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Steel: Tracking the cycle... - Views on News from Equitymaster
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  • Mar 19, 2007

    Steel: Tracking the cycle...

    Steel has been considered as an important tool for development of any modern economy and the level of per capita consumption of steel is treated as one of the important indicators of socio-economic development and standard of living of the people in any country. However, in the past, performance of the Indian steel industry was adversely affected by over capacity, softening of steel prices and cheap imports. The imbalance in demand supply leads to volatility in steel prices. Thus, stability in steel prices will come with equilibrium in steel demand and supply.

    In this article, we analyse the reasons for the volatility in the Indian steel industry by understanding the steel price cycle.

    A typical price cycle in steel industry would go through the following phases.

    A demand supply imbalance, as in the case of all industries, leads to instability in steel prices. Historically, the industry has always been keen on investing into new capacities during the peak cycles when prices were high. To grab the opportunity of improved realisations, manufacturers operate at optimum levels and indulge in capacity building that leads to excess supply situation. In order to retain their market share in excess supply situations, producers compete for volume share by resorting to price-cutting. Such moves lead to softening of prices leading to margin pressures. Steel being a capital-intensive industry, generally players have to fund expansion and modernisation projects by a mix of debt and internal accruals. Moreover, being cyclical industry cash flows are not certain. As mentioned earlier, capital investments take place at the peak of cycle that leads to cash outflow in terms of finance charges. When the realisations are better, things go unnoticed. However, when the steel cycle turns, the burden on margins increases with lower realisations and increased finance charges (debt taken to expand capacity during peak time) which in turn impacts the cash position of the company. The strained financials over a period of time call for shutting down of units and once again demand supply equilibrium is achieved.

    In this article we will take a closer look at three periods: 1992-97, 1997-2002 and 2002 onwards.

    1992-96: The Indian iron and steel industry was deregulated in January 1992. Deregulation was an integral part of the general policy of liberalisation, economic reforms and structural adjustment programmes initiated in the early 1990s. It opened up avenues for participation of private capital in the capital and technology intensive integrated segment of the industry. During the mid-90's, the global economy was in a growth phase and therefore contributed to better performance.

    1997-2002: The industry had built up additional capacities during the early 90's in anticipation of higher growth, which did not materialise. The industry was affected adversely during this period on account of over-capacity, cheap imports, economic slowdown (Asian crisis), declining global steel prices and anti dumping duty imposed by USA on Indian exports. Prices have been under pressure both internationally and domestically as a result of oversupply, coupled with stagnant demand growth. In India, this downward price phase coincided with the coming up of new capacities in the private sector such as Essar Steel, Ispat Steel, etc. After the Asian meltdown of 1997, the global steel industry experienced a serious and prolonged downturn. Stagnating demand at home and abroad and the global slowdown made matters worse.

    2002-2006 The global steel industry, in recent past has witnessed a massive wave of mergers and acquisitions. The other major difference is that the industry is witnessing steady rise of firms from emerging economies such as India, Brazil, etc. which enjoy competitive advantage in terms of key resources such as iron ore, coal and low wage rates. Consolidation leads to better pricing environment. On account of consolidation it is expected that the volatility of the steel sector, with sharp swings in prices - will moderate. Currently, the stable to firm prices witnessed by industry are not on account of consolidation but have also been led by rising demand. Growth in the end user industry such as housing and urban development, growing automobile sector and thrust on infrastructural development has led to buoyancy in steel sector.

    To conclude…

    Consolidation has always helped steel companies benefit from the economies of scale and also leads to adjusting production levels to ensure that the inventory corrects itself and the state of equilibrium is re-established. To conclude, acts like global consolidation and alliances tend to benefit the industry as a whole.

    Increased spending on infrastructure and the government's initiatives on housing sector are the key positives for the steel sector, as these are the key demand drivers for steel. Going forward, we remain apprehensive about the continuation of the strong performance by domestic steel companies. Though we believe that volume growth would be visible in the years to come, largely due to the continuation of infrastructure spending (including housing), and strong demand from the auto sector, which could help in driving demand for value added steel products like CR (cold roll) steel and exports, we expect realisations to come under pressure on account of excessive supplies. From a long-term standpoint, the demand in India is not sufficient to absorb the increased supply and hence for an improved and consistent demand supply equation, India needs to ramp up its exports.



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