Corporates

Metals & Mining / EMEA Steel

2012 Outlook: Challenging Conditions Persist

Weaker EMEA Steel Demand in the Short-Term
Outlook Report

Rating Outlook Rating Outlook

NEGATIVE Developed Markets Hardest Hit: Renewed pressure on market conditions and economic
growth in developed markets is likely to negatively affect both steel prices and demand in the
period to end-2012. Fitch Ratings expects the current steel price decline to continue into 2012,
signalling the end to the gradual post-2008 crisis recovery and increasing the vulnerability of
highly leveraged steel companies.

Weaker EMEA Steel Demand: Fitch expects anaemic economic growth across Western
Europe and North America, which will translate into lower steel demand growth in developed
markets of between 2% and 3% in 2012. Decreased revenue and cash generation in 2012 is
likely to limit steel companies’ ability to significantly deleverage, maintaining negative rating
pressure over the next 12-18 months. However, Fitch’s steel demand growth expectations in
emerging markets are more robust at over 5% a year in 2012.

Cyclical Steel Industry: The steel industry is highly cyclical and is significantly affected by
changes in global market conditions. During the previous financial crisis, the adverse effects on
steel companies were exacerbated by rapid and significant swings in market steel inventory
levels, which contracted by over 50%. Steel inventory levels are currently almost 20% lower
than when the previous downturn hit, partially limiting the adverse effects of an expected
destocking phase in early-2012

Cost Development: Fitch expects raw material input costs, notably iron ore, to continue to fall
in line with lower steel prices in 2012, providing some cost relief in Europe. However, cash
costs of steel production facilities in higher-inflation emerging environments such as Africa,
Figure 1 Latin America and Russia are also expected to be affected by rising fixed costs. Notably,
EU Steel Rating Outlooks continued above-inflation annual escalation in labour and energy costs could affect profitability
(%)
and cash generation in 2012.
100
80 Planned Capacity Reduction: Larger steel producers have announced plans to idle or close
60 50% 50% higher-cost production facilities in Europe in an effort to rebalance steel supply as demand
40 conditions soften. Plant closures will also aid in reducing costs (albeit with some time lag),
20 increasing capacity utilisation and ensuring sustainable profitability.
0
Positive Stable Negative
What Could Change the Outlook
Source: Fitch
Supply/Demand Balance: The Negative Outlook is driven by expectations of reduced
profitability for steel producers in 2012 on the back of weaker market conditions and excess
industry production capacity. Despite industry-wide cost-saving initiatives, the realisation of
tangible benefits are expected to be delayed to post-2012. Furthermore, Fitch notes that
Related Research significant execution risks exist in the short-term.
Other Outlooks
www.fitchratings.com/outlooks The Outlook may be revised to Stable once a more favourable supply / demand balance is
reached, and will be influenced by the development of steel market conditions and the
Analysts successful execution of sustainable cost-saving initiatives.
Roelof Steenekamp
+44 20 3530 1374
roelof.steenekamp@fitchratings.com

Peter Archbold
+44 20 3530 1172
peter.archbold@fitchratings.com

www.fitchratings.com 2 December 2011


 Steel prices to contract to mid-
2010 levels and demand
conditions to remain challenging
in 2012.
 EMEA steel producers to benefit
from improved liquidity positions
at end-2011.
Related Criteria
Corporate Rating Methodology (August 2011)
Worldwide Steel Outlook: Recovery Losing
Steam in Short Run (July 2011)
Steel Raw Materials Outlook: Prices to Remain
High (July 2011)
Global Economic Outlook: Downward
Revisions as Advanced Economies Stall
(October 2011)
2012 Outlook: Challenging Conditions Persist
December 2011
Corporates
Challenging Market Conditions in 2012
Lower Steel Prices
In Q311, steel prices contracted by around 15% from high levels reached in mid-2011 as
market participants adopted a wait and see approach to a worsening global economic outlook.
Fitch believes that the current weaker price environment is reflective of renewed economic
uncertainty on the back of the sovereign debt crisis in the eurozone, driving the current steel
price correction. Fitch expects challenging market conditions and economic uncertainty to
continue into 2012. Steel prices, on average, should normalise closer to mid-2010 levels over
the next 12 months, limiting issuers’ free cash flow (FCF) generation and the gradual recovery
in operating margins to pre-2008 crisis levels.
The current steel price correction is, however, expected to bottom-out towards mid-2012, with
average steel prices rising again in 2013. Prices in 2013 will be boosted by stable automotive
and industrial demand growth and an expected acceleration in construction activity across
emerging markets.
Figure 2
Steel Price Development Into 2012
2008-2011
(USD) US domestic rebar US domestic hot rolled CIS export billet
1,100
900
700
500
300
H108 H208 H109 H209 H110 H210 H111 H211F H112F
Source: Fitch
Weak Growth in Developed Markets
Fitch expects average steel demand growth to remain constrained in key developed markets,
notably Western Europe and the US. On aggregate, real steel demand growth is expected to
slow to between 2% and 3% across these markets. Apparent steel demand will however be
slightly negative in H112 as orders are delayed in more challenging market conditions and
inventory levels are depleted. Overall, weak growth in developed markets will be largely offset
by continued strong steel demand in emerging markets, notably Africa, China, Eastern Europe
and the Commonwealth of Independent States.
Construction Sector in Decline
Construction market steel demand for long products in Europe is expected to continue to
decline, estimated at between 5% and 10%, in 2012. Continuing turbulent market conditions
will lead to a delayed recovery in the civil and commercial construction sectors. Fitch expects
continued deferral of large new construction projects and expansionary capital investment, with
construction activity in the US and Western Europe not expected to reach pre-crisis levels prior
to 2015 at the earliest.
Availability of Emerging Market Funding
Emerging markets continue to deliver on existing large infrastructure and mining development
projects underway, notably in India, Brazil and sub-Saharan Africa, with further medium-term
expansion planned. However, a major obstacle remains the availability of funding for new
projects, coupled with the rising cost of bank and capital market finance. Existing infrastructure
and capital investment projects across emerging markets will positively affect aggregate steel
demand over the next 12 months to end-2012. Weaker market confidence levels at end-2011,
together with the possible introduction of austerity measures should global economic conditions
2
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take a turn for the worst, may lead to further postponement or deferral of planned investment
projects to post 2012.
Figure 3

Global Apparent Steel Use Steady Automotive Steel Demand

2010 Middle Similar to the construction sector, automotive steel demand will be boosted by continued robust
South America East
3% Africa & Oceania automotive demand growth in emerging markets, notably in Russia, India, China and Brazil.
CIS 4%
3% This contrasts sharply with western European automotive demand which is expected to
4%
North America contract in 2012. However, Fitch expects European steelmakers‘ overall sales to global auto
9% Asia
(incl
manufacturers to benefit from global supply contracts, limiting their financial exposure to the
EU &
Europe
China) weaker eurozone countries somewhat during 2012. Aggregate automotive steel demand
63%
14% across Europe, including steel sourced for exports to emerging markets, should show healthy
Source: World Steel Association positive growth in the near-term.

Industrial Steel Demand

The outlook for the engineering and manufacturing sectors remains closely tied to the broader
economic outlook in Europe. After strong growth during 2011, EMEA industrial steel demand
growth is expected to slow markedly in 2012, yet remain positive. Growth will be largely driven
by the development of the sovereign debt crisis, investor sentiment and availability of funding in
bank and capital markets. Fitch expects low single-digit steel demand growth across the
broader industrial sector in 2012, boosted to some extent by continuing high order books,
which is expected to sustain activity levels in H112.

Rising Inventory Levels

Limited Destocking in 2012
The adverse effects of weaker demand on steel companies in 2009 were exacerbated by rapid
movements in steel market inventory levels during the previous financial crisis. During 2010,
market inventory levels have gradually picked up from low levels in 2010, yet the nominal value
in the EU and the US remains almost 20% lower than 2007 and 2008 historical levels. This
partially limits the expected adverse effect of rapid destocking on steel producers’ financial
profiles in 2012.

Figure 4

European Service Centre Inventories

EU inventory (LHS) Months supply (RHS)

(m/ton) (Months)
2,500 3.5

2,000
2.5
1,500

1,000 1.5
Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10 Jan 11 Jul 11 Nov 11
Source: Industry data

Rising Inventory
Monthly steel Inventory supply has also been slowly increasing since mid-2011 on the back of
weaker real steel demand and market participants taking a cautious ordering approach in
uncertain trading conditions. Fitch expects this trend to continue into 2012, yet for monthly
inventory levels to remain well below the peak levels of between 3.2 and 3.4 months reached in
early-2009. Nominal inventory levels are expected to rise further into early-2012, but to
normalise close to current levels thereafter.

2012 Outlook: Challenging Conditions Persist 3

December 2011
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Figure 5

US Service Centre Inventories

US inventory (LHS) Months supply (RHS)

(m/ton) (Months)
14,000 3.5
12,000
10,000
2.5
8,000
6,000
Figure 6 4,000 1.5
Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10 Jan 11 Jul 11 Nov 11
EMEA Steel Revenue
Growth - 2009 to 2012F Source: Industry data

(%)
30
Fitch’s central rating forecast is not currently for a double-dip scenario in 2012, although the
10
global economic and market outlook has worsened in late-2011, which has increased the
-10
likelihood of such an event. The lower nominal inventory levels in the EU and US relative to the
-30
previous downturn places steel producers in a more favourable position than were the case in
-50
2009, as a severe downturn scenario would see destocking having a far less pronounced effect
2009 2010 2011 2012F in 2012 compared to early-2009.
Source: Fitch
Threat of Rising Cost Inflation Persists into 2012
Relief from Raw Material Costs
On aggregate, Fitch expects raw material input costs to continue to moderate across Europe
into 2012 on the back of the current weaker commodity price environment, giving steelmakers
some cost relief over coming months. European iron ore prices have partially adjusted in H211
in response to weaker global steel prices, albeit with some time lag, while coking coal prices
have been slightly slower to adjust in light of the tight market conditions.

During 2011, high material prices drove a large portion of industry cost increases, constraining
steelmakers’ operating margin recovery. However, Fitch notes that some fixed costs, notably
related to higher electricity, gas and labour costs, may not adjust quickly in a weaker price
environment. This, together with the lag times associated with raw material price movements
versus steel prices, may limit operating margins and cash generation in early to mid-2012 for
less-integrated steel companies.

Emerging Market Costs

Operating costs in emerging markets have traditionally been significantly lower than those in
developed markets, notably due to cheaper labour and energy costs. Fitch, however, expects
these benefits to diminish over the medium to long-term.

Fitch believes that continuing energy infrastructure investment costs and rising domestic cost
inflation in the CIS and sub-Saharan Africa may lead to sustained cash cost increases per
tonne of output. This may adversely affect iron ore and steel producers’ medium to long-term
competitive positions when compared with global peers.

2012 Outlook: Challenging Conditions Persist 4

December 2011
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Figure 7
EMEA Steel Sector – Summary of Financial Forecasts
2010 2011 2012F Comments
Steel sector median
EBITDA margin (%) 23.9 23.3 21.5 Slight contraction in operating margins in 2012
on the back of lower steel prices and slower
adjustment in input costs
Funds from operations 11.5 12 12.1 Stable FFO into 2012. FFO generation to benefit
(FFO)/revenues (%) from planned cost saving initiatives and capacity
reduction plans.
Free cash flow -1.9 -2.4 0.4 Measures to conserve cash to boost FCF include
(FCF)/revenues (%) reduced capital expenditure (postponing and
deferral of non-essential capex), reduced
dividends and positive working capital inflows.
Median FFO adjusted gross 2.5 2.3 2.2 Limited scope for significant deleveraging in
leveragea (x) 2012
Median FFO interest coverb 9.1 10 9.7 There has been a marked shift to longer-term
(x) fixed-rate bond finance in 2010 and 2011.
Interest cover ratios to remain largely stable in
2012
a
Gross adjusted debt/FFO + interest + rents
b
FFO + interest/interest
Source: Fitch

Key Issues
High Operational Leverage
Due to high operational leverage, steel producers’ revenue/profitability can vary significantly
from cyclical peak to trough. Steel producers have a high proportion of fixed costs to total costs,
making their financial profiles vulnerable to rapid demand and price fluctuations. Companies
with a high proportion of contracted sales and/or ownership of raw material inputs will typically
have less variation in their results.

Inherent Cyclicality
The steel sector is exposed to significant demand cyclicality and price volatility, stemming from
variations in end-user demand and relatively inelastic supply. Apparent demand movements
are exacerbated by steel inventory movements, pronouncing the cyclical demand effects on
cash generation. Fitch expects a mixed regional picture in 2012 in the key demand sub-sectors
of automotive, construction and industrial. Growth in steel demand in China, India and Brazil
should be strong, while Germany, South Africa and Russia should show moderate steel
demand growth. Weaker markets include North America and EU countries.

Limited Rating Headroom

Fitch-rated EMEA steel producers carry, on aggregate, relatively high leverage at the rating
levels. Notably, ArcelorMittal S.A.’s (AM, ‘BBB’ / Negative) funds from operations (FFO) gross
leverage position of 3.2x at end-2010 leaves limited rating headroom. However, leverage is
viewed in relation to both the market position and business mix. In this regard AM benefits from
being the world’s largest steel producer with a significant presence in all the key steel-
consuming regions. AM is the market leader in Europe, the US and Africa, and is also the
world’s most diversified steel producer in terms of product mix and geography.

2011 Review
Recovery Stalled
After a period of continuous growth between 2004 and 2008 (boosted by the global automotive
and construction sectors), the sharp fall in demand resulting from the end-2008 global
economic crisis has again highlighted the steel market’s vulnerability to market volatility and
sharp price corrections. Steel prices gradually recovered in 2010 and the first-half of 2011 from
lows reached in early-2009. Renewed concerns regarding market and economic prospects in
the eurozone in Q311, however, lead to reduced demand across major steel markets, leading
to inventory levels slowly rising and steel prices contracting by between 10% and 15%.

2012 Outlook: Challenging Conditions Persist 5

December 2011
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Focus on Cash Conservation

As the market outlook worsened in late-2011, steel companies announced plans to defer /
postpone non-essential capital investment projects, close / idle higher-cost production facilities
and dispose of non-core business interests in an attempt to boost FCF generation. Fitch
expects limited tangible financial benefits to be realised across the industry in 2012, but notes
that profitability should improve from 2013 onwards.

Improved Liquidity
EMEA steel companies have significantly improved their liquidity positions in 2010 and 2011,
notably through reducing reliance on short-term banking facilities by securing new long-term
capital market finance. This has improved access to fixed-rate bond market funding, reducing
exposure to floating interest rate movements in volatile financial markets while significantly
extending debt maturity profiles.

Figure 8

EMEA Steel Aggregate Debt Breakdown

2008 vs. 2011
Bonds Notes Bank Other
(%)
100
80
60
40
20
0
2011 2008
Source: Fitch

2012 Outlook: Challenging Conditions Persist 6

December 2011
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2012 Outlook: Challenging Conditions Persist 7

December 2011