Steel Authority of India Ltd. (SAIL), the domestic public sector steel behemoth, is India's largest steel producer and is the world's 15th largest. The company commands almost 1/3rd of the domestic market share with its 12 MTPA capacity. It operates 4 integrated steel plants and 2 specialty steel plants. After witnessing a severe deterioration in financial health during the period FY98-FY02, the company got into the turnaround mode since FY03. In this article, we look at, in brief, the fall and the rise of the steel giant.
Dating back to FY95, akin to similar times as today, steel prices were ruling at about US$ 500. Again, akin to similar times as today, major domestic steel players went on a major capacity expansion spree. This resulted in increased supply of the metal in the market, which led to a demand-supply mismatch. The effect - steel prices started to crumble and crumble really fast in FY96. Though some stability did set in during FY97 and 98, 'the damage had already been done'. This was followed, once again, by a sharp fall in steel prices in FY99. While some efficient players like Tisco managed to weather the steel cycle downturn, though with much reduced profits, it were the inefficient ones, SAIL being one of them, which were pushed into the red.
SAIL was expanding its capacity during the period FY97-FY00. However, as mentioned above, steel prices were largely in a correction mode during this period, affecting the cash flows and the profitability of the company. The company thus resorted to market borrowings (debt) to meet its requirements. Further, it must be noted that during those times, the bank rate used to hover in the range of about 12%, which led to increased commitment towards debt servicing (interest payments) by the company. The chart above depicts the rising debt and interest payments (as a % of sales) during the late 1990's.
Dwindling profits, a large part of which can be attributed to the huge interest payments owing to the burgeoning debt situation, naturally started to show its effect on the net worth of the company (see chart above), which eroded by almost 75% from over Rs 80 bn in FY98 to Rs 20 bn in FY03. The stock price of the company also moved in line with the deteriorating performance of the company and crashed by almost 75%-80%. However, the upturn in the steel cycle that began in FY02 helped the company to recover from bleeding profusely. Again, this soon got reflected in the stock price, which moved up from Rs 5 levels at the start of FY03 to Rs 60 during FY04.
This was on back of the improving performance of the company, which suddenly woke up (or so it seems) probably to the fact that it was amongst the leaders in eroding shareholders wealth. Since then, however, the company has shifted into fast gear and has consistently managed to improve its performance. While its debt levels have reduced to almost 50% of the FY99 levels, the company managed to reduce its losses by almost 80% in FY03 reducing its losses from Rs 17 bn in FY02 to Rs 3 bn in FY03. It must be noted that a sharp reduction in interest outgo (as a % of sales) was a big catalyst to this growth of the company (see charts above). Other measures included pruning its bloated work force by almost 1/3rd, improving raw material usage and energy consumption.
However, while the company has continued its splendid performance in terms of delivering bottomline growth numbers in FY04, the stock has gone into a correction mode since then, losing nearly 50% from its peak. The one big reason for this is that markets tend to factor in the future performance of the company. So, does this mean that the company is likely to start under performing again? We feel, most likely.
This is because, the situation now and then (mid-nineties) is not much different. Steel prices are at their peak, (in fact they managed to achieve newer highs this time) and steel majors are, once again, in a massive capacity expansion mode. Though the recent rise in steel prices is more a factor of rising input costs like iron ore, coke and coal, it must be noted that it is largely China that has been responsible for this as it is buying huge amounts of steel in order to feed its infrastructure growth.
However, it must be noted that there are already major concerns that the Chinese economy is currently in an over-heated state and a slowdown from hereon is inevitable. Whenever this happens and China slows down its consumption of steel, which we feel is not far, it could be doom time again for steel manufacturers.
As far as the Indian steel companies are concerned, the still relatively inefficient steel companies like SAIL, could once again face hard times. Lower realisations, owing to fall in steel prices, would lead to lower cash flows and thus lower profitability, which would put immense pressure on the debt position of the company as it is planning to raise its steel capacity from 12 MT to 20 MT by the end of this decade. Thus, at the current juncture, we would advise investors to keep history in mind and act accordingly.