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India’s steel production in the first quarter fell 53% year-on-year. Photo: Bloomberg
India’s steel production in the first quarter fell 53% year-on-year. Photo: Bloomberg

Lower exports and poor operating leverage weigh on steel companies

  • While production improved in June over May, the overall impact of the lockdown in the first quarter is high
  • Inventory of finished steel remains high even though it is marginally lower than in May

MUMBAI: Steel companies are likely to face a slow-growing export market in the next few months after a sizeable jump in exports in Q1. In addition, the drop in domestic steel production will keep the growth of the sector in check this year.

Pressure on exports is mounting as the global recovery faces a seasonal slowdown. In addition, export prices dipped marginally even as the quality of exports is tilted toward low-margin products. A drop in Chinese demand for steel is expected to weigh on the recovery.

“Avenues to export come under pressure as China steel demand is likely to wane due to seasonal rains/floods, and slowing construction; and as the EU modifies steel safeguard measures to country-specific quarterly quotas as countries exhausted full-year quotas in the first few months," said analysts at JM Financial Institutional Equities in a note to clients.

Besides, domestic steel production in Q1 slipped by as much as 53% year-on-year. This means that operating leverage will get impacted due to huge fixed costs. Analysts say that margins are likely to face a squeeze on lower blended realisations and lower export prices. While lower iron ore prices are a solace, that may not be enough to ease cost pressures.

However, note that steel companies have been improving capacity utilisation levels lately. In June, many steel companies have reported better utilisation levels as compared to May.

Nevertheless, domestic consumption remains a big worry. Some recovery in the rural economy has led to an improvement in demand in June over May, but overall consumption trends remain far behind normal.

“In our view, lacklustre domestic demand is a key concern for steel prices. In the past seven weeks, relatively robust international prices did not have a run-on impact as domestic demand is weak. Furthermore, cost-push is absent in the domestic market as coking coal price has come off and domestic iron ore price is down 30% from three months ago," said analysts at Edelweiss Securities in a note to clients.

That could see steel stocks tapering off in the coming months. After all, the ongoing rebound in steel stocks has been going on for some time now, while earnings growth may not be much.

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