The leading global ratings agency Fitch Ratings has said in a report that rising raw material prices and VAT tax refund-related liquidity concerns are exposing some longstanding structural weaknesses in the Ukrainian steel industry and could, ultimately, lead to a consolidation among producers.
"Given the challenges facing the Ukrainian industry at present,
M&A transactions can represent an attractive way-out for smaller/weaker producers facing either substantial debts, the need to modernize their plant and/or those lacking in raw material self-sufficiency," Fitch's Industrials team's senior director Peter Archbold said. "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," he added.
The Ukrainian steel industry currently faces several significant challenges, Fitch noted. First, 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 Donetskstal Iron and Steel Works, which recently announced it had stopped production from two of its blast furnaces.
Second, a material proportion of Ukrainian production, around 35-40 percent, continues to come from energy-intensive, obsolete open hearth furnaces. Some producers using this technology have also run up large arrears to the state-owned gas supplier Naftogaz, which is understood to have recently announced a reduction in gas supply to some producers. The country's 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 ArcelorMittal Kriviy Rih understood to be owed in excess of $300 million.
Fitch noted that the recently announced transaction involving
Ilyich Iron and Steel Works of Mariupol (
Ilyich) and fellow Ukrainian mining and steel producing company Metinvest is typical of many of the factors driving
M&A activity in the region.
Ilyich is a large producer (approximate crude steel capacity of 6-8 million mt per year), 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 southeast
Ukraine - was an added operational factor.
Ilyich is also understood to be facing significant capex to replace its obsolete open hearth furnaces.