As home demand for steel dulls, firms turn to exports to liquidate inventory

  • Growth in steel demand slumped to 1.7% in August, the slowest expansion in at least a year
  • The deceleration reflects the dual impact of the seasonal slowdown in construction due to the monsoon and weakness in end-user industries, notably automobiles and capital goods

Growth in steel demand slumped to 1.7% in August, the slowest expansion in at least a year, shows provisional data from the Joint Plant Committee, compiled by SBICAP Securities Ltd. In the 12 months, demand rose in the range of 4-13%.

The deceleration reflects the dual impact of the seasonal slowdown in construction due to the monsoon and weakness in end-user industries, notably automobiles and capital goods.

With production not seeing commensurate cuts, inventories piled up. To liquidate these, producers stepped up exports, which grew 37% last month. “Exports have soared on weak domestic demand and higher inventories with producers. Due to this, India turned a net exporter in August 2019 (on a monthly basis) for the first time after February 2019," analysts at SBICAP Securities said in a note.

The reprieve will, however, be restricted. Realizations from exports are generally lower than the sales in the home market. Importantly, prices in global markets continue to soften. Chinese hot-rolled coil (HRC) prices declined by $20 per tonne sequentially in August, according to SBICAP Securities.

The situation is no better in the country. Domestic HRC prices are at a 37-month low, point out analysts at Edelweiss Securities Ltd.

“Weakness in domestic consumption is the likely driving factor of subdued HRC prices. For the first time in the past five years, domestic HRC prices have slid relentlessly despite a more than 10% discount to the landed price of Chinese imports over the last seven weeks," they said in a note.

The low prices will crimp the margins of domestic steel producers. Based on the current spot steel and raw material prices, SBICAP Securities estimates the spreads of Indian steel producers—the gap between prices and raw material rates—to fall by around 2,000 a tonne sequentially in the current quarter (Q2 FY20).

The Street is mindful of the financial impact, reflected in changes in earnings estimates. “We trim our estimates to address a weak Q2 and bake in a gradual recovery in spreads from Q3, capturing a sharper drop in raw-material prices," Investec Capital Services (India) Ltd said in a note.

But inventories can be a challenge if the expected recovery in demand does not materialize, post-monsoon. Some analysts fear companies will liquidate inventories at lower prices. This can suppress earnings for a longer period, potentially weighing on the scrips.

“We expect profitability of steel companies to take a hit in the following quarters owing to (inventory) de-stocking and low spreads. Our FY20/FY21 estimated Ebitda is at a discount to the consensus, and we expect the Street to revise down estimates," analysts at Edelweiss Securities said in the note. Ebitda is earnings before interest, tax, depreciation and amortization.

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