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Steel stocks betting on demand revival?

Steel stocks betting on demand revival?
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First Published: Wed, Nov 03 2010. 10 00 PM IST

Updated: Wed, Nov 03 2010. 10 00 PM IST
Steel stocks have been under pressure in the past month. Shares of Steel Authority of India Ltd (SAIL) and Tata Steel Ltd have declined by 15% and 10%, respectively from their highs in early October. During this time, the broad markets have moved in a narrow band, with the Nifty hovering between the 6,000- and the 6,200-mark. Shares of JSW Steel Ltd, too, at one point had corrected by as much as 12% from its highs in early October. But they recouped most of those losses after its results announcement, thanks to a higher-than-expected volume growth outlook. The company’s shares are now just 4% lower than the October highs.
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Part of the problem is the softness in international steel prices, despite the fact that China, the world’s biggest manufacturer, has dropped production to meet energy efficiency targets. China’s production fell by 7% month-on-month in September. But the larger problem is that raw material suppliers haven’t relented despite the relative softness in steel prices. As a result, margins of steelmanufacturers have been under pressure, as is evident from the September quarter results of steel companies across the globe. As an analyst with a foreign brokerage puts it, raw material suppliers have enjoyed a larger portion of profits in the value chain this year, while steel makers’ profit margins have compressed. Steel companies haven’t been able to pass on the input costs, reflecting the subdued demand situation.
Indian steel makers cut prices by 2-3% on 1 November, but that’s partly because of the appreciation in the currency and the cut was expected. According to the analyst mentioned above, even in October, Indian manufacturers were offering discounts to offset the impact of the appreciating currency. But the important thing is that at current steel prices and based on high input prices, margins of steel manufacturers are lower than what the Street has been anticipating. Both SAIL and JSW Steel reported a lower-than-expected Ebitda (earnings before interest, taxes, depreciation and amortization; a measure of profit)/tonne in the range of $120-130 (Rs 5,328-5,772).
The trend is likely to change only if demand picks up substantially from current levels in the global market. Another factor investors would need to watch out for is the premium Indian manufacturers have enjoyed over global steel prices, because the country has been a net importer of steel. But net imports have reduced substantially in recent months, and according to one estimate, domestic steel capacity is expected to increase by close to 40% in the next year-and-a-half. The increased capacity would further reduce the need for imports, and as a result, the price premium can be expected to reduce. Not all of this weakness is reflected in steel stocks, and an investment at current levels would be akin to a bet on a revival in demand early next year.
Graphic by Yogesh Kumar/Mint
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First Published: Wed, Nov 03 2010. 10 00 PM IST