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More Consolidation Coming to Chinese Steel Industry

Bridget Freas, CFA

Bridget Freas: Hi. My name is Bridget Freas. I'm an Equity Analyst with Morningstar. Joining me from China Gerui is CFO, Edward Meng. China Gerui is a specialty steel processor focused on the construction, electrical and packaging markets within China.

Edward, good morning.

Edward Meng: Good morning. Thank you for having me here.

Freas: Thank you for being here. Just to start off, I'd like to get a sense for what you are seeing in terms of demand going forward. Obviously, in China, overall steel consumption has grown dramatically in the last couple of years, but has shown some signs of weakening in the last couple of months. What are you seeing in your end-markets and what's your outlook for the next year or two?

Meng: Good question. Actually we are in this niche market of cold-rolled steel products. So, ever since 2007, despite the weak market in an overall crude steel industry, we continue to see very strong demand for the product that we produce. And we expect that trend is going to continue to grow at a very healthy pace. Right now in China, the situation is, although China is a net exporter of crude steel, but China is still a net importer of the kind of products that cold-rolled steel, that we produce high-end, high-precision.

Also that's provides a opportunity for us to further capitalize on the replacement of import, at the same time, continue to supply the increasing demand in the domestic China market because of the overall growth of the consumption power, growth of the middle class, which are the ultimate end-user of our products. Going forward, we see that and this trend is going to continue. And the company's well-positioned as the market leader right now to capitalize on this opportunity.

The other thing is, this cold-rolled steel market is not really moving in tandem with crude steel market, while that over the recent couple of months, we have seen the bill of excess supply, which actually is driving down the steel price in general -- the steel price. But we have seen this that actually demand for our products has been continuing to be very strong. And for that respect, we are very confident for the Company's growth going forward in the next couple of years.

Freas: Just looking at the competitive environment, when we think of Chinese steel producers, we think of some of the big names that have 50 or 100 times the capacity of China Gerui and some of these big players actually do participate in the narrow strip cold-rolled coil space. Yet, as you said earlier, you've been able to hang on to the number one market share. So, what do you think keeps these steels giants from using their operating leverage to really take a commanding position in this market, given the high profitability and strong demand growth outlook?

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Meng: Right. That's very interesting observation, Bridget. I mean, actually in China, the larger players in the crude steel market like Baosteel, Hebei Iron and Steel, they are more focusing on volume and they are confident about, given their state-owned background, they are more -- there performance is validated on the basis of volume. Yes, they are involved in the cold-rolled steel markets production but there products are primarily for auto-sheets; again, volume based. I mean this niche market, that we are competing – are serving our customer, we are the number one player right now, 12.5% market share.

We are on the higher-end, high-precision to high-end side of the market, I mean in the range of products, but our competitors including that the state-owns, given they have very limited investment in the cold-rolled steel right now, they are not interested in matching investments in this side -- in this segment of the market.

And then on the other side, the other players most of them are smaller ones, some of them even mom and pop, and some of them of just to several segments of whole production process. Not like China Gerui, where we are 100% focusing on this business of ours, which we do well. And we are handling the whole production from the hot rolled coil all the way down to let's say cold-rolling, annealing, slacking and then chromium or zinc or tin plating. So, that's something definitely a huge competitive advantage for us.

Freas: The Chinese government has been quite vocal about wanting to consolidate its steel industry. I would imagine a company like China Gerui, with sort of commanding niche position, high profitability, low leverage; this might make it an attractive acquisition target. So, what are your thoughts on the company being acquired, you know, perhaps by one of your suppliers?

Meng: Yeah, right now, you are right, the Chinese government is encouraging consolidation, but right now, that consolidation process is primarily happening in the upper strength, in the crude to steel manufacturing or production a segment of the market.

In our segment, this segment of the market for high-end cold-rolled steel, as I've said we are the leader right now in talking about the market share.We see that consolidation process stretches going to migrate into this segment of the market. Given our position, our brand awareness in the market and given our ample amount of financing available to us, we anticipate we'll be more of a consolidator, rather than a consolidatee.

The company really operates on at a standalone basis. We are 100% in this cold-rolled steel business. We do not operate based on preparing for a sale or ready for a takeover. So, if that happens where you value it, I mean any decision will be made on the, on the basis of benefiting overall our shareholders.

Freas: Edward, thank you for being here.

Meng: Thank you. Again, thank you for having me.