The Global Purchasing Managers’ Index (PMI), after bottoming in September at 52.5, has shown a sharp move to 55 by December. The pick-up is led by the US this time round; US manufacturing new orders index has picked up from 55 in September to 78 in December.
Overall, in the current phase, the developed world is outperforming the emerging world. The UK’s PMI has touched a 16-year high in December—we expect moderation but still the levels will remain elevated. Germany’s indicators are also showing robust signs.
However, southern Europe (Greece, Portugal and Spain) continues to be in a weak state.
Prior to this, the second half of 2010 saw softening in demand as reflected in moderation in PMIs. In line with this, global steel production (annualized) declined from its peak of around 1,500 million tonnes (mt) in May to around 1,400 mt in December. Considering this demand softening, the raw material cost push could not be passed on and steel manufacturers faced margin squeeze. With our view of pick up in demand for 2011, we expect margins to expand from the third quarter of FY11 levels in spite of the continuing cost push.
Pick up in demand
Order backlogs for the US and CIS steel mills have increased from one-two weeks to four-six weeks.
Eurofer, the European Confederation of Iron and Steel Industries, expects European construction steel to pick up modestly by 2.1% in 2011 after three years of contraction; European industrial production is expected to rise 3.4% in 2011.
US construction machinery manufacturers expect growth rate to accelerate to around 13% in 2011 from around 6.5% in 2010. This is an indirect indicator that US construction should accelerate in 2011. The January 2011 monthly report from the US Precision Metalforming Association, which is representative of metal demand in the US, shows 52% of its members surveyed expect an improvement in incoming orders for the next three months. This is up from 44% in December and only 25% in November.
Margins to expand
The second half of 2010 saw softening in demand as reflected in moderation in PMIs. In line with that, global steel production declined 7% from its peak in May.
As a result, the raw material cost push could not be passed on. Considering our view of pick-up in demand for 2011, we expect margins to expand from the third quarter of FY11 levels in spite of the continuing iron ore and coking coal cost push. However, coking situation may moderate extent of margin expansion.
Tata Steel Ltd continues to be our top pick. We are revising up our FY12 hot-rolled coil price assumptions for Europe and India from $660 per tonne and Rs31,818 per tonne (net) earlier to $775 tonne and Rs34,545 per tonne, respectively. We expect FY12 earnings before interest, tax, depreciation and amortization margins for JSW Steel Ltd and Tata Steel Europe to be Rs177 per tonne and $61 per tonne, respectively.
Edited excerpts from a report by Edelweiss Securities Ltd. Your comments are welcome at firstname.lastname@example.org