Weakness from end markets and commodities volatility

After facing a slowdown in a number of end markets and a weak commodity backdrop early in the year, the Covid-19 crisis has landed the metals sector with multiple challenges: a severe financial markets-induced commodity price correction, demand loss and a shutdown of production. We expect significant weakness in a number of end markets, notably automotive, aerospace and consumer-related manufacturing, but think construction should pick up quickly.

The steel sector is struggling with persistent overcapacity, to which EU import restrictions have only brought limited relief. While the Chinese lockdowns lasted, a number of factories have produced into inventory, with the result of large cumulated stockpiles. European companies are particularly affected, amongst others, due to their automotive and aerospace exposure. The former represents about 20% of steel consumption in Europe. A number of large companies in the sector have announced the shutdown of production lines and reduced output. According to CRU, idled production amounts to 19mt and 5mt of capacity in Europe and the U.S., respectively. Global steel production has fallen by 15% ytd (source: WSA). The UK industry shows particular weakness as a result of a comparatively high cost structure. The sector on average produced mid-single digit Ebitda margins prior to the crisis and was already loss-making in Europe, but what was left of profitability is likely to have been wiped out.

To make matters worse, the industry is on the front line for increased action with regards to regulatory action on greenhouse gas emissions.

Balance sheets in the diversified sector are solid, with an average net debt/Ebitda at 2.0 at the end of 2019, which should allow companies to weather current challenges. However, we anticipate a number of assets exposed to particularly weak end customers and/or with a weak cost base to face existential struggle.