Where are steel stocks headed? - Views on News from Equitymaster

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Where are steel stocks headed?

Aug 20, 2003

Down! This is what we believe will happen. We feel that the steel story (read steel stocks) is on the verge of dying and it is only a matter of time before steel stocks change into reverse gear. As is known to everyone, steel stocks have registered astounding gains over the last 18-20 months on the back of strong steel demand combined with higher prices. Just to put things in perspective, while Tisco has gained almost 200% since January 1, 2002, its peer SAIL has gained about 800% in the same period. Let us not discuss about other smaller steel stocks here, as the story there is nothing different. However, now the question at the top of investors mind is, what next?The question has already been answered. However, let us first consider some simple figures before we delve into fundamentals and valuations.

The charts here have a story to tell. And we think that it is not a good one! The above two charts (and also the two charts below) basically indicate the trend in actual delivery (of the stock) which took place since January 1, 2002 and the same is compared with the share price and daily traded volumes of the stock under consideration. The two stocks under consideration are SAIL and Tisco.

Rather than explaining all the observations in the charts above, the same have been presented in a tabular format below.

 Price (Rs)Vol. (nos. m)Delivery (%)Price (Rs)Vol. (nos. m)Delivery (%)
2003 (to date)131137%158524%
Note: All figures are averages.

However, just to throw a brief light on what the above table indicates, let us look at a couple of figures for SAIL. The average stock price increased from Rs 7 in 2002 to Rs 32 in the month of August this year. Though the periods are not comparable, it indicates the quantum of appreciation that has been witnessed in the stock. Also, the traded volumes have increased 19 folds in the same period. However, the not so good indication here is the volumes based on delivery, which has fallen from almost 60% to 20%. In fact, on the day (August 18, 2003) when the SAIL stock appreciated by 30% in a single trading session, the actual quantity for delivery on the NSE was under 10%. This indicates that a substantial part of the trading volume was pure speculation with punters trying to make a quick buck. However, over the next couple of days (including today), SAIL stock tanked 25%. It should not be forgotten here that the last time when such kind off erratic volumes were witnessed on the bourses in banking stocks (not a long time ago), the market regulator initiated an enquiry.

Now, enough of the number game! Now let us get down to the fundamentals and a rough calculation as to what the valuations of the two stocks actually deserve (for detailed and accurate calculations, you need to be a subscriber to Equitymaster’s premium products i.e. Quantum View and Research reports).

What is the reality?

  • China’s dependence on imports of meeting its domestic steel consumption is expected to reduce in the future. As a result, steel prices may not sustain at the current levels.

  • While it is true that Tisco could insulate from cyclicality in steel prices by concentrating in value-add products, things are not pretty as it sounds. Assuming 50% of sales comes from value-add products on the projected capacity expansion, valuation seem to be stretched.

  • Though SAIL may turn profitable in FY04, sustainability is a serious issue. Why will a consumer buy steel from SAIL who is not so cost efficient when you have Tisco as an option? Agreed that government is there to support SAIL. But for how long? Whether this warrants such a sharp spurt in SAIL’s stock price is anybody’s guess.

  • If this is not enough to convince, it must be noted that practically all the good news has been already factored into the stock prices. We believe that a commodity stock should ideally be valued based on long-term economic growth (which means, at the current GDP growth rate, P/E should be around 6x-7x). But at the current price, Tisco and SAIL are trading at a P/E multiple of 8x and 17x respectively!

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