Material Matters: Nickel, Steel & Manganese

This story features AURIZON HOLDINGS LIMITED, and other companies. For more info SHARE ANALYSIS: AZJ

A glance through the latest expert views and predictions about commodities. Nickel; steel raw materials; steel scrap; and manganese, thermal coal.

-Market may be underappreciating margins for Indonesian NPI operations
-Steel-making raw materials likely to come under pressure in the second half
-Macquarie makes significant upgrades to manganese ore and thermal coal forecasts
 

By Eva Brocklehurst

Nickel

China's nickel ore imports have lifted 41% in February as imports from Indonesia surged. Commonwealth Bank analysts observe the rise in nickel ore exports from Indonesia more than offset a decline from the Philippines. The analysts envisage downside pressure on nickel prices amid surpluses in the nickel ore and nickel pig iron (NPI) markets.

Around 2% of global nickel supply was added in 2017 alone. This could increase in 2018 as Indonesia's government has approved over 28.4mt of low-grade nickel ore exports. The analysts still envisage Filipino nickel ore exports could recover in 2018, although this may take longer than previously expected.

The Philippines accounts for around 20% of global nickel ore output and around half of the nation's nickel output was at risk of closure under former mining minister Gina Lopez. The analysts suspect nickel prices will be driven by developments in the stainless steel market, as it accounts for around two thirds of nickel consumption.

Canaccord Genuity takes a closer look at the NPI segment, believing the market is underappreciating the margins for Indonesian NPI operations. In a global context, the analysts believe NPI is the most significant segment providing supply growth in the nickel market, estimated to account for over 30% of the current nickel market.

The broker agrees stainless steel will continue to dominate the nickel market in the near to medium term. Integrated stainless/NPI production could displace higher costs production elsewhere and potentially free up class 1 nickel products for other uses. NPI product offers several advantages such as competitive capital and operating costs, high suitability for steel making and superior payability.

In the wake of a site visit to state-of-the-art integrated stainless steel and NPI production facilities in Indonesia, the broker upgrades nickel price forecasts by 15% for 2018 and 4.5% for 2019. The broker also upgrades Western Areas ((WSA)) to Hold from Sell and increases the target to $3.10.

Steel Raw Materials

High steel inventory in China over March and weak downstream demand have put steel-making raw materials under pressure. Iron ore has fallen -13% month on month while metallurgical (coking) coal has dropped -11%. Morgan Stanley still expects China's steel sector to pick up in the second quarter and support prices before markets come under further pressure in the second half of the year.

The broker suggests that several factors clashed in March, with the traditional peak season for construction and extended winter capacity cuts keeping China's demand lower for longer. In the second half, nonetheless, the forecast slowdown in housing starts and infrastructure construction should begin to weigh on demand and margins once again.

The upside risk for both iron ore and metallurgical coal could come from higher scrap prices, which would put pressure on electric arc furnace (EAF) costs and result in lower growth in output in China. In turn, this would raise demand for iron ore. Metallurgical coal risks are largely supply-based amid the ongoing Aurizon ((AZJ)) dispute which threatens up to 20mtpa of coal shipments.

Steel Scrap

Macquarie observes steel scrap has outperformed amid the price weakness experienced by steel raw materials. Scrap prices have increased in the year to date versus the declines posted by iron ore and coking coal. The broker observes steel trade protectionism has underscored this situation along with a likely increase in scrap demand in the US, which is world's largest scrap exporter.

EAF producers are expected to experience some margin compression in 2018 relative to integrated producers, and higher scrap prices could end up benefiting iron ore pellet producers. Macquarie's envisages the scrap trade is well supported and this is key to Sims Metal Management ((SGM)).

While a boost to domestic EAF production in the US could constrain the export market supply over time, the broader incentive to increase scrap collection will also grow as prices rise. While recent threats to impose a 25% duty on recycled aluminium could affect around 5% of the company's revenue, Macquarie believes diversion to other markets is entirely possible.

Manganese, Thermal Coal

Macquarie make significant changes to its forecasts for manganese ore and thermal coal pricing. Manganese ore has benefited from Chinese environmental reforms and the broker incorporates price increases of 13-25% over the next five years and a 50% lift to the long-term forecast.

The loss of the Chinese domestic production capacity is expected to mean more high-cost seaborne ore is supplied to the market in the long-term. As a result, the broker upgrades South 32 ((S32)) to Outperform from Underperform as its long-term outlook has been significantly enhanced.

Upgrades to coal price forecasts have transformed the long-term outlook for both Whitehaven Coal ((WHC)), upgraded to Outperform from Neutral, and New Hope Corp ((NHC)), on Outperform and currently the broker's preferred coal exposure.

Other notable changes that have affected Macquarie's coverage include long-term upgrades to forecasts for copper, aluminium and alumina. The changes reflect the application of forecast marginal cost of production in 2024. The broker reiterates an Outperform rating for Alumina Ltd ((AWC)), as the stock is underpinned by a strong dividend yield.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms