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Steel: On higher grounds - Views on News from Equitymaster
 
 
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  • Apr 2, 2003

    Steel: On higher grounds

    If you happen to look at the top gainers list of the year in the equities market, you will find steel stocks in that list. In fact, the top gainer in FY03 among the BSE-30 stocks is Tata Steel (Tisco). The stock has gained 37% in the last one year. Similar is the story with all other steel stocks. Steel Authority of India (SAIL), Jindal Iron & Steel (JISCO), Essar Steel and Isapt Industries are the other stocks that have registered stupendous gains in the last 12 months. We look at why FY03 was a dream run for stocks and their prospects going forward into the next year.

    Steel: Top gainers over the year
      March 28, 2002 March 31, 2003 Change
    Jindal Iron & Steel 5.45 73.35 1246%
    Ispat Industries 1.20 4.85 304%
    Essar Steel 3.20 7.00 119%
    SAIL 4.90 8.80 80%
    TISCO 97.65 133.40 37%

    The primary contributor, to the turnaround in performance and therefore, the sentiment towards the sector, was the rise in steel prices. If we go back and look at year 2001, the sector saw one of its worst times. The steel prices plunged touching 20-year lows in January 2002. However, then, there was a dramatic turnaround in the pricing environment.

    The price increase was primarily triggered in the international markets. Demand from China, which imports roughly 30 m tones of steel (India’s total capacity is 34 m tones), has kept the demand ticking in the international markets. Demand from China has been on the rise primarily due to its economic growth. The country has posted a GDP growth of about 8%. Further, the country is hosting Olympics for 2008, which has created demand for white goods and consumer durables in the country. Apart from China, the decline in over capacity at a global level and protectionist measures taken by the America (not applicable to India due to the status of a developing nation) also aided the Indian steel companies.

    Just to put things in perspective for FY03, prices of HR Coils improved from US$ 260-270 in March 2002 to the current levels of US$ 380-400. Similarly, the prices of CR Coils also improved from US$ 330-340 levels in March 2002 to the current US$ 490-500. The domestic steel prices are closely linked to the international steel prices. And as a result, a similar trend in price movements was also observed on the domestic front. While the HR prices improved from about Rs 13,000 to Rs 20,000 levels in the last 12 months, CR prices improved from Rs 17,000 to Rs 24,000 levels in the same period.

    India exports only 11% of its steel production. Thus, the major rise has, therefore, been due to rise in domestic prices as domestic prices are closely linked to the international steel prices. But despite the hike in prices, the domestic demand continued to be strong. The domestic steel industry went through a phase of high volumes on the back of healthy demand from the housing and infrastructure sectors. Demand from other user industries, like auto and consumer durables, also aided the growth of the sector.

    Performance snapshot
      Sales Operating profits
    (Rs m) 9mFY02 9mFY03 Change 9mFY02 9mFY03 Change
    SAIL 97,503 118,174 21.2% 3,166 12,421 292.3%
    TISCO 47,847 57,355 19.9% 9,102 14,800 62.6%
    Essar 15,195 20,881 37.4% 653 2,170 232.4%
    Ispat 13,483 20,359 51.0% 73 2,808 3762.9%
    JISCO 7,636 10,198 33.6% 542 2,020 273.0%

    Another major factor, which improved the performance of the steel companies, was the gains derived as a result of increasing efficiencies. The domestic steel companies took advantage of the prevailing low interest rates and restructured their debt, which reduced their interest outgo, thus improving their bottomlines. Also, cost reductions at operational level including employee rationalization by some steel companies helped the companies report better bottomlines.

    Interest outgo snapshot
    Interest Costs
    (Rs m) 9mFY02 9mFY03 Change
    SAIL 12,071 10,393 -13.9%
    TISCO 3,065 2,326 -24.1%
    Essar 4,590 4,172 -9.1%
    Ispat 2,640 2,788 5.6%
    JISCO 922 822 -10.9%

    Moreover, the recent assistance provided by banks and financial institutions to the industry in the form of debt restructuring has come as a boon for the domestic steel companies. This restructuring exercise has brought down the average cost of debt of the steel companies from 16-17% to the current 11-12%, which will further reduce their interest outgo in the years to come.

    The domestic steel industry saw healthy production growth of 8% during the 10 months ending January 2003. Demand for steel is derived demand, depending on the growth of auto and consumer durables. These core sectors have also recorded positive growth in FY03 (10 months ending January 2003). Commercial vehicles production registered a growth of 30% in the period. Passenger cars & multi-utility vehicle witnessed a growth of 8% in production while two-wheelers grew by 21%. Consumer durables sector too recorded a growth of 3% for the period April – December 2002.

    However, all is not as impressive as it seems. Even the steel sector has some major concerns going forward. Though steps have been taken in order to resolve the problems, they still remain a cause for concern. The most important of all the concerns is the problem of global steel overcapacity. In 1998, the overcapacity was at 250 m tonnes (MT), which currently rests at about 170 MT. This could be on the back of the decision by global steel companies to take a planned cut of 125 MT in capacities by 2005.

    Overcapacity is a major concern in the sense that, increase in capacities could have a direct negative impact on steel prices. Already, companies have shown their intentions of building up capacities on the domestic front. Globally too, discontinued steel capacities have come back into existence which would increase the supply of steel in the international markets. Steel prices managed to keep their head up due to the continuous strength in demand, particularly by China. However, with signs of inventory built-up in China, import of steel by China could be hit.

    Another concern is that the production and consumption of steel is likely to come under pressure if economic sluggishness in major developed economies (including the US) continues. This could impact the bottomline growth of companies like SAIL, Tisco and Essar Steel, which export mainly to the American markets. Rising possibility of India coming under the net of anti-dumping duties by major steel importing countries (US and China) also add to the uncertainties. Although, the long-term growth prospects look encouraging for the Indian steel sector, short-term challenges continue to remain. The two biggest concerns for the steel industry (domestic and global) are the sustainability of the steel prices at current levels (due its cyclical nature) and the effect of a prolonged US-Iraq standoff. The steel prices seem to have peaked and a growth in demand for steel from the current high base is also quite difficult. Moreover, any cut down in consumption by China would create a huge surplus in international markets, which could pull down the steel prices. Undoubtedly, the domestic steel sector had one of its most profitable years in recent times. However, growing concerns in the short term could have some impact on the sector.

     

     

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