What I Find Exciting about Tata Steel and Boring Steel Stocks 

In February 2023, the Geological Survey of India announced the discovery of 5.9 million tonnes of lithium reserves in Reasi district of Jammu & Kashmir. This may be the seventh largest deposit of the rare element, accounting for roughly 5.7% of all the reserves in the world.

They are also said to be of a higher grade-550 parts per million (ppm) against the average 220 ppm-making it highly lucrative, given how lithium prices have soared in the last few years.

According to the International Energy Agency, lithium prices went up more than seven-fold between the start of 2021 and May 2022.

Why is lithium so important?

Lithium is a soft, shiny grey metal found in the earth's crust. Due to its ability to pack energy, it has utility across a range of sectors and has gained the moniker 'white gold'. It is now primarily used to build the batteries that power modern appliances. They also power electric vehicles, a segment that will corner most of the global lithium production in future.

All these years India did not have its own lithium resources and like crude oil, was dependent on imports. In fiscal 2022, India imported lithium and lithium ion worth almost ₹14,000 crore. But with the focus on green mobility, the demand for lithium in India is likely to explode in the future.

What are the pitfalls of lithium mining?

Just like any mining activity, there are adverse impacts on the environment, including water, soil and air pollution. Extracting lithium from its ore is highly water-intensive, taking about 2.2 million litres of water for one tonne of lithium. The Himalayas are a highly fragile and eco-sensitive region and as the recent Joshimath subsidence shows, it is vulnerable to long-term adverse consequences of unplanned development works. Mining in the region can attract opposition from environmentalists.

Will it mitigate China's lithium dominance?

China does not have too much lithium reserve of its own, but as the largest market for electric vehicles, it controls both the supply and demand side of the lithium industry. It controls over half the global lithium processing and almost 75% of cell components and battery cell production in the world. In effect, proliferation of EVs could mean India becoming dependent on China, just like it is reliant on the Middle East for crude oil today. J&K's reserves, however, provide a major opening for India to be self-reliant.

In other words, the lithium gold rush in India has just begun.

But apart from lithium, pretty much every metal that goes into smartphones is grabbling limelight these days.

The impact of China+1 on the smartphone manufacturing sector.

Apple Inc's partner Foxconn Technology plans to invest about US$ 700 m on a new plant in India to ramp up local production. This underscores an accelerating shift of manufacturing away from China as Washington-Beijing tensions grow. The Taiwanese company plans to build its new smartphone factory in the state of Karnataka.Now, it is extremely uncertain whether Foxconn will import key components of the smartphone. Especially the rare metals not readily available in India.

But investors expect the PLI benefits for the sector to attract massive investments. And therefore, the demand for the key metals could explode.

For its not just Apple but several other US brands that are seeking alternative production units in India. It's a rethink of the global supply chain that's accelerated during the pandemic first and the Ukraine war later.

There is a possibility that India becomes a global electronics manufacturing hub. And this is the key drive of the investor rush towards these metals. Unlike popular perception, lithium and cobalt are just two of the many metals that go into the smartphone. So, seeking investment opportunities in the others is both complicated and speculative.

Metals Needed for Smartphones

Meanwhile, a boring metal that typically has few takers is showing strong signs of an upsurge in demand. The undercurrents are so strong that the prices of the metal have gone up by almost 50% in the last 18 months.

Steel prices in India may have been on a tear. However, globally, low demand has caused prices to crash by nearly 40% in the past year. By December 2022 prices had crashed t nearly US$ 590 per tonne from the early-April peaks of US$ 1,000 per tonne. The reason for the crash is primarily low demand from China.

But India is expected to emerge as a saviour for flagging global steel demand.

Over next few years, China's massive construction sector may remain stagnant. And the US and Europe are likely heading into recessions.

India is poised to capture most of the steel demand thanks to a massive infrastructure and corporate capex boom.

The Indian government is seeking to modernise roads, rail networks and ports in attempt to compete with China as a manufacturing hub. So, according to the World Steel Association, India's steel demand could soar to 200 m by 2030. This will make India the highest steel consumer amongst major economies.

Add to that the demand for steel in the aftermath of earthquakes in Turkey. Rebuilding and reconstruction of Turkey after the devastating earthquakes is expected to cause global massive demand for steel.

In 2021, Turkey's crude steel production exceeded 40 million tonnes (m). Of this, more than 22 m was exported, making it an important player in the world steel trade.

After the earthquake not only will the nation be unable to meet its own demand. But Turkey may also seek to import. This will stoke both volumes and prices for largest steel producers globally.

So, understandably, the undercurrents for demand of steel and much stronger than the fancier metals needed for smartphones. The visibility is much higher. And Indian steel makers are much better placed to cater to the demand, both domestically and for exports.

So, investors should keep the fundamental demand drivers in mind rather than getting swayed by speculative bets.

According to a CII report, growth of crude steel production in India has not kept pace with the growth in capacity of production. As per this report, steel sector contributes ~2 per cent to India's GDP and employs half a million people directly and 2 million people indirectly. As of FY21, India is the world's second largest steel producer with ~102.5 MT production and an installed capacity of 142.2 MT. On the consumption front, India is the third largest steel consumer in the world and has a finished steel consumption of 94.9 MT in FY21. Sectors that have emerged as leaders in using finished steel are -- construction (62 percent); capital goods (15 percent); automotive (9 percent); intermediate products (6 percent); consumer durables (5 percent); and railways (3 percent)

In recent years, India has become a net exporter of steel as India's steel imports have been much lower than imports since FY11. Domestic production of specialty steel was able to meet 85 percent of India's demand in FY21, with the balance met through imports. Significant portion of steel import was of specialty steel comprising high grade alloy steel and specialty steel. Even though India is the second largest steel producer worldwide, specialty steel accounts for only 18 percent share of exports in FY21.

The growth in steel exports is also aided by lower domestic demand and the foreign trade agreements that India has with countries like Japan and South Korea. While countries like Japan and South Korea export value-added steel products to India compared to India which exports hot rolled coils (HRCs) to these countries, markets like EU and USA have protectionist policies like quota restrictions and Middle East is also considering the same. The Union Government has also formulated policies aimed at bolstering the domestic steel sector and some of these policies are:

• National Steel Policy, 2017;
• Steel scrap policy;
• Domestically Manufactured Iron and Steel Products (DMI&SP) policy etc.

The government has also rolled out Production Linked Incentive (PLI) scheme for specialty steel to ensure raw material security for steel sector particularly focused on iron ore and coal.

If you take into account the financials of the top steel makers in the country....the key concerning factors are:

• The level of debt on their books
• The free cash flow
• The return ratios of the companies over several cycles

An additional point to take note of is the working capital cycle of the companies and their respective asset turnover ratios.

So even though the stocks may be available closer to the book values, being careful of the balance sheet risks could help avoid value traps.

Yet another way to evaluate the valuation multiples of Indian steel makers is to compare them with their global peers. Since steel is a commodity that is traded globally, a comparison with international peers could give a fair idea of the upside in prices.

For instance, like we can see here, the Indian steel makers seem fairly valued when compared to their American counterparts. However, their valuations seem expensive when compared to other Asian and European steel majors.

Indian Steel Companies Vs Global Peers

To delve deeper into the fundamentals of the 'best steel stocks to have in your watchlist' the Equitymaster Screener can be a very useful tool.

Hope you like this video. Thanks for watching.