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After two back-to-back years of robust growth, steel companies are staring at a significant decline in earnings over the next 12 months as the industry faces multiple headwinds from export duty on finished steel, unprecedented coal and energy cost pressures, and muted domestic demand, Icra said on Thursday. The rating agency has revised the sector’s outlook to stable from positive.

According to the agency’s latest note on the steel sector, the industry could be on the way to an accelerated mean reversion as the operating environment becomes far less attractive in the coming months.

Such challenges would be accentuated by high inflation and front-loading of policy rate hikes. Consequently, in Icra’s base case scenario, while the domestic steel demand growth forecast for FY2023 was kept unchanged at a healthy 7-8%, the domestic steel industry’s overall operating profits for the current fiscal is revised downwards by around 30% compared to the previous estimate made before the Russia-Ukraine conflict, as margins get squeezed between lower steel prices and elevated input costs.

Jayanta Roy, senior vice-president & group head, corporate sector ratings, Icra said, “The steady rise in coking coal costs had started to nibble at the margins of steelmakers even before the export duty was announced. Therefore, we have seen that the consolidated operating profits per metric tonne for the four leading domestic steelmakers coming-off by around US$ 110/MT in Q4 FY2022 compared to the high-watermark of US$ 326/MT recorded in Q1 FY2022."

"With domestic hot-rolled coil prices correcting by around 9% since the imposition of the export duty, and with coking coal consumption costs poised to spike by around 30-35% quarter-on-quarter, notwithstanding the correction in domestic iron ore prices, the industry’s operating profits are expected to sequentially decline by US$ 80-90/MT in Q1 FY2023. While the margin pressure is likely to persist in the seasonally weak second quarter when steel prices would remain under pressure, the correction in coking coal spot prices by ~27% in the last three weeks augers well for steelmakers’ second half margins when demand conditions improve," he added

As steel is a globally traded commodity, in periods of weak domestic demand and/or more remunerative seaborne prices, large steel mills have demonstrated the flexibility to allocate a greater share of the production towards exports, which has supported capacity utilization levels and overall earnings in FY2021 following the pandemic outbreak.

The government’s recent announcement of 15% export duty on various finished steel products covers over 95% of India’s finished steel exports, and therefore makes exports a much less attractive proposition now as mills evaluate the economics of a higher duty.

Consequently, India’s finished steel exports are expected to decrease by 25% Y-o-Y in FY2023, with the decline likely to be more pronounced in highly competitive markets like South-East Asia and the Middle East compared to Europe, where export offers typically are higher. However, with semis being kept out of the ambit of duties, export of semis is likely to witness a significant increase of 40% Y-o-Y in the current fiscal as other finished steel categories wage the impact of a large export duty, Icra said.

Steelmakers are also exploring the possibility of switching to export of value-added/ alloy steel categories which are out of the ambit of duties. On the import front, with competition heating up in the domestic market, and domestic hot rolled coil prices trading at a discount of around US$ 110-120/MT over the landed cost of Chinese export offers, domestic mills would target to partly substitute the import of commoditized steel grades, and this is expected to lead to India’s overall finished steel imports contracting by around 10% Y-o-Y in FY2023.

India’s domestic steel demand, after reaching an average run-rate of 9.7 million tonne (mt) per month in Q4 FY2022, has sequentially slowed down somewhat in the current quarter, when it recorded a lower average run-rate of 9.3 mt/month during April-May 2022. While demand has remained weaker than expected at the start of year, a pick-up in infrastructure spending in core sectors like railways, roadways, multimodal logistics parks, and energy has the potential to spur demand for steel in the second half of the fiscal, especially with the significant fall in domestic steel prices.

Following the steel upcycle, steel mills have announced large-scale expansion plans which would lead to India’s steel capacity increasing by 40 million tonne per annum (mtpa) in the next five years (FY2022 – FY2026), which is almost double the quantum of capacity added during the previous five-year period spanning from FY2017 – FY2021. However, notwithstanding these sizeable expansion plans and a moderation in industry earnings going forward, given the deleveraging that has happened, the steel industry today is more resilient to withstand project related risks, which had significantly weakened the sectors’ credit profile during the previous capex cycle of FY2012-FY2016.

“With the capital deployment for these upcoming projects remaining relatively modest during the initial years of implementation, the industry’s key leverage ratio of Total debt/ OPBITDA is expected to remain at a comfortable 1.5 time in FY2023, weakening from the decadal low of around 1 time recorded in FY2022, but remaining at a significantly lower level than 2.9 times witnessed in FY2019 during the pre-pandemic period," added Roy.

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