Markets
Why steel stocks have quadrupled in the last year
Summary
Investors are betting that elevated commodity prices will result in a deleveraging cycle that could significantly address the problem of high debt in the sector
There is never a dull moment for steel stocks, or so it seems. After years of playing second fiddle in India’s stock market rallies, the sector is now leading the charge, thanks to the strong global recovery in commodities.
Investors are betting that elevated commodity prices will result in a deleveraging cycle that could significantly address the problem of high debt in the sector. As a result, steel stock prices are scraping the sky.
This has driven the Nifty Metal index up 51.2% so far this year, while the broader market Nifty has risen only 3.7%, bogged down by rising covid-19 cases.
Frontline steel stocks such as Tata Steel Ltd, JSW Steel Ltd and SAIL Ltd have more than quadrupled in the past year. Steel prices are rallying on the back of surging global demand for the metal, which has heightened investor interest in steel producers. Global inventory levels are shrinking as well, note analysts after supply disruptions due to covid-related lockdowns in various countries.
Besides, economic recovery in the US is driving a pick-up in areas such as housing. This will be another driver that may keep steel demand elevated in the near term.
“There are multiple tailwinds for the steel sector. Apart from demand increase in China, steel players are helped by a favourable demand-supply balance in the western steel markets as well. All this has kept steel prices high. But even if the cycle softens, the deleveraging benefits will aid sentiment," said Siddarth Gadekar, metals analyst, Equirus Securities.
So far this year, Chinese hot-rolled steel spot prices have jumped 27% as measured in dollars, as per data from Bloomberg. All this is expected to raise the cash profits of the sector.
Analysts expect that the high net debt seen by the sector over the past decade may shrink to very low levels in the coming year or two, depending on how long the cycle lasts.
“The cycle will correct, but even a 12-quarter cycle length, given the current magnitude, would make the Indian steel sector leverage a thing of the past," said analysts at ICICI Securities Ltd in a note to clients.
Another factor that should keep net debt levels low is that there are no new heavy capital expenditure plans announced by steel companies.
“While companies are actively looking out for acquisitions and organic capex, the rate of capex increase will not be as quick as the increase in spreads, leading to deleveraging. This may create an enhanced window for balance sheets to remain comfortably leveraged for longer," said ICICI Securities in its note.
Tata Steel and SAIL are expected to be the biggest beneficiaries of the steel deleveraging cycle.
Tata Steel’s net debt to earnings before interest, taxes, depreciation, and amortization (Ebitda) is expected to shrink from over 6 times in FY20 to 1.23 times in FY23, and SAIL’s net debt to Ebitda could shrink about 11 times to 0.7 times in FY23, note analysts at ICICI Securities.
Of course, much still depends on how long steel prices sustain at the current elevated levels.
No doubt, India’s steel companies have an advantage of being backward integrated, which gives them a better grip on costs even as iron ore prices remain firm. That does provide some comfort. But any disproportionate decline in steel prices could spoil the party for steel investors.
