In light of recent news on the renegotiation of coking coal contracts, we have reviewed Indian steel stocks’ positioning within the region and believe that a competitive advantage is returning to Indian companies.
Steel prices dipped again in December by around $100/t and should be pushing the depressed margins of 3Q a bit more.
However, JSW Steel and Tata Steel reported that they have renegotiated coking coal contracts with some suppliers down to $175 from an earlier price of $300/t, and this should help them reduce the impact, while SAIL will likely bear the full brunt of it.
The companies were caught by surprise due to the sudden stoppage of orders, from the auto sector in particular.
Most companies are adapting their product mix toward growing sectors, such as infrastructure and rural housing, looking for import substitutes (India has 7mt of gross imports) and new usage trends.
Given recent gas finds in the country, there is emerging demand for API grade plates and HRC for pipeline building, which is being tapped by companies like JSW Steel.
Although inventories at the trader level were low, major Indian steel producers have cut production only marginally and are sitting on 45 days of inventory.
Since December, inventories have started showing a decline but remain high and are putting pressure on domestic prices. The latest production release from JSW Steel indicates production of 320kt for January and sales of 350kt.
Outlook and valuation
After a fall of 85% from the peak, most stocks are trading at the lowest levels on PER, EV/EBITDA and P/BV seen historically.
In fact, leveraged companies like JSW Steel and Tata Steel are now possibly trading at liquidation levels. The institutional holding has declined substantially, and the sector is looking under-owned.
As falling steel prices are putting immense pressure on margins in spite of a reduction in raw material costs, we believe that companies with highly efficient cost structures will be the ones that will remain profitable and that will also be able to push more volume.
Based on these parameters, JSW Steel is our top pick among pure steel companies. Jindal Steel and Power is our top pick among diversified steel plays.
We have downgraded SAIL to NEUTRAL as the stock has run up significantly, while we believe it will continue to face higher coking coal costs for the next two quarters.