Fitch Ratings shows rising raw material prices and VAT refund related liquidity concerns are exposing longstanding structural weaknesses in the Ukrainian steel industry and this could ultimately lead to a consolidation of producers.
Mr. Peter Archbold, Senior Director in Fitch Industrials team, said “Given the challenges facing the Ukrainian industry at present, M&A transactions could represent an attractive way out for smaller or weaker producers facing either substantial debts, the need to modernize their plant and or those lacking in raw material self sufficiency.”
He said that “While a much needed consolidation would benefit the Ukrainian steel industry, concentrated ownership structures mean that any merger or acquisition would be a less than straightforward process.”
The Ukrainian steel industry currently faces several significant challenges.
1. Several smaller steel mills lacking in raw material self sufficiency are not only facing a situation where rising iron ore and coal prices are causing production costs to outstrip selling prices, but there is also a genuine concern about sourcing sufficient materials to continue production. Typical of producers in this position is Donetsk Iron and Steel Works, which recently announced that it had stopped production at two of its blast furnaces.
2. A large proportion of Ukrainian production around 35-40% continues to come from energy-intensive, obsolete open hearth furnaces. Some producers using this technology have also run up large arrears to Naftogaz, the state-owned gas supplier, which is understood to have recently announced a reduction in gas supply to some producers. The country broader economic crisis has also not helped, with the state delaying the refund of VAT paid on exported steel products in effect depriving producers of working capital. There is also some evidence that the processing of VAT refunds is being applied on a selective basis, with the foreign owned Kriviy Rih understood to be owed in excess of $300 million.
Fitch notes that a recently announced transaction involving Mariupol Ilyich Iron and Steel Works and fellow Ukrainian producer Metinvest is typical of many of the factors driving M&A activity in the region. Ilyich Iron and Steel Works is a large producer but lacks raw materials self-sufficiency with Metinvest already supplying a high proportion of its iron ore requirements and a portion of its coke requirements. The location of the two companies both in Mariupol in southeastern Ukraine was an added operational factor. Ilyich Iron and Steel Works is also understood to be facing significant capital expenditures to replace its obsolete open-hearth furnaces. (KyivPost)