Steel Revisited

Economic News

22 Jul 2010
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Despite an increase in gas prices, which has put pressure on Ukraine's all-important steel industry, it looks like it will be a good year for Ukraine's economic growth. Once again, a rise in world steel prices is helping to fuel the country's economic fortunes.

The government announced this week it expects the economy will expand by at least 6.5% on the back of an 8% increase in industrial production, which is dominated by the metallurgical sector.

While this is good news for the economy as a whole, insiders admit the steel industry is notoriously cyclical. While revenues from steel exports are fuelling domestic consumption, some analysts argue that an over-reliance on metals as the principle source of growth may lead to a bad hangover in the future.

Atif Ansar, Managing Director of Next Frontier Capital, an investment firm operating in Ukraine said, "Ukraine should be focusing on developing post-industrial sectors, such as service and its potentially vast agricultural sector in order to cushion the economy against future steel price fluctuations."

"In the medium-term, growth will still be driven by industry," according to Jock Mendoza-Wilson, spokesman for System Capital Management (SCM), Ukraine's largest integrated holding company, which has invested heavily into steel production assets.

Andrei Bolshakov, head of strategy for Metinvest - the holding company of SCM's mining and steel assets argues that leading Ukrainian producers, such as Metinvest are investing heavily to diversify their production to become immune to steel price volatility.

If previously Ukrainian producers were largely oriented towards steel-hungry China, they are now taking on Russian companies in strategic markets in Europe and the US.

Much like their Russian competitors, Severstal and Evraz Holding, Ukrainian players have looked to acquire European companies to gain access to these heavily protected markets.

SCM took over Ferriera Valsider, an Italian producer of hot rolled steel coil in 2004. According to Bolshakov, it makes sense to produce downstream products close to consumers, thus bypassing trade restrictions.

Bolshakov told OBG that SCM is considering new acquisitions, but not necessarily at any price. The main priority, according to Bolshakov, is to improve the efficiency of existing production assets in Ukraine.

Metinvest, much like its Russian rivals, is a vertically integrated steel producer covering the entire supply chain from processing plants for raw materials (iron ore and coking coal), steel mills, rolling plants and trading companies.

In an effort to optimize the efficiency of its different production units, Metinvest brought all of SCM's metallurgical assets under one roof last year. According to Bolshakov, this will help bring out a number of synergies and reduce the costs.

Ukrainian steel producers find themselves under pressure to make investments as quickly as possible while global steel market prices are favourable. Although Ukraine has a lot of local liquidity, large steel enterprises find it hard to finance their ambitious growth plans from their own sources.

Analysts believe Metinvest is following the trend set by Russian producers such as Severstal by preparing the holding for a possible international initial public offering (IPO).

Mendoza-Wilson told OBG an IPO is certainly an option, but not a necessity. "Our mission is to be in the position of going public. It does not mean we are definitely going to follow that road."

Companies such as SCM have become trendsetters for other Ukrainian companies seeking to adopt Western-style management and corporate governance in order to have better access to international capital markets.

"Slowly but surely, Ukrainian companies are beginning to realize that the perception of corporate governance and transparency is going to affect the cost and access to international capital," Next Frontier Capital's Ansar recently told OBG.

Additional pressure, analysts say, is coming from an increase in gas prices, which for steel makers is still quite visible in their cost structure. Increasingly though, the leading steel makers are phasing out their old blast furnaces, thereby reducing their exposure to gas price hikes.

Following a sharp increase in gas prices last year, Ukraine's industrial sector has invested in more efficient energy and production processes. With steel well placed as Ukraine's principle export and revenue driver in the short to medium term, these developments bode well for the country's economic growth.

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