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JSW Steel’s margins trip on iron ore

The company finds itself in a tight spot and needs access to higher quality iron ore at cheaper prices
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First Published: Mon, Jan 28 2013. 07 37 PM IST
A file photo of the JSW Steel plant in Vijayanagar, Karnataka. Cost of goods sold as a percentage of sales rose by 70 basis points sequentially, which caused margins to fall. Photo: Aniruddha Chowdhury/Mint
A file photo of the JSW Steel plant in Vijayanagar, Karnataka. Cost of goods sold as a percentage of sales rose by 70 basis points sequentially, which caused margins to fall. Photo: Aniruddha Chowdhury/Mint
Updated: Mon, Jan 28 2013. 10 36 PM IST
JSW Steel Ltd’s December quarter earnings reflect the difficulties it faced—dull steel demand, soft trends in steel prices and non-availability of quality iron ore. Still, the company managed to sell 2.17 million tonnes of steel during the quarter, similar to what it sold in the preceding quarter. However, its sales declined by 6.3% to Rs.8,275 crore, explained by a decline in average price realizations. This was expected.
But what was surprising was the deterioration in its margins as analysts had expected them to remain stable. However, the company reported a sharp 1.4 percentage point sequential drop in operating profit margin. Apart from falling realizations, low productivity due to non-availability of iron ore appears to have affected its cost effectiveness.
Soft trends in coking coal prices should have benefited JSW Steel. However, cost of goods sold as a percentage of sales actually rose by 70 basis points sequentially. That caused margins to fall, despite the company controlling other operating costs. Interest costs have also increased, partly due to the drawdown of debt to fund its projects.
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JSW Steel finds itself in a tight spot. It can produce more steel and improve its utilization, but to be profitable at the current price levels, it also needs access to higher quality iron ore and at cheaper prices. At present, it says there is low-quality iron ore available for high prices. This is because of the ban on mining, and sale of existing ore stocks through the e-auction route in Karnataka.
Relief on this front will become available only when the next category of mines in Karnataka gets the Supreme Court’s permission to resume mining, and after getting the necessary state government approvals. That may take some time.
The only visible way out, at least in the near term, is for steel prices to perk up. This depends on both domestic and international factors. Local demand continues to be low and in the December quarter, domestic demand rose by just 0.9%. An optimistic view is that after the central bank cuts interest rates, demand for real estate and steel-intensive sectors such as automobiles will improve. Government spending on infrastructure is expected to improve. And as a corollary, overall steel demand will improve. Even if this transpires, it will take time for the effect to be felt by domestic steel makers.
A quicker fix could come from the international scene, where Europe’s steel market continues to be in the dumps, but China has been giving hope that the worst is over. December saw a continued increase in steel output, a sign that domestic demand is indeed reviving. If that continues for a few more months, excluding February when demand slows due to the New Year, then it can provide support to steel prices. A more stable demand situation in the European Union would help, as well.
This is the macro-situation in which JSW Steel is operating and it does not look pretty. But the company continues to take a longer-term view as it continues to support its capital projects. These will increase capacity and the share of higher margin steel products to the total.
JSW Steel’s profit before tax and exceptional items declined by 40.1% on a sequential basis, as higher costs and lower other income came on top of a fall in profitability. Still, its shares held steady on Monday, after its earnings were announced. Investors may be thinking it can’t get any worse from here on, and even if the situation on the ground takes time to improve, a revival in business sentiment may be around the corner.
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First Published: Mon, Jan 28 2013. 07 37 PM IST
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