Steel sector update

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Weak global demand softens steel
Jitendra Kumar Gupta / Mumbai June 04, 2010, 0:45 IST

An economic revival and a pick-up in demand helped steel companies to report better results, in addition to significant improvement in the operating margins for the quarter as well as the year ended March.

Although things had been better compared to last year, steel prices have fallen by about 15 per cent recently, due to concerns over global demand and China’s calibrated economic slowdown and monetary tightening, with pressure on the raw material front.

Thus, global steel supplies, earlier estimated at par with consumption at 1,229 million tonnes (mt), could see some surplus this year, as well as in 2011. This, in turn, could lead to further easing of steel prices. Not surprisingly, the stocks of metal companies, especially steel producers, have been under pressure. The BSE Metal index is down over 13 per cent in the past month as compared to the Sensex’s 0.4 per cent decline.

Changing dynamics
Steel Authority of India (SAIL) has already cut its product prices by Rs 1,000-1,500 a tonne in the past few days. In the coming month, demand from the real estate and construction sector, which usually slows during monsoon, could put additional pressure on domestic prices.

“We are expecting another correction of Rs 1,000 a tonne,” says Eric Martins, who tracks the metal sector at Systematix Research. On the other hand, while raw material prices are also coming down (iron ore prices are $120 a tonne currently, from $140 in April; coking coal prices are down to about $220 a tonne from from $250), the decline is lower than the fall in steel prices. Thus, expect some pressure on margins.

Among the few positives, analysts believe that, unlike other global markets, India does not have any problem relating to demand in the medium to long term, which is expected to grow at 10-12 per cent in 2010-11. This will be led by demand from the construction, automobile and consumer goods sectors and rebound in the industrial capex cycle.

This should benefit domestic steel producers.

JSW Steel
JSW Steel, which generates 84 per cent of its revenue from India, will be among the key beneficiaries of a healthy domestic steel demand. “India is a steel-deficit market and companies like JSW Steel, which will increase capacity by another 40 per cent by March 2011 to 11 million tonnes per annum, should benefit,” says Martins.

The company currently procures 80 per cent of iron ore and 100 per cent of its coking coal needs from the market. While it could see some pressure on margins, it will benefit on account of partial integration, in terms of iron ore and coking coal supply, aided by the acquisition of mines over the next two years.

At Rs 1,070, the stock is trading at eight times its 2011-12 estimated earnings.

SAIL
SAIL, largely a domestic play, will benefit on account of the better outlook for steel demand in India. Except for coal (almost 70 per cent of its requirements are imported), SAIL is fully integrated in terms of iron ore requirements. Additionally, analysts expect volumes to rise visibly, as the company is increasing its saleable steel capacity from 13 mt per annum to 20.23 mt per annum in the next two years.

Analysts also expect a 20-22 per cent annual growth in SAIL’s earnings over the next two years. The stock is trading at eight times its 2011-12 estimated earnings.

Tata Steel
With the outlook for the domestic market looking good, analysts prefer such companies as SAIL and JSW Steel, which have a larger India presence. Tata Steel, which generates almost 60 per cent of its sales volume from European markets, could remain under pressure.

“We advise investors to switch to SAIL from Tata Steel, considering the uncertain headwinds with regard to the euro and rupee appreciation versus the pound (an eight per cent impact in the first three months of 2010-11) for Tata Steel. Second, lack of volume visibility for Corus, inability to protect margins and increasingly higher working capital requirement for Corus will continue to mar the profitable domestic operations,” says Abhijit Mitra, who tracks metal companies at ICICI Securities. Wait for clear signs of a pick-up in growth in the euro zone.


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