earlier, compared with the median forecast for a 3.7 percent gain in a Bloomberg News survey and a 1 percent increase in May. The currency’s appreciation has stalled in the past month.

“The slowdown in the GDP growth rate and the shift in economic growth drivers pose challenges for China’s state-owned enterprises,” Moody’s senior analyst Kai Hu said in a May 27 release. “The credit profiles of SOEs facing overcapacity problems in competitive industries, such as steel, building materials, and heavy equipment manufacturing, and those that have a heavy debt burden will be particularly vulnerable.”

— With assistance by Helen Yuan, and Fion Li

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