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Strong Steel Production, Iron Ore Steady

‘Death by Amazon’…Don't Believe the Hype

Street Talk Podcast

Street Talk Episode 23 - As More Banks Reach for Yield, Advisers Urge Caution

National Broadband Initiatives Crucial To Asia-Pacific Broadband Market Success

Electric Vehicle Infrastructure: U.S. Utilities Getting Charged Up, but Are Regulators Plugged in to the Concept?

Metals & Mining
Strong Steel Production, Iron Ore Steady

Highlights

We increase our price expectations for 2018 marginally to US$67.1/t due only to strong prices through April 20, 2018.

May. 15 2018 — The forces shaping the steel value chain are causing divergence in our expectations for steel and iron ore prices. Much of the strength in the steel market is reflected in headline 62% Fe iron ore prices, yet risks remain to the downside due to ample supply — we have marked our 2018 expectations to market given robust prices until April 20, yet continue to expect a profile of gradually declining prices for the near term. Four themes lead us to form these expectations.

The primary expectation is for stronger, synchronous global growth. Fundamentally, at a macroeconomic level, the world is now on a more robust foundation when considering real GDP growth — the International Monetary Fund noted that economic growth in 2017 was the strongest since 2011, and has revised both 2018 and 2019 figures upwards by 0.2 percentage points to 3.9% apiece. We therefore expect consumer demand within China, and demand for the country's exports, to be firm for the near term — this includes demand for steel-intensive products, which will provide support for downstream finished steel production.

Second, finished steel demand in China increased in March 2018 from already-robust levels. Most relevant is the strength in China's residential housing market — residential floor-space started grew by 12.2% year-over-year in March. We estimate that 54% of China's 752 Mt consumption of finished steel will come from the construction sector in 2018, and this reported strength in the first quarter of 2018 residential data supports our view. We also see strength in general-purpose machinery demand, which continued to grow at 6.8% year-over-year in March as China continues to replace and upskill its aging stock. Industrial production growth of 7.3% in February and Purchasing Managers Indices of 52.0 and 51.0 from National Bureau of Statistics and Caixin sources respectively, also combine to indicate solid steel-intensive economic growth in the world's largest consumer and producer of finished steel.

Q2'18 resistance found at US$63/tThird, we observe strength in China's crude steel production rates yet see less strength in pig iron production. If we remove any seasonality, particularly the timing of the Chinese New Year, crude steel production has risen by 5.0% year-over-year to 211 Mt in the first quarter of 2018. However, we note that China's production of pig iron over the first two months of this year was reported by the World Steel Association to be broadly constant year-over-year at approximately 113 Mt.

Data from S&P Global Platts indicates that steel scrap demand has risen recently, with some mills reporting 18% scrap in the blast furnace. We consider these large proportions of scrap employed to be approaching a technical limit and do not see much potential for further substitution of iron units away from iron ore, particularly now that coking coal prices are lower. These technical data points on the specific utilization techniques for Chinese blast furnaces lead us to expect less upside demand potential for iron ore.

Discounts resist downward trend yet remain around 40%Finally, we continue to expect seaborne iron ore supply to grow by approximately 2.2% year-over-year in 2018. Data from the first quarter of 2018 shows that the aggregate quantity of iron ore produced by the world's "Big 3" iron ore miners grew by 2.7% year-over-year to 236 Mt. This was led by Rio Tinto, which grew production 6.9% by adding 5.6 Mt of incremental tonnage compared with the first quarter of 2017; BHP Billiton Group simultaneously added a further 4.9 Mt to first-quarter 2018 volumes. This incremental volume is being added at a time when crude steel production is growing strongly, yet pig iron production is relatively flat — we expect this ample supply of seaborne iron ore to weigh negatively on seaborne iron ore prices for 62% Fe material in the second quarter of 2018.

However, we acknowledge that there is some risk to these expectations, whilst Vale SA has maintained 2018 guidance of "around 390 Mt", the company removed 4.2 Mt from seaborne volumes in the first quarter of 2018. This could see less near-term liquidity in premium-quality seaborne iron ore availability, but we maintain our annual expectations for Vale based on guidance and market reports — it seems more likely that extra volumes will enter the market later this year.

The net effect of these forces is for the steel market within China to continue to tighten and for the global iron ore industry to remain in a modest surplus. We increase our price expectations for 2018 marginally to US$67.1/t due only to strong prices through April 20. This is higher than the S&P Capital IQ surveyed mean of US$63.8/t.

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Credit Analysis
‘Death by Amazon’…Don't Believe the Hype

Highlights

Written by Camilla Yanushevsky, with analysis contributions from Melissa Doscher, Senior Manager, Risk Services, and Jim Elder, Director, Risk Services

Is Amazon unstoppable? And if so, what is Amazon’s next target?

May. 23 2018 — From an online bookseller that launched in 1995 to a high-tech conglomerate with global reach, Amazon.com Inc. has a bullseye on every market it touches. Today, Amazon is a retailer, hardware developer, cloud services provider, content streaming service, clothing designer, and, more recently, a home security company with its announcement to purchase Ring Inc. on February 27, 2018.

The company has rallied 37% this year, crushing Wall Street expectations for its first quarter earnings, posting $1.6 billion in profit and prompting nearly two dozen firms to up their price targets on the e-commerce giant. A few of those newly minted price targets place the company north of the $1 trillion threshold.1

Not surprisingly, the market is questioning — is Amazon unstoppable? And if so, what is Amazon’s next target?

How do Amazon’s acquisitions stack up?

Amazon, along with its subsidiaries, has made 96 merger and acquisition transactions since its 1995 launch, the largest being its acquisition of Whole Foods Market Inc. for approximately $13.7 billion, announced on June 16, 2017.

Figure 1: Amazon's largest acquisitions ($M) from January 1, 2008 – April 27, 2018

Figure 2: Amazon’s M&A activity by industry (%)

To compare the disruptive impact of innovation in the various sectors that Amazon has entered, we looked at Amazon’s 10 largest deals announced since January 1, 2008 and examined industry and company-level probability of default (PD) changes using our PD Market Signal Model, a structural model that calculates the likelihood of a company defaulting on its debt or entering bankruptcy protection over a one-to-five year horizon.

Among these 10 major acquisitions, Amazon’s announcement to purchase food retailer Whole Foods Market Inc. on June 16, 2017 was the most disruptive, with the food retail sub-sector PD increasing from 3.73% on June 15, 2017 to 4.85% on June 23, 2017, or by about 30%. We attribute the PD escalation to the sheer size of the transaction, more than 10x the size of any of its past transactions, as well as the saturation within the food retail sub-sector.

But is the Amazon hype overblown?

With the exception of the Whole Foods purchase, our PD Market Signal model shows Amazon may not be the ‘Death Star’ it is hyped up to be. Seven of Amazon’s 10 largest acquisitions –Annapurna Labs Ltd. (Semiconductors), Souq.com FZ-LLC (Internet and direct marketing retail), Elemental Technologies LLC (Application software), Ring Inc. (Consumer electronics), Zappos.com Inc. (Internet and direct marketing retail), Twitch Interactive Inc. (Internet software and services), and Audible Inc. (Internet software and services)had a positive impact on the short-term market perceived quality of the target industry, with the magnitude of PD changes significantly greater for Amazon’s more recent acquisitions Annapurna Labs Ltd. (01/22/2015), Souq.com FZ-LLC (03/28/2017), and Elemental Technologies LLC (09/03/2015).

By contrast, only slight PD changes were observed for acquisitions during Amazon’s earlier years – Zappos.com Inc. (07/22/2009), Twitch Interactive Inc. (08/25/2014), and Audible Inc. (01/30/2008) when the market perception of the “Amazon Effect” was less in full flight.

In the case of Amazon’s most recent announcement to buy Ring Inc. for $992.8 million, we attribute the positive impact – the median PD for the consumer electronics sub-sector decreased 13.76% from 9.45% on February 26, 2018 to 8.15% on March 6, 2018 – to the lack of a ‘surprise factor.’ Amazon had previously invested in Ring through the Alexa Fund, which exclusively provides funding to Alexa-enabled devices.

Figure 3: One-week median U.S. Industry Market Signal Probability of Default change following Amazon’s acquisition announcement: January 1, 2008 – April 27, 2018

On a company-level, the “Amazon Effect” is more obvious. For example, significant escalations in PD were observed for both small- and large-cap companies in the peer groups of the acquired companies. Small-cap WOD Retail Solutions Inc.’s one-year PD increased from 0.12% on August 24, 2014 to 1.81% on September 1, 2014 (1,409.73% change) following Amazon’s announcement to acquire live streaming video platform company Twitch Interactive Inc. Similarly, Alphabet Inc.’s PD rose 170.75% from .03% on January 29, 2008 to .08% on February 6, 2008, following Amazon’s decision to buy Audible Inc., one of the world’s largest audio entertainment and information providers, on January 30, 2008.

Figure 4: Amazon’s target peer group: Largest changes in One-Week Market Signal Probability of Default following acquisition announcement, January 1, 2008 – April 27, 2018

What is Amazon’s next battleground?

While Amazon’s plans with Ring have yet to be disclosed, the deal certainly gives Amazon a leg up on Google and Apple in the smart home market, which many market participants expect to be Amazon’s next battleground. Ring already supports Amazon’s virtual assistant Alexa, which Amazon’s Director of Applied Science and Alexa Machine Learning, Ruhi Sarikaya, recently announced will soon be able to track memory and context.2

Ring, alongside Alexa can be leveraged with the smart lock system, Amazon Key, to facilitate the safe delivery of Amazon products in home. In just a few years, the trifecta Ring-Key-Alexa integration could lead to a completely new home landscape from security, to deliveries, and even lifestyle. Intelligent personal assistants, smart keys and video doorbells could be as ubiquitous as television sets.

While the immediate impact of the Ring acquisition might have had a positive impact on the sub-sector’s PD, this move might provide a glimpse into how disruptive Jeff Bezos’ longer-term strategy might be. With its smart doorbells and security cameras, Ring literally opens the door for Amazon to start selling services, not just goods. Is the market letting a giant through the front door?

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1 McDonald, L. (2018, May 08). Why Amazon could be the next black swan for the market.

2 Making Alexa More Friction Free (April 25, 2018). Retrieved April 27, 2018.

Beyond Amazon, Alibaba Leads Disruptive Innovation In Race To $1 Trillion Valuation

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Listen: Street Talk Episode 23 - As More Banks Reach for Yield, Advisers Urge Caution

More banks are reaching further out the yield curve in their loan portfolios to meet customer demands but, increasingly, advisers believe institutions need to proceed with caution. In the episode, experts from PIMCO, Sandler O’Neill, Chatham Financial and PrecisionLender discuss rate risk and how banks focused on funding will ultimately prove the winners.

Street Talk is a podcast hosted by S&P Global Market Intelligence.

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Technology, Media & Telecommunications
National Broadband Initiatives Crucial To Asia-Pacific Broadband Market Success

Highlights

The following post comes from Kagan, a research group within S&P Global Market Intelligence.

To learn more about our TMT (Technology, Media & Telecommunications) products and/or research, please request a demo.

May. 17 2018 — This year's Broadband Forum Asia, held in Bangkok, Thailand, April 24-25, focused on ways to accelerate the growth of fixed broadband markets in developing countries. Looking at the success of advanced fixed broadband markets in the Asia-Pacific region, executives agreed that government participation is crucial to success.

In 2013, the Chinese government launched the Broadband China initiative with an investment of $323 billion and a target of full nationwide broadband coverage by 2020. The government has focused on accelerating fiber deployments, driving fiber's share of broadband households from 21.6% in 2013 to 84.2% in 2017. China has also become the world's largest fixed-line broadband market with an estimated 348.5 million subscribing households at year-end 2017.

Similarly, Vietnam's broadband initiative aimed at driving economic growth through fiber deployments accelerated fiber's share of broadband households from 47.4% in 2015 to 77.5% in 2017. Although the country's broadband penetration rate remains relatively low, Vietnam is one of the fastest growing fixed broadband markets in the Asia-Pacific region. Le Trung, deputy director of the infrastructure development center at FPT Telecom, said Vietnam is on the right track in terms of migration from asymmetric DSL, or ADSL, to gigabit passive optical networks, or GPONs. Trung further explained that FPT is positive about achieving 10 Gbps PON connections in the future after reducing its CapEx and operating expenses through advanced technology, including the use of software-defined networking optical line termination, or SDN OLT.

Broadband and fiber penetration by market in 2008 (%)Broadband and fiber penetration by market in 2017 (%)

Harin S. Grewal, cluster director of networks and technology for Singapore's Info-communications Media Development Authority, or IMDA, noted that the government provides grants of up to S$750 million (US$569 million) and S$250 million (US$190 million), respectively, to network companies (responsible for passive infrastructure including wirelines and ducts) and operating companies (responsible for active infrastructure including switches and routers), both for a license period of 25 years. In return, operators are obliged to meet fiber rollout and adoption targets under this initiative, called the Next Generation National Broadband Network, or NGNBN.

As of April, 13 operating companies are funded by NGNBN in Singapore while the number of retail fixed broadband service providers has increased to 28 from three when the program was launched in 2010. With the entry of more operators, Singaporean broadband subscribers enjoy competitive services and pricing with an average revenue per user of $25.33 and affordability index of 0.3% based on the market's 2017 per capita gross national income purchasing power parity.

Speed is another important indicator of the success of a broadband market. The Singaporean government requires new operators to reach a minimum of 100 Mbps peak downstream bandwidth and 50 Mbps peak upstream bandwidth per end-user connection by its launch; they are also expected to improve with downlink bandwidths exceeding 1 Gbps in the future.

Singapore achieved nationwide fiber coverage in mid-2013 and fiber is being deployed in new buildings. Hong Kong, on the other hand, struggles to extend fiber coverage to remote locations such as villages and outlying islands. Government plans to subsidize operators for expanding fiber coverage to about 380 villages is expected to drive marginal growth of the broadband market.

Global Multichannel is a service of Kagan, a group within S&P Global Market Intelligence's TMT offering.

As of April 25, 2018, US$1 was equivalent to $1.32.


Energy
Electric Vehicle Infrastructure: U.S. Utilities Getting Charged Up, but Are Regulators Plugged in to the Concept?

Highlights

Electric vehicles allow consumers to realize transportation fuel savings and states to meet their emissions-reduction goals, and offer utilities a unique business opportunity. A recent report identifies regulatory initiatives that address the issue.

Until a few years ago, the nation's electric utilities had little direct interest in the automotive industry. While fleet vehicles have always been part of the utilities' infrastructure maintenance and customer service activities, and utilities with auto industry customers have always been impacted by the sector's overall health, few people recognized the full direct impact that electric vehicles, or EVs, could have on the utilities' business prospects until it became clear that EV technologies were viable, and that consumers were willing to begin moving away from vehicles with combustion engines. It is now becoming apparent that EVs could foster significant new demand growth for the electric utility sector after more than a decade of sluggish to negative growth in most parts of the country.

In addition to allowing consumers to realize significant transportation fuel savings and certain states to meet their ambitious emissions-reduction goals, EVs clearly offer the utilities a unique business opportunity. Electric sales for most utilities have been flat for several years due to sluggish economic growth and widespread adoption of conservation initiatives, and EV investments and, more broadly, increased use of electricity to charge EVs could be a boon to many utilities in the years ahead.

While many utilities have indicated interest and plans to pursue opportunities in the EV market, quantifying investments is a challenge due largely to companies not providing a clear delineation of commitments to capital costs, versus expense allocations.

Based on a preliminary analysis of the EV sector, Regulatory Research Associates, an offering of S&P Global Market Intelligence, has discerned certain key trends, as summarized below.

  • In states that have a strong focus on renewable energy development and alternative energy technologies, the backbone charging infrastructure for EVs is more developed than it is in those states that have been reluctant to adopt policies supportive of the industry. For example, California, which has been supportive of the nascent EV sector, leads the nation both in terms of the number of EVs in use and the number of charging stations, and has been a leader in calling for more stringent emissions reductions.
  • A significant issue that utility commissions are grappling with is whether third-party entities that own EV charging stations should be treated like regulated utilities due to the fact that they are essentially resellers of electricity. Utilities in some jurisdictions are interested in investing in charging stations and seeking rate base treatment of their investments, while utilities in other jurisdictions are primarily focused on ensuring that adequate distribution infrastructure is in place to support third-party charging stations and the beneficial impact that EVs are expected to have on electric sales.
  • There is a need to design time-of-use rates to incentivize off-peak EV charging, thereby minimizing adverse effects on the larger distribution grid. In fact, if structured correctly, funneling load to off-peak periods could smooth out demand, creating less dramatic peaks and valleys, thereby allowing the grid to operate more efficiently.
  • Certain regional approaches are being taken to standardize EV policies and infrastructure development. For example, in 2013, the governors of eight states, namely California, Connecticut, Maryland, Massachusetts, New York, Oregon, Rhode Island, and Vermont, established the ZEV Program Implementation Task Force, which is a coordinated approach to support policies to foster the development of EV markets and the required charging infrastructure, and "remove barriers to the retail sale of electricity and hydrogen as transportation fuels and promote competitive plugin electric vehicle charging rates."
  • In October 2017, the governors of Colorado, Idaho, Montana, Nevada, New Mexico, Utah, and Wyoming signed a memorandum of understanding that calls for collaboration to create an "Intermountain West Electric Vehicle Corridor." The agreement calls for promoting EV market development and establishing standards for EV fast-charging corridors across these states.

Although the ZEV Program Implementation Task Force and the agreement to create the Intermountain West Electric Vehicle Corridor are perhaps the most disciplined attempts to date to standardize EV related policies for maximum efficacy, many other jurisdictions are addressing the matter on a case-by-case basis.

For further information concerning key regulatory initiatives, prominent legislation, and noteworthy proceedings addressing generic EV related matters, refer to RRA's Special Report dated May 2, 2018.

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