Pact of steel

Poland's steel sector is choking on debt and only urgent restructuring will help save it.

For Andrzej Capiga, the prospect of taking over steel producer Huta Katowice (HK) was one of the greatest challenges of his life. The steel mill had the largest debts in an already debt-ridden industry and bankruptcy was imminent. But in January last year, he rose to the task and took the job as chairman after quitting as Bank Śląski's director of corporate banking for the Śląsk region.

A former human resources director at HK, Capiga said he had wanted the top job since 1991. "When I started, the steel mill qualified for bankruptcy," Capiga said. "My mission was to bring the mill to a state of relative financial and economic stability."

At the time, the mill's prospects had never looked worse with negotiations for its sale to U.K. steel group Corus ending in failure. Debts caused by production stoppages and outdated production processes were running at zł. 2.5 billion ($595 million), and 2000's financials showed net losses of zł. 573 million ($138 million) on revenue of zł. 3.7 billion ($880 million).

But since his appointment, Capiga has managed to keep the mill afloat and guarantee production by restoring relations with banks and suppliers including Polish State Railways (PKP), coal mines and power generators, which collapsed last year. His efforts kept net losses down to zł. 168 million ($41 million) in the first eight months of 2001. Nevertheless, despite HK's slowly improving outlook, Capiga said that only the government's immediate restructuring of steel industry debt will keep creditors at bay and ensure that production can continue uninterrupted in the long term. HK will also require state financial support to help cut its workforce and increase productivity. "Only rapid and decisive action from (the state treasury) can guarantee the long-term safety of HK," Capiga said.

The problems of HK are a mirror of the Polish steel industry, which has fallen victim to the failure of successive governments to establish a credible rescue plan. After a decade of privatization, Warsaw's Lucchini Warszawa steel mill, 67% of which belongs to Italian steel conglomerate Lucchini, is the only domestic steel mill to have found a foreign investor. Rather than sell the remaining mills to private investors, the government maintained 100% control of 10 mills and used stocks in the remaining 12 to pay off their debts to suppliers and local authorities.

The lack of restructuring is blamed by analysts for the industry's inability to respond to trends on the global market, with prices at a 20-year low because of overcapacity. This overcapacity amounted to 200 million metric tons last year worldwide and 40 million metric tons in the European Union (EU) alone. "The problem is that the capacity of the steel industry is fairly inflexible," said Alan Wilkes, an adviser at U.K. steel industry consultancy Hatch Beddowes. "It takes so much investment that owners are forced to keep production rates high to keep steel costs down per ton." As a result, inventories of unsold finished product grew to 11% of total production in 2000 for the country's 23 steel makers. This year, overcapacity has continued and steel mills have responded with an average cut in production of 2% a month leading to falling profits.

Global demand for steel

The industry has also been slow to change steel production in line with global demand, which has seen growth in flat products - used in cars and white goods such as refrigerators - that provide the highest profit margins for steel makers. Too much of Poland's production is still geared toward long products such as rails and construction beams - a highly price-competitive sector with low profit margins. "Over 58% of production is long products," said Karol Lipowczan, vice chairman of the Metallurgical Chamber of Industry and Commerce (HIPH). "The appropriate production structure would include more than 50% flat products, since this would match current demand and their market price makes their production more profitable." This production structure fails to address domestic demand and has resulted in growing steel imports from Germany, Slovakia, the Czech Republic and Ukraine, which represented 35% of total sales last year and is expected to increase to 40% this year. Poland's steel industry is therefore in the paradoxical position of maintaining overproduction while having to satisfy a growing proportion of its demand through imports.

But the country's steel mills are starved of the capital needed to adapt to more profitable production of cold-rolled flat steel items. Domestic banks, which have financed modernization projects such as a new rolling mill for Huta Baildon in 1999, have changed tack since being privatized. Under the influence of their foreign investors, they have imposed tougher lending criteria for investment loans and harsher terms when dealing with overdue debt. HK's bankers, a consortium of Bank Handlowy, Bank Przemysłowo Handlowy, Powszechny Bank Kredytowy (PBK), Kredyt Bank and Bank Pekao, have frozen its accounts three times this year, leading to deteriorating relations with its energy suppliers and state telephone company Telekomunikacja Polska (TPSA). "The normal process is that when we don't see good prospects, we reduce the credit limits for this sector," said Arkadiusz Śliwiński, deputy director of the treasury department at PBK. "When we block or reduce these limits, we ask (steel producers) to pay back part of their outstanding loans."

The reluctance of banks to finance the steel industry's short-term debt has caused growing friction between steel makers and their contractors, which have not been paid. The power sector has responded with electricity cuts and supply limits. In August, HK was told its electricity supply would be cut if its 2000 zł. 125 million ($30 million) debt to local generator Bździński Zakład Elektroenergetyczny was not paid. Meanwhile, Kraków's Huta Tadeusza Sendzimira (HTS) had similar problems with Zakład Energetyczny Kraków, which reduced the power supply in July when the mill failed to pay its electricity bill. To add to the pressure, government figures indicate that the steel industry's debt to PKP exceeded zł. 500 million ($122 million).

This year the industry's total debt grew by zł. 200 million ($48.7 million) in the third quarter alone, totaling zł. 9.5 billion ($2.3 billion), according to the HIPH. A major problem is that 84% of this debt is short term, so debt repayments starve mills of capital during periods of sluggish demand. After this year's decelerating economic growth, the HIPH forecasts year-end losses for the industry of zł. 1.3 billion-1.4 billion ($317 million-$341 million), compared to zł. 937.9 million ($227 million) in 2000.

Buzek's rescue plan

The former Solidarity Election Action-led government attempted to remedy the problem with its revised restructuring program for the iron and steel industry. Spearheaded by former Deputy Economy Minister Edward Nowak, it was signed by President Aleksander Kwaśniewski in September.

The plan hinges on the creation of a steel conglomerate, Polskie Huty Stali (PHS), by merging HK and HTS with two smaller Silesian mills, Huta Florian (HF) of Świźtochłowice and Huta Cedler of Sosnowiec. According to the program, the resulting conglomerate will have assets of zł. 4 billion ($975 million) and produce 7.5 million metric tons of steel a year, with annual sales of zł. 8 billion ($1.9 billion). The production structure of the conglomerate should meet global demand, with plans to increase output of flat products for domestic sale and export by 2005. The program aims to increase productivity at the new conglomerate to 400 metric tons of steel per employee per year with a total workforce of 12,000. To achieve this, 81,000 steel workers will be sacked by 2003, costing the government zł. 80 million ($19.5 million).

But according to Andrew Kotas, a former privatization consultant to the government and chief executive officer of steel industry news Web site steelonthenet.com, the plan to merge HST and HK has become less attractive in the past three years. Kotas said the idea for the merger has been around since the early 1990s when HK's surplus steel-making capacity made it a perfect match for HST, which produced more expensive steel, but had better technology for producing flat products.

"Three years ago, HST invested in a new continuous caster that can put out 2.5 million tons of steel a year," Kotas said. "It has also undertaken a major modernization of its blast furnaces and in coke making. The business case for the merger is much weaker because in terms of production of steel, HST is now self-sufficient."

HK's debts have also made the management of HST, which has itself debts of around zł. 1.4 billion ($341 million), skeptical about the merger. Wioletta Kałużny, spokeswoman at HST, said the firm favors a smaller merger with HF. "This would be logical since Huta Florian processes the products we make and their financial condition is similar to ours," Kałużny said.

The revised program also aims to restructure the industry's debt to the state, which this year exceeded zł. 1.2 billion ($285 million), by suspending repayments and interest until 2005. After this, steel mills will have five years to clear their debts in installments. But there is concern that these measures fail to measure up to the current scale of the industry's debt.

"We have taken this as a step in the right direction, but with the current state of the industry we are concerned that this level of support will not be enough," said HIPH's Lipowczan. "If such solutions had been proposed in the middle of the 1990s, then they would have been comparable to the restructuring needs of the industry."

But the steel industry is also worried by the delay in implementing the program, mainly caused by Poland's recent political uncertainties. "We are concerned that the change of government will mean that we will have to wait even longer for the enabling acts," Lipowczan said. The new government, led by Prime Minister Leszek Miller, has still not said how it will address the restructuring program.

The main difficulty for the new administration will be choosing between restructuring PHS and selling the group to one of two parties: Indian steel giant Ispat or a consortium of European steel makers - Luxembourg's Arbed, Salzgitter and ThyssenKrupp Stahl of Germany and France's Usinor. Both are interested in taking over, restructuring and developing PHS. But according to the Economy Ministry, a new deputy minister in charge of restructuring the steel industry has not been appointed and no information is available on the government's steel strategy. Treasury Minister Wiesław Kaczmarek was not available for comment as the Business Journal went to press.

For HK's Capiga, the restructuring program must be introduced, regardless of whether the government chooses to privatize the steel mills later rather than sooner. "The worst thing to do would be to simply ruminate over the proposals that have appeared recently," Capiga said. "The best course of action would be to begin by introducing the restructuring program for the iron and steel industry."

While the revised program addresses the problems of the largest steel mills, which account for more than 70% of all national production, there is concern that it neglects the country's nine privatized mills. The program states that the consolidation of private and partly state-owned steel mills should be undertaken by their owners which, according to Kotas, overlooks the key problem of ownership in the industry.

"What (the mills) need are strong strategic investors from abroad who can add either finance, strong technical expertise or access to global distribution networks," Kotas said.

Greg Goodale