Steel companies’ share prices, under pressure in the recent past on worries related to demand and falling prices, rebounded on Thursday.
Those of JSW Steel and Tata Steel, which had fallen 16-26 per cent from their September highs, gained up to 3 per cent. Jindal Steel (JSPL) which had seen a 52-week low on Wednesday, gained about 2 per cent.
The Street’s concern was due to global demand slowing on the back of an escalating trade war and declining prices in both China (the top global consumer) and international markets. However, experts feel these concerns were overdone. With strong demand momentum, they are not so worried on the medium-term prospects of steel makers.
Kaustubh Chaubal, vice-president at credit rating agency Moody's, says in India in particular, consolidation in the sector and solid product demand will support the profitability of Tata and JSW Steel. These observations should allay some concerns related to aggressive stressed asset acquisitions and expansions by Indian steel makers at the cost of higher debt.
Indian manufacturers are currently on a strong wicket, given robust demand and higher realisations in the domestic market. With a favourable cycle on their side, they have been in the past few years spending on expansion and acquisition. Tata Steel, in addition to its ongoing expansion at Kalinganagar (Odisha), recently acquired the assets of insolvency-hit Bhushan Steel and Monnet Ispat. JSW Steel, apart from expansions at its own plants at Dolvi (Maharashtra) and Vijaynagar (Karnataka) has been making acquisitions both in India and outside. Steel Authority of India (SAIL) and JSPL, which have completed their expansions, are looking at reducing their debt, aided by better cash flows.
On leverage, analysts expect Tata Steel’s ratio of net debt to operating earnings at 3.4. JSW Steel’s is expected to be 3.3, assuming it acquires Bhushan Power. SAIL’s metric on this front is higher at 4.9.
Given these numbers, the Street was nervous about the ability of companies
to maintain their profitability. Indian producers have over two years seen significant rises in realisation, with the support provided by government measures to restrict cheaper import and from strong local demand. Some analysts say domestic steel profitability is at a decadal peak.
Concern on realisations and rising raw material costs are higher for non-integrated entities. Reports suggest domestic prices are at a premium to import parity ones. This could cap the upside for steel prices despite robust demand, while increasing the risks that import which is cheaper will increase.
The falling Chinese domestic steel spread, indicating pressure on prices and therefore oversupply there, have added to the worries. Analysts say concerns remain on higher export from China, more so as winter production cuts have not been as severe till now. While winter pollution control measures last year had led to blanket cuts in production, this year's cuts are being applied city by city, say analysts at CIMB. On the positive side, while spreads in China might have come down, the costs remains inflated, say analysts. This, they feel, will control further erosion in steel prices. While share valuations are expected to remain depressed until trade tensions ebb, we see Indian stocks trading at a premium to the world’s average, say analysts at Edelweiss Research.
The concerns on China demand should also ease a bit, looking at Moody’s observations. The latter says escalation of the Sino-US trade dispute will have a limited effect on Asian steel demand,. This demand in 2019 is likely to be similar to that in 2018 and China's capacity cuts will tighten supply.
Some days earlier, Edelweiss had said that despite unfavorable macro indicators, the ferrous sector continued to surprise positively. One reason was relatively better demand indicators for long steel products, along with China’s restrained export despite weakness in hot-rolled coil prices, and firm domestic spreads in India.
Tata Steel remains the top stock pick, given its integrated operations, planned debt reduction and progress on the European joint venture. JSW Steel has significant earnings growth opportunities as well. JSPL and SAIL are seen a s likely to report better performance, led by stabilising expansion.