Rising steel prices could add heft to Tata Steel’s profits, but they must sustain
Investors must watch for sustainability in steel prices. While the cyclical uptick in demand has been good, production disruption during lockdown has meant that channel inventories have slipped.
Things are falling in place for Tata Steel Ltd. With both production normalizing and demand continuing on the upswing, the steel sector is now on a better footing than before. The street expects Tata Steel to post better operating profits in Q3 over Q2. The Tata Steel stock is trading close to its 52 week-high with gains of 38% till date in November.
An improvement in the company’s troubled European operations is also on the cards. Steel spreads could improve to record levels in Europe because of lower inventory levels and rising steel prices. Tata Steel’s European sales volumes are expected to clock gains as overall European production rebounded strongly with a 9% month-on-month gain in October.
European capacity utilization of 65% are at the highest levels and realizations are at two-year highs since February, according to a Credit Suisse report.
European operations posted losses at the operating level of ₹462 crore in September, which was lower than the ₹626 crore loss in Q1. This shows that better realizations and demand can improve forward prospects of European operations.
Morgan Stanley in its note recently said that “Europe is witnessing price hikes in carbon steel, leading to material improvement in spreads, which if it continues will lead to earnings upgrades for companies including Tata Steel," Morgan Stanley recently said in a research report.
An asset sale of Tata Steel’s Ijmuiden, Netherlands, facility is expected to fetch about $2-2.5 billion as per analysts’ estimates. That could ease net debt levels in the coming quarters.
Global steel prices also remain buoyant. China’s domestic hot-rolled coil prices increased by $40 per tonne in the past month to $630 in end-October. Domestic prices have also increased by about ₹3,700 per tonne in the past month.
On the other hand, prices of raw material such as coking coal have been soft. Rising iron ore prices are not likely to dent Tata Steel’s profitability because of the company’s captive iron ore mines. “A sharp increase in realisation, muted coking coal costs, and self-sufficiency in iron ore is likely to boost gross margins further for all steel majors in Q3," said JM Financial Institutional Equities in a client note.
Still, investors must watch for sustainability in steel prices. The cyclical increase in demand has been good, but production disruption during the lockdown has meant that channel inventories have slipped. This is one reason that steel prices are rising. A rise in inventories could see global steel prices take a breather.
Further, the global economy remains weak. Hence, any slowdown poses a risk to steel prices. Tata Steel’s one-year forward price-earnings multiple for FY22 is at about 9 times earnings, according to Bloomberg consensus estimates.
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