Is the state really ending its involvement in the steel industry, asks Wael Gamal "In 1973, the Egyptian Iron and Steel Company was assigned the task of manufacturing cans for the Egyptian army in preparation for the war instead of importing them from abroad. Although the importing option was cheaper, the decision was taken to make them locally in order to not attract attention. This kind of non-profitable activity is not valid any more. The industry now is totally driven by profit criteria. The language and rationale of the 1960s and 1970s is over," Ali Helmi, chairman of the famous company told Al-Ahram Weekly. Helmi's comment reflects the huge transformation undergone by the steel industry in the last two decades. After the Egyptian Iron and Steel Company was established in 1954 as the first fully integrated Egyptian public-sector steel company and began to produce both rebars and flat steel products, it was an exemplar of state involvement in industry. The company was the biggest player in the market until the 1990s when the industry was opened to the private sector, allowing for a radical change in the industry makeup. The share of the public sector dwindled due to its lower productivity levels, poor efficiency and low capacity utilisation, as well as differences in the technology employed. Public-sector participation in the Egyptian steel industry is now focussed on the production of flat steel products -- these accounted for 36 per cent of total local production in 2002, down from 60 per cent in 2001, and are produced by the Egyptian Iron and Steel Company. For rebar production, the contribution of the public-sector companies is negligible, amounting to a mere 4.7 per cent of the total rebar production in Egypt in 2002 (excluding the public-sector portion of Alexandria National Iron and Steel) and is produced mainly by Delta Steel, National Metal Industries and the Egyptian Copper Works. There are currently 20 steel mills in Egypt, of which three are integrated and semi-integrated mills. The industry is highly concentrated, with the top five producers accounting for more than 90 per cent of total Egyptian output. Until the mid-1980s, around 90 per cent of Egypt's steel demand was met by imports from Eastern Europe. Now, over the past three years, the industry has been suffering from an excess capacity of around 2.5 million tonnes, while imports account for a declining market share. Although relatively modest on a global scale, total Egyptian steel production had reached 5.9 million tonnes per annum in December 2002, up from 5.4 million tonnes in 2001. The increase in production came mainly as a result of the entry of the new private- sector steel producers. Helmi considers the new situation "a long-awaited success for the private sector in heavy industry". Despite all this, international ratings for the industry are still disappointingly low. A special report on the industry by Fitch Ratings claimed that all the Egyptian steel companies are deeply in debt and therefore lack the credit characteristics that could put them within an investment-grade category. "Furthermore, the international ratings for individual players are generally constrained by the sovereign ceiling of the country in which they are located. The Egyptian sovereign rating is low at 'BB+' for the foreign currency rating. Under such circumstances, Fitch believes that all Egyptian steel companies fall within the lower end of the rating scale," the report said. In fact, since mid-2000, the operating environment has been unfavorable for steel producers in Egypt over the past two years. The slowdown in the GDP growth rate at market prices has hit the construction, real estate and industrial development sectors, the major steel consumers, with local demand for steel subsequently contracting by five per cent in 2002 (13 per cent in 2001). Furthermore, a series of local currency devaluations has resulted in wide currency mismatches and large cash foreign exchange losses, in addition to an increase in finance costs for steel producers with large foreign exchange exposures. Continued pressure on the pound in an industry whose imported raw materials represent around 45 per cent of total production cost along with rising global prices for raw materials and an economic slowdown have all factored against local steel producers. The Egyptian government is leading the response to these factors. The government is set to propose a ten year national plan for the industry to determine local needs of steel amid expectations of rising steel demand in the near future. The announcement, which came after a meeting of the ministerial team for investment and employment, signals that despite its plans to privatise at least most of its steel plants, the state will not be allowing a fully market-run system. The rationale for this stems from the fact that the steel industry generally possesses very strong forward linkages. Many other industries depend on steel to varying degrees (construction, infrastructure works, housing, automotive, consumer durables, etc). In other words, steel consumption (and production) increases when economies are growing and government investment in infrastructure and transport is substantial. Given that steel is a capital- intensive industry and vital for the economy at large, the governments of many emerging markets invest directly or indirectly in the industry, and often provide protection through tariffs and duties. The Egyptian government was no exception, being very supportive of local producers in taking action against "dumping" by foreign suppliers as the industry cycle bottomed out in the beginning of 2000. It was not until 2004 that the Egyptian government attempted to curb selling prices hikes by lowering its tariff duties on imported steel to five per cent from 20 per cent and removed all anti-dumping tariffs on imported steel. The cut in tariffs did not have any short-term repercussions, with selling prices remaining in the high range, resulting in higher profitability, especially for Ezz Steel Rebars (ESR). On the other hand, the state guaranteed two positive factors -- maintaining very cheap labour and relatively inexpensive electricity -- while some steel-producing companies have started to use natural gas in their production process, which contributes to their cost-effectiveness. Moreover, critics from outside and within the industry even accused the government of shielding the biggest private player of the market -- Ahmed Ezz, who dominates nearly 68 per cent of the market through El Ezz Group. Dabbling in politics as well as business, Ezz is a member of the Policies Committee in the National Democratic Party and head of the Planning and Budget Committee in Parliament. The committee is responsible for determining public expenditure on infrastructure, the main source of demand for the steel industry. The state also is pursuing plans to restructure the Egyptian Iron and Steel Company, the biggest public company, with a conference on the subject scheduled for the end of this month. The company has been suffering severe financial problems and a huge debt service burden, some LE480 million annually. But recent government action succeeded through exports and high international market prices in generating a profit of LE40 million. "The company is even a very good option for investors if it is to be privatised," said May Attia, steel sector analyst at HC Brokerage. This selective state intervention and close ties to the industry has encouraged a bullish mood for Egyptian steel stocks. A report by HC brokerage published in November 2004 entitled "Steel Mask Taken Off Growth" labelled the sector as "overweight". Nonetheless, the report's final recommendation is "Buy" and its positive outlook are based firstly on "strong growth prospects in the exports market in the short to medium term and in the local market in the medium to long term, which will in turn allow producers to operate at higher average utilisation rates (especially that the industry is characterised by high operating leverage)". Also, there are healthier price levels, "which will subsequently lead to regaining higher profit margins, along with an increase in the attractiveness of stocks' valuation". Despite the expansion in rebar consumption in Egypt during the past decade (from 1.8m tonnes in 1992 to 3.1m tonnes in 2002), per capita crude steel consumption remains below that of other regional emerging markets (UAE, Qatar and Saudi Arabia), allowing for future growth contingent on the state of the domestic economy. The HC report also expresses the belief that Egyptian producers will continue to channel extra production capacities to the global and regional markets, "especially in the short and medium term, thereby increasing their foreign currency proceeds and accordingly hedging themselves against risks in foreign currency outflows (either to finance operating cycle or to service foreign currency debt)". Exports played a positive role in saving profit margins recently, but they are still insignificant mainly because of the limited number of local steel producers that can meet international standards. The report goes further to assert that it is local rather than export sales that will be the key growth catalyst in the long term. "We believe that Egyptian exports' growth potential will be limited in the long term, in light of a lower forecasted global demand growth rate, primarily due to a lower demand growth rate in China." This means the future of the industry is depending deeply on what the government will be achieving in reviving the economy in the near future. Additionally, the recent surge in the pound exchange rate against the dollar can constitute another obstacle by raising the prices of Egyptian steel exports. How harmful this will prove to be for the industry depends on "the extent of the decrease of exports in the case of continuing sluggish local demand. The steel industry is a high operating leverage industry and this will hit profit margins," Attia explains. But she also mentioned possible positive effects, as the cost of importing raw materials drops, "benefiting ESR and the small companies which don't export".
