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Laying the foundations for

a financially sound industry

Steel Committee meeting

Paris, December 5th, 2013

CONFIDENTIAL AND PROPRIETARY

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Disclaimer

While McKinsey & Company developed the outlooks and scenarios in

accordance with its professional standards, McKinsey&Company does
not warrant any results obtained or conclusions drawn from their use.
The analyses and conclusions contained in this document are based on
various assumptions that McKinsey&Company has developed regarding
economic growth, and steel demand, production and capacities which
may or may not be correct, being based upon factors and events
subject to uncertainty. Future results or values could be materially
different from any forecast or estimates contained in the analyses
The analyses are partly based on information that has not been
generated by McKinsey&Company and has not, therefore, been entirely
subject to our independent verification. McKinsey believes such
information to be reliable and adequately comprehensive but does not
represent that such information is in all respects accurate or complete

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Contents

▪ The global steel industry is not

financially sustainable

▪ The outlook remains challenging

▪ Long term financial health might be

elusive without significant restructuring

McKinsey & Company | 2

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A large portion of the steel industry has operated with negative

Average net debt to % players with negative
cash flows even in benign conditions EBITDA ratio cash flow

Cash flow1 for sample of 72 steel players, USD billion

38.1
34.7
32.4
30.3
27.1

14.4
9.8
3.3
1.1

-16.2 -16.0
2002 03 04 05 06 07 08 09 10 11 12
33% 18% 13% 22% 22% 17% 34% 62% 36% 41% 56%

3.0 1.9 0.8 0.7 0.9 1.0 1.5 3.1 2.4 3.0 4.2

1 Total operating cash flow minus capital expenditures minus interest expenses
SOURCE: S&P Capital IQ

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The leverage level of the steel industry is increasing

Net debt/EBITDA

Net debt / EBITDA margin for selected 72 companies

Series
%, 2002-2012
Net debt / EBITDA
Times
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0
2002 03 04 05 06 07 08 09 10 2011 2012
Pre-2003: 2003-2008: Margin improvement 2008-12: Margin deterioration
Price-margin and upstream integration and excessive leverage
squeeze

SOURCE: S&P Capital IQ

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EBITDA margins have deteriorated
PRELIMINARY

Average EBITDA margin in the steel industry1

Percent

20 19 Minimum required global average

18 18 EBITDA margin for long-term
17 sustainability
16 17

15 14
13

11
10 10
10 Steel industry reached financial
8
sustainability only on the back of an 8
immense credit bubble in the global
economy
5
Average EBITDA margin
(2010-13): 10%

0
2002 03 04 05 06 07 08 09 10 11 12 13E2

1 Considering sample of 65 companies

2 Consensus forecast

SOURCE: Bloomberg McKinsey & Company | 5

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EBITDA must cover all stakeholder obligations

PRELIMINARY

Measurement used

Net earnings
(after stakeholders
costs)

Investment /  CAPEX (during period of low

reinvestment into investment, i.e. mostly main-
the business tenance CAPEX occurring)
 Average cost of debt
Interest payment
to debt holder

EBITDA must  Effective tax rate

cover all Tax to government
stakeholder
costs
Unfunded  Unfunded liabilities, gap to be
liabilities (e.g., closed in medium term
pension funds, …)
 Average cost of equity
Return to
shareholders

SOURCE: McKinsey McKinsey & Company | 6

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Meeting current stakeholder obligations requires a 17% global average

EBITDA margin
Required EBITDA for long term sustainability (global average)1
USD / ton, Hot rolled 2012 GLOBAL AVERAGE

106

54 USD / ton 43

52
18
The global steel
5
industry must
11
generate
additional USD
29 76 Bn at current
production level
to become
2012 Sustainable Capex cost Debt cost Unfunded Tax cost Equity cost sustainable
EBITDA EBITDA liabilities
Percent of
8% 17% 7% 3% 0.5% 2% 4.5%
turnover2

▪ Capex ~7% ▪ 7% cost of ▪ Average ▪ 25% effective ▪ 9% cost of

of revenues debt unfunded tax rate equity
Assumptions1 ▪ ~250 USD/ton liabilities (gap ▪ ~325 USD/ton
of debt to be closed in of equity
medium term)

1 Considering sample of 83 companies

2 Assumes a price of 634 USD/ton in 2012 for hot rolled

SOURCE: McKinsey analysis; Bloomberg; MEPS McKinsey & Company | 7

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For any greenfield capacity expansion, the sustainable EBITDA margin is

even higher xx EBITDA margin

Required EBITDA for new greenfield capacity

USD / ton, HRC 2012  Lower-end of the range applies for

low-cost countries (e.g. China)
140-200  Higher-end of the range
characterizes mature steel regions
40-50

~70-150
USD/ton 35-50

~50-70 15-30 50-70

Typical Sustainable Capex cost Debt cost Tax cost1 Equity cost
EBITDA EBITDA for
new capacity
25-30%

SOURCE: McKinsey analysis McKinsey & Company | 8

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Contents

▪ The global steel industry is not

financially sustainable

▪ The outlook remains challenging

▪ Long term financial health might be

elusive without significant restructuring

McKinsey & Company | 9

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EBITDA margin range expected to be lower than in the past ROUNDED NUMBERS

POSSIBLE MARGIN RANGE “New Normal” (2013-2018)

EBITDA %

17
3
14

2007 "peak" Recent "slope" Mid-term Mid-term Cycle range

erosion "peak" Cycle bottom

1 Overcapacity defined as (crude steel capacity) - (crude steel equivalent of finished steel apparent steel demand)

SOURCE: McKinsey Analysis McKinsey & Company | 10

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Contents

▪ The global steel industry is not

financially sustainable

▪ The outlook remains challenging

▪ Long term financial health might be

elusive without significant restructuring

McKinsey & Company | 11

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The size of the EBITDA pool in any industry is driven by 3 factors

EBITDA pool simulation logic EBITDA pool simulation

Drivers

▪ Supply-demand (1+1/Slope) x (1+CU)

Capacity evolution EBITDA = CU –
% 4 x PPr
utilization ▪ Incidents/Revamps
Demand ▪ Ramp-up curves
CU =
Capacity
C1 Cash Cost
▪ Input cost factors 140
Slope of the (e.g., raw Demand
EBITDA cost curve materials) 120
pool C90 ▪ Macroeconomic Price (market) C90
Slope = factors affecting 100
C10 Price (floor)
the cost curve 80
(e.g., exchange
Cash Cost
rate) 60
Curve
Margin over
▪ Lead time for 40
C10
capacity additions
marginal
cost
▪ Perception of 20
Price shortage 0
PPr = ▪ Role of traders CU
C90 ▪… -20 Percent
10% 80% 90%

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The average commodity attractiveness is “structurally” EBITDA pool

underpinned by the slope of its cost curve

Profitability – EBITDA margin
2011
Percent
60
Copper
50 Uranium
Mining Average
40 Gold
Seaborne Iron ore (2002) Zinc Iron ore
(2011)
thermal coal
30 Alumina

20
Aluminium

10 Steel (2002)
Steel (2011)
0
0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 2.2 2.4 2.6 2.8 3.0 3.2 3.4 3.6 3.8 4.0 4.2 4.4 4.6 4.8 5.0 5.2
Slope of the cost curve (2008)
Ratio C90/C10

1 Rich ore equivalent

SOURCE: Raw Materials Group database; McKinsey analysis McKinsey & Company | 13
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Focus of this presentation

Possible measures (not exhaustive)

1 ▪ Unilateral closures
▪ Legally sanctioned cooperation
Capacity agreements
utilization
– JVs/alliances
(CU)
– Specialization, off-take agreements
▪ ….

2 ▪ “Fair trade” measures

EBITDA Slope of the
pool cost curve
▪ Swing capacity

3 ▪ Differentiation
Return over (product and service)
marginal
cost
▪ Sustainable cost reporting (all-in
sustainable cost – AISC)

SOURCE: McKinsey (originally presented during OECD steel committee meeting, July 2013) McKinsey & Company | 14
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Bridging the ~50 USD/ton margin gap to reach a sustainable 2

EBITDA margin would require closing ~300m tons of global capacity 3

EBITDA pool simulation logic

EBITDA margin (left axis)
Capacity closure need (right axis)

Capacity EBITDA Margin Capacity closure need

utilization Percent Million ton
Sustainable
Demand 18 350
CU = target
Capacity 16
300
14
Slope of the
250
EBITDA pool cost curve 12
C90 ~300m tons of
Slope = 10 200
C10 capacity closure
at current
8 150
demand level
Return over 6 2012
marginal cost situation 100
Price 4
RMC = 50
C90 2

0 0
EBITDA margin formula 76 78 80 82 84 86 88 90 92 94
(1+1/Slope) x (1+CU) Capacity utilization
EBITDA = CU – %
% 4 x RMC

SOURCE: McKinsey analysis McKinsey & Company | 15

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Beyond unilateral closures , several restructuring options have 2

been mentioned 3

What is shared Require

upfront anti-
Description Sourc. Prod. Com. Log. trust review

▪ Players unilaterally and independently

1 Unilateral closures reduce excess capacity according to
their own timetable

Unilateral closures
▪ Some players close all or majority of
production and negotiate agreement to
2 and off-take
source needed steel from remaining
agreement
players, potentially at preferential rates
Likely the
▪ Closures same as above. In addition, basis of
players negotiate a lease of capacity, ongoing
Unilateral closures
3 potentially at preferential rates dialogue with
and leasing
OECD and
regional
Combined ▪ Upstream capacity is pooled into a authorities
4 upstream steel subset of entities with joint ownership
utility
Asset ▪ Two or more payers agree to specialize
5 specialization with in certain products and either exit
off-take agreement noncore areas or swap assets
▪ Players agree to partner in certain areas
Alliances or “code and reduce/ eliminate production where
6
sharing” one partner is stronger and relies on the
other for future production needs

SOURCE: McKinsey analysis McKinsey & Company | 16