Jun 8, 2005|
Steel: The orphaned lot!
Have you heard of Tata Steel (or Tisco) lately on the bourses? Or for that matter Steel Authority of India (SAIL)? Well, largely, the possibility is that you haven't heard of these in recent times and even if you have, the chances are that the voices advocating an investment into these are rather subdued.
Flashback, just a couple of years ago, these very stocks were the darlings of the bourses and almost everybody wanted to own these. Today, there are very few investors, who are even 'thinking' about investing in these. Why this sudden change in investor outlook towards these stocks?
The reason for the disownment of steel stocks in the recent past can be seen in the table above. As can be distinctly seen, both - the metal index and steel stocks - had outperformed the benchmark index until before 6-months. However, since then, the steel story has taken a U-turn with the benchmark index outpacing the BSE Metals Index and steel stocks. Though the BSE Metal Index also includes representatives from other sectors like aluminium, zinc, etc and hence the entire quantum of correction could not be blamed onto steel stocks, it must be noted that Tisco and SAIL together account for 50% of the BSE Metals Index weightage (total steel stocks weightage is nearly 65%).
In the above backdrop, we conducted a poll on our website asking investors whether, in their view, the steel story was over. The result - largely (nearly 2/3rd) of those who took the poll remained optimistic about the steel story, the balance believed that the euphoric times for steel is now over. As far as our stand is concerned, we go with the minority (this is not a stand that we have taken now, but almost a year back!). And there is enough reason for us to believe so.
The fall in steel stocks can be attributed to the sharp fall in steel prices witnessed globally. And with Indian steel producers now enjoying a limited protection in terms of import tariffs, the impact of the fall in international steel prices did not take much time to percolate down to the Indian shores. This led to the recent (May 2005) reduction in steel prices in the domestic ranging from Rs 500 to Rs 2,000 per tone i.e. US$ 10 to US$ 40. However, the reported fall in international markets is much higher, in the vicinity of about US$ 100 per ton. Seemingly, the markets have already started factoring in lower realisations for many steel companies going forward, which would consequently affect their financial performance.
Though one may argue that despite a 10% to 15% fall in realisations, the valuations of steel stocks look attractive, one has to understand that the steel cycle has 'most probably' peaked. Thus, from hereon, going by the cyclical nature of this industry, the downside for steel prices could be much more. There have been instances in the previous cycles of steel prices collapsing by as much as 50% within a span of 12-months and this time 'may' not be different. However, the only thing that's different this time is seemingly the fact that steel prices this time 'may' not test their earlier lows of US$ 200 per tonne as in early 1999 and early 2003. This is because the input costs, i.e. iron ore, coking coal, etc. are in short supply. Though this is expected to ease 2007 onwards, nonetheless, their average costs would be higher considering the demand for them to meet the expected additional steel capacities.
As per estimates, substantial amount of steel capacities are being added round the globe on the pretext of continued Chinese demand. The Chinese demand assumes significance owing to the fact that in the past 3 years, nearly 75% of the incremental world steel production has found its way into the Chinese markets. While the assumption is right, one must look at what the future holds for China. While we are no experts on the Chinese economy, the fact that it has reduced its imports from as high as 35 to 40 MT just a couple of years back to about half currently and falling as yet, is enough of a warning signal. This is in wake of the fact that it is increasingly meeting its requirements internally. Further, continued efforts by the Chinese government to cool down its economy could impact consumption growth.
All of the above does paint a real grim picture of the things to come for the industry. We continue to believe that investing in steel stocks is a very high-risk option, even as stock prices have fallen significantly.
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