Tata Steel’s outlook pinned on China’s appetite for steel
China has cut steel production and its steel consumption is increasing—a situation that will drive prices higher, and eventually benefits Tata Steel
The villain is now playing the hero’s role. A few years ago, global steel majors railed against China’s steel industry for its excess production, which flooded their markets. A wave of protectionist measures followed to keep Chinese steel out, including in India. Since then, steel prices have risen but they weakened in the past few quarters.
Tata Steel Ltd’s management pointed out that steel prices have increased again, chiefly due to China. In the June quarter, domestic demand was dull and realizations declined sequentially. But an increase in global steel prices can change that. China has cut steel output and even better, its steel consumption is increasing. That’s a situation that will drive prices higher. On Monday, Chinese rebar steel futures rose by 7% to their highest level in four years, according to Reuters, sparking a similar jump in iron ore prices.
Tata Steel’s management said that international steel prices had risen by $80-100 per tonne in the past 4-5 weeks. India’s steel production has risen sharply because of capacity expansion. Tata Steel’s production was up by 32% in the June quarter, over a year ago, according to government data. The country’s steel output rose by 6.7% but consumption rose by only 4.6%. The rest has to be exported but becomes less profitable as prices have fallen.
That’s why Tata Steel’s consolidated revenue declined by 15.7%, with average realizations per tonne declining by 1.6%. The drop was mainly due to steel deliveries declining with a slight fall in realizations. But Ebitda declined by 32.4%, much more than sales did, because material costs declined by only 11.1%. Ebitda is short for earnings before interest, tax, depreciation and amortization, an indicator of operating profitability.
In Tata Steel’s case, in India, higher iron ore prices don’t matter because it has captive sources, but it imports about 70% of its coking coal requirement.
A spike in coking coal prices was the main reason for the jump in costs. The net result was a 21% decline in Ebitda per tonne in India. In Europe, the company benefited from higher realizations but even here, Ebitda declined due to higher input costs.
The increase in steel prices has to sustain so that Tata Steel (and other steel companies too) find it viable to export steel, which will reduce the domestic surplus and support prices. Its European operations too will benefit from better realisations. Conversely, if steel prices reverse then it could mean tougher times ahead. A lot depends on whether China continues to support global steel prices by producing less steel and consuming more of it.
Tata Steel said it’s close to reaching an agreement on its UK pension plan. If that happens and it also helps in the long-pending restructuring of its European business, that could be a swing factor for valuations. The goods and services tax rollout too has affected its India performance and a post-GST recovery can also help performance.
Its shares are up by more than a third since early-May. The 29% sequential decline in its Ebitda and the 47% decline in its profit before tax and exceptional items suggest caution although its year ago growth numbers looks good. If steel prices sustain the uptrend, the coming quarters should see much better numbers both in India and in its overseas operations.
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