Operating margins of steelmakers to fall from 23% to 18% this year: ICRA2 min read . Updated: 18 Sep 2019, 03:52 PM IST
- The demand environment is expected to improve somewhat in the second half of FY2020
- India’s steel imports shrunk 6% in the first four months of this fiscal
Mumbai: Growth in domestic steel consumption is expected to slow down to 5-6% in FY2020 from 7.9% in FY2019, according to credit ratings agency ICRA. The agency has attributed the fall in demand growth to an unprecedented slowdown in economic activity, with GDP growth tapering down to 5% in the first quarter of the current fiscal.
ICRA said there will be significant pressure on profit margins of steel companies in the September quarter due to a sharp fall in steel prices and firm raw material costs. The demand environment is expected to improve somewhat in the second half of FY2020 following a likely pick-up in spending on infrastructure.
Dragged down by significant correction in steel prices, the operating profit margin of an ICRA sample of steel companies, accounting for around 60% of the domestic installed capacity, declined around 450 basis points year-on-year in the first quarter of the current fiscal. Given the challenging operating environment prevailing at present, ICRA estimates the industry’s operating margin to decline to around 18% in FY2020 compared with 23% in the previous fiscal.
Jayanta Roy, senior vice-president and group head – Corporate Ratings, ICRA, said in a note: “Our analysis of prevailing trends of 22 companies comprising 60% of industry size indicates that reduced demand and steel prices amidst firm raw material costs have restricted the revenues and operating margins of the industry in Q1FY2020. A likely pick-up in infra spending in the second half and softer coking coal prices could benefit steelmakers for the remainder of the year."
In line with the deterioration in profitability, the industry’s debt protection metrics have also weakened. The interest coverage ratio for the ICRA sample declined to around 3 times in the first quarter of FY2020, down from the intermediate peak of 3.5 times recorded in Q2 FY2019. With steel spreads steadily gravitating lower, the industry’s total debt to OPBITDA is poised to deteriorate to around 4.5 times in FY20 as against 3.5 times in FY2019.
The bulk of the domestic steel industry’s ongoing capacity expansion projects are being undertaken by the larger integrated steel players who have the benefit of a stronger balance sheet. In FY2019, the industry operated at a capacity utilisation rate of around 84%. With fresh capacity addition of only around 3 million tonne per annum being planned in the current fiscal, the industry’s capacity utilisation rates are expected to remain at a healthy level of 85% in the current year as well, notwithstanding a slower demand growth.
“Demand worries will continue to keep steel prices under pressure, which are at present trading at a discount to imported offers. Domestic HRC prices have dropped 13% since March 2019, whereas domestic rebar prices have dropped 14% in the same period. In FY2020, domestic iron ore prices are expected to remain range-bound and there is a possibility of an ore supply deficit in the next fiscal, if mine auctions are delayed. On the other hand, blast furnace players would benefit in H2 from a steep correction in coking coal prices in recent months," added Roy.
India’s steel imports shrunk 6% in the first four months of this fiscal. A steeper 23% fall in steel exports and unrelenting imports from free trade agreement (FTA) countries including Japan and Korea, are likely to keep India a net importer of steel in the near term. However, the quantum might stay low as domestic steel is currently trading at a significant 16% discount to landed cost of Chinese imports (of hot rolled coil) and at an 8% discount to landed cost of Japanese imports.