ThyssenKrupp Paradox Mixed Bag for German Steelmaker

Shares in ThyssenKrupp rose sharply in 2016, despite the German industrial giant's disappointing results. Investors point to the steel market’s looming consolidation as a key reason for their confidence.
Is Thyseen the real deal, or just a bunch of smoke?

It's something of a paradox for one of the world’s largest steel makers. Shares in ThyssenKrupp saw significant gains in 2016 despite the company posting disappointing results and falling short of its financial targets.

Difficult markets and an increasingly unpredictable political environment were bad for business at one of Germany’s oldest companies, which traces its roots back to 1842. Profits and revenues declined in 2016 as the industrial group faced a series of painful setbacks that doomed its plans for a return to reasonable profits.

The steel company fell short of its target of making at least €2 billion ($2.1 billion) in operating profit, posting earnings of around €1.4 billion in the 2015/16 fiscal year. That was more than €200 million less than the previous year. Its margin for adjusted earnings before interest and taxes (EBIT) declined for the first time in years.

Management did not beat around the bush when it came to its disappointment: "These are results that do not meet our standards," Chief Financial Officer Guido Kerkhoff said during an earnings press conference at the company’s headquarters in Germany’s Essen in late November.

Yet none of that was enough to dent the optimism of investors. Shares in the group rose sharply, gaining 6 percent in December alone and more than 23 percent since the beginning of the year. It's made ThyssenKrupp the fourth most highly-valued company in Germany’s blue-chip DAX index. The industrial group’s market capitalization currently is at roughly €12.8 billion.

So what's behind the paradox? Investors point to expectations of a rebound in the global steel market – and hope that a wave of conslidation is about to hit the long-struggling industry.

The ThyssenKrupp management is so strongly in favor of a merger that they will do everything necessary to make it happen industry insiders

When it comes to ThyssenKrupp, they cite two major trends: One is the steady expansion of the company's broader industrial business, which already accounts for a large portion of its earnings. In other words, the company is relying less and less on steel to make money. The second trend involves hopes of finding a sustainable solution for the group’s steel unit, which Chief Executive Officer Heinrich Hiesinger wants to merge with a competitor as soon as possible.

The most promising candidate for such a merger remains the European steel division of Indian industrial conglomerate Tata. But Britain’s decision to leave the European Union, impacting Tata’s British steel mills, put a hold on those plans. Internal disputes at Tata are adding to the delay over merger talks, with management desperately searching for a permanent solution to Tata's high pension obligations – an issue ThyssenKrupp wants to stay out of.

Yet despite a great deal of resistance, partly among the companies' own staff, many analysts still expect some form of a merger to take place. "The ThyssenKrupp management is so strongly in favor of a merger that they will do everything necessary to make it happen," said one industry insider, who declined to be named.

Management and investors believe a merger will lower production costs and possibly lead to higher prices, a move that a new heavyweight could implement more easily than either one of the companies on their own.

A merger would also significantly improve the profitability of ThyssenKrupp's steel division. It's a big part of the reason many expect the industrial firms stock to continue rising in 2017.

"The speculation over a possible spinoff of the European steel business and the improved outlook for material-intensive areas will likely support the share price," steel expert Dirk Schlamp of Germany's DZ Bank wrote in his latest research note. Citing consolidation talks in the industry, Deutsche Bank also stuck a buy recommendation on the group’s share and set a target price of €26, well above the company’s current €22.7 share price as of 10:45 a.m. Frankfurt time on Thursday.

ThyssenKrupp’s “problem child”, its industrial division in the midst of a restructuring, could spell further trouble for Mr. Hiesinger.

Some positive developments on the long-struggling European steel market could also add momentum in 2017. In recent months, the European Commission has initiated proceedings in a number of dumping cases, especially against cheap Chinese steel imports, in crackdowns that are beginning to spell higher steel prices. Arcelor Mittal, the Luxembourg-based world market leader and a major Thyssen competitor, has announced it will raise prices within the E.U. this year.

So far ThyssenKrupp has hardly benefited from higher prices, with the steel group bound by several long-term customer contracts, particularly with the auto industry. But many analysts expect higher prices to rub off on earnings in the first half of 2017.

But some experts caution against expectations of an ongoing upward trend in the market, as costs for raw materials like iron ore and coking coal have risen considerably at the same time. That could put pressure on profit margins in the long run. The higher prices have also caused producers to ramp up idle capacities relatively quickly, but that in return could upset the delicate balance between supply and demand in the industry.

ThyssenKrupp’s other “problem child” is an industrial division in the midst of a restructuring, which could spell further trouble for Mr. Hiesinger. While its elevator business is running strong – contributing €860 million in earnings or about half the company's total in the last fiscal year – its important plant construction unit, Industrial Solutions, has suffered from weak energy and commodity prices. The division saw a drop in orders of nearly 30 percent, with the adjusted EBIT profit margin falling by 16 percent as a result.

It seems likely, however, that the division's bad fortunes have already bottomed out. Market observers believe there are signs orders are recovering, especially for major projects in the cement and mining industries. ThyssenKrupp has effectively prepared itself for the future challenges in its markets, Sven Diermeier, an analyst at Independent Research, wrote in a recent research note.

Adding to the mix of challenges is a yet entirely unknown issue – the question of U.S. President-elect Donald Trump and his intentions. If he follows through with a promised stimulus plan, especially one involving infrastructure spending, that could have a positive effect on the business of global steel makers such as ThyssenKrupp.

 

Martin Wocher is an editor with Handelsblatt, focusing on the mechanical engineering and steel industries. To contact the author: [email protected]