Will steel stocks continue to go under the hammer?

The fortunes of the steel industry are directly linked to macroeconomic behaviour. It was therefore a foregone conclusion that with the major economies contending with slowdown, steel makers around the globe would be severely impacted, which was reflected in their September quarter earnings. The BSE-Metal Index is down by 38% over the past one year which is double the fall witnessed by BSE-Sensex (19%) over the same period. Even if one discounts the negative speculation and undue and exaggerated fear that is pulling all stocks down, the steel company stocks have been hit by specific and genuine concerns.

Coal and iron ore are the two main raw materials used for manufacturing steel. Coal India has reduced linkages to the steel industry in the last few years due to sharply rising demand from priority sectors like power. The situation is likely to get worse. As large scale power capacities are expected to get commissioned in the coming years, Coal India's production is unlikely to keep pace with demand. Coking coal has witnessed a slight decrease in prices. However this decline has been offset the depreciating Rupee which has led to increase in spot prices. Currently India imports about 60% of its coking coal requirements. Big steel companies like Steel Authority of India Limited (SAIL) and JSW Steel will be hurt the most as a large part of their coking coal requirement is met through imports.

The sector has also been plagued with various scams. The illegal mining of iron ore in Karnataka and Goa has led to halting of production and export ban in Karnataka. Also increased focus of government agencies in enforcing mining and transportation regulations to curb illegal mining. This has led to decline in production of iron ore and disrupted supply leading to shortage of iron ore for steel production.

The slowdown in demand from Western countries and China (which accounts for 40% of world steel consumption) threatens to take the steel industry back to 2008 levels. China's biggest steel maker Bao Steel is to cut December prices of its principal products, underscoring weak demand. Some plants in Europe and China in particular have preponed shutdown for maintenance, in order not to see their steel inventories rising and putting further pressure on prices.

In India increase in interest rates to tame inflation has led to slowdown in demand of steel from infrastructure and automobile industry. Domestic carmakers, facing the worst slowdown in eleven years due to rising cost of finance and fuel, are scaling down production to reduce inventory which has led to decline in steel demand. India's largest domestic steel maker SAIL has halved domestic demand for the alloy to 6% this fiscal from the earlier 10-12% on the back of difficult interest rate regime along with slowdown in key sectors.

Going forward, the steel industry in India will face some tough times. With raw material situation becoming worse day by day and slowing demand for steel products, the Indian steel makers, especially the non-integrated steel makers are in for some turbulent times ahead. Having said that, there are some solid stocks in Indian steel sector that can offer substantial upsides in the long term if invested in at hammered down prices.