We believe the margin outlook for Indian steel companies has weakened in recent months, notwithstanding the improvement in operating profitability reported by large steel companies since the lows of the fourth quarter of the financial year 2008-09. The improvement in operating profitability over the last eight quarters was aided by the gradual recovery in global steel demand brought about by the stimulus packages announced by various countries in the aftermath of the global financial crisis in 2008.
However, in the current calendar year, global demand conditions have deteriorated, with growth prospects appearing uncertain in developed countries. Even China, the largest steel consuming nation in the world, presents the possibility of a slowdown in steel demand, following its government’s attempts to prevent overheating of the Chinese economy.
Growth in steel consumption in India has slowed significantly to around 2.5% in the first six months of the current financial year from around 14.5% in the corresponding period last year, with project offtake slowing and other macroeconomic challenges. Nevertheless, large steel capacity expansion projects are likely to get commissioned in the short to medium term.
In Icra Ltd’s estimates, almost 25 million tonnes of new capacity, which is about 30% the country’s current production capacity, is expected to be commissioned in the next 18-24 months, which in turn could alter the domestic demand-supply position, keeping realizations under check, notwithstanding any benefit that may accrue to steel companies from a depreciating currency.
Improvement in the conditions of steel industry after the fourth quarter of 2008-09 led to a rise in the prices of key raw materials, with international prices of both iron ore and coking coal recovering significantly after 2009. The raw material industries being highly concentrated and with bottlenecks for incremental supply persisting, raw material prices are likely to stay buoyant in the short to medium term. High raw material prices would dent the profitability of steelmakers, especially in a weak demand-supply scenario which is likely to constrain the ability of producers to pass on cost increases. The higher capital charges arising out of expansion projects being commissioned would also add to the pressures on the net margin of the steelmakers concerned, especially in a scenario of high interest rates.
On the other hand, higher working capital requirements to operate expanded capacities, especially in a rising raw material price scenario along with the contractual obligation to service project debt are expected to exert some pressure on the liquidity profile of such companies.
Edited excerpts from a report by Icra. Send your comments at firstname.lastname@example.org.
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