X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.


Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Identifying a steel stock: Do's and don'ts - Views on News from Equitymaster
 
 
  • PRINT
  • E-MAIL
  • FEEDBACK
  • A  A  A
  • Aug 25, 2003

    Identifying a steel stock: Do's and don'ts

    Steel stocks have been the object of heavy reviews off late in discussions about the Indian equity markets. And this is not without reason. In recent times, steel stocks have gained tremendously on the bourses. Whether this is a factor of rising speculation or fundamentals of steel stocks, is a different story altogether. However, in this article, we try to elucidate factors one should keep in mind before investing in a steel sector company.

    Profile
    Steel industry plays an important role in the economic development of a country. India, being the 9th largest steel producer in the world, has a share of about 3.2% in world steel production of a little over 900 million tonnes (MT). Despite this, the per capita steel consumption in India is one of the lowest, thus providing the domestic industry with a huge potential to scale greater heights.

    On basis of scale of operations and level of integration, steel makers can be categorized into the following two types:

    • Integrated Steel Producers (ISP)/Primary producers: These have manufacturing facilities right from the iron ore (raw material) stage to the finished steel stage. They use the blast furnace methodology for manufacturing steel.

    • Secondary producers/Mini Steel Plants: This segment uses scrap and sponge iron as raw materials to produce steel. Their production method comprises mainly of Electric Arc Furnace (EAF) and induction furnace units.

    As far as the steel products are concerned, they can be classified into three categories. Semis, which are intermediate products, are cast from liquid steel for further rolling into finished products (longs and flats). Longs are primarily used in construction, infrastructure and heavy engineering. Finally, flats are used in automobiles and consumer durables. These are high-value products and thus enjoy higher margins.

    Now let us proceed with the various parameters indicated in the flowchart above:

    Revenues
    Revenues are a function of volumes and realisations. Lets look at the volumes side first.

    Volumes
    The demand from steel comes both from the domestic and export fronts. Also, this being a core sector, its volume performance is directly linked to the economy. This is because the demand for steel is derived from spending in infrastructure, housing, automobiles and consumer durables sectors. Fortunes of the steel sector are, thus, linked to the prospects of these sectors. Competition also plays a significant role in determining the prospects of the steel industry. Domestic steel producers face intense competition from global majors, chiefly due to the latter's larger scale of operations (giving them benefits of economies of scale). Going forward, this sector is likely to face competition from aluminium, which is not only as strong but substantially lighter than the former. This could create a threat for steel, as user industries like auto, railways, etc. where fuel efficiency is an important factor, could switch their preferences to aluminium.

    Realisations
    Apart from the cyclical nature of the industry, realisations are also dependent on the following:

    • Contract sales: Company's policy pertaining to its sales has an impact on realisations. Ideally, steel companies, to avoid uncertainty regarding realisations created due to volatility in global steel prices (due to cyclical downturns or unexpected events), get into forward sale contracts with their customers, which could be anything from a month to a year. However, at times of cyclical upturns, companies over exposed to long-term contracts are not able to fully exploit the benefits of rising steel prices.

    • Value added (CR): Realisations are also dependant to a large extent on the products profile of a steel company. Companies with a larger presence in value added segments (like Cold Rolled (CR) products) are able to realise higher prices (about 20%-25% higher) for their products.

    • Competition: Competition plays a major role in affecting realisations, as international steel companies with huge capacities (thus an appetite to bear lower realisations) tend to offload their produce in the markets at lower prices, thus making Indian steel exports price uncompetitive. Indian companies also face international competition on the domestic front when lowering of import duties result into international majors flooding their products into the domestic market. In this case, cost efficiency plays a major role for survival.

    Expenses
    As said above, in face of increasing competition, survival would depend on cost efficiency, more so in times of a downturn. It is, thus, imperative for these companies is to keep a strict check on their expenses and maintain (if not improve) their standards of efficiency. Some of these expenses are pertaining to raw materials, power, employees and interest cost.

    On raw material and power fronts, companies with captive facilities have an added advantage as purchasing these requirements from the market is expensive relative to their sourcing from internal (captive) facilities. Employee efficiency also plays an important role due to the large number of employees employed by this industry. Finally, as steel companies are capital-intensive in nature and have significant exposure to debt, managing interest cost is of utmost importance.

    Key parameters to be kept in mind while investing in a steel company:

    • Cyclicality of the sector: This is a very important point, which should be remembered, before investing in a steel stock. This is because; this very factor can make or mar the fortunes of the sector and steel companies. Investments into a steel stock near the peak of its cycle could result in a huge chunk of the investment being wiped it. Nevertheless, identifying the bottom of the cycle is not an easy task.

    • Integration advantage: Whether the company is backward integrated (ISP, as discussed above) or not, is a key factor for consideration. Backward integration has various advantages as have been mentioned above (captive facilities).

    • Operating performance: The operating performance of a steel company is dependant to a large extent on the cyclicality factor. However, steel players with larger presence into contract sales and value added products are insulated, to a relatively greater extent, from the steel cycle. In this regards, operating profit margins (OPM) is one parameter to consider. OPM is also dependant on various internal parameters such as power cost per unit and production per employee. However, it must be noted that in the case of production per employee, the numbers could be skewed to the extent of the companies' presence into mining of raw materials.

    • Valuations: Two important ratios to look at in a steel company could be the Price to Earnings (P/E) ratio and the Price to Book Value (P/BV). Since steel is a core industry and its performance is linked to economic growth, the P/E multiple of steel stock should more or less hover around the country's GDP growth. However, at the same time, companies with greater exposure to international markets (exports) could command a higher valuation. The P/BV ratio can also be used as a parameter for comparison. This is considering the fact that the steel sector is capital intensive in nature with huge asset base and debt. Book Value is basically the NAV of assets in the balance sheet. P/BV thus indicates, theoretically, what the shareholder would receive if the company would ever go into liquidation.

    Click here to identify stocks from other sectors.

    Related Links for Steel Sector: Quarterly Results  NEW | Sector Analysis Report | Sector Quote | Over The Years

     

     

    Equitymaster requests your view! Post a comment on "Identifying a steel stock: Do's and don'ts". Click here!

      
     

    More Views on News

    Tata Steel: A Strong Quarter (Quarterly Results Update - Detailed)

    Aug 12, 2017

    Tata Steel reported a robust operating performance on the back of strong domestic and European operations.

    SAIL: Loss at EBITDA Level Due to Higher Raw Material Cost (Quarterly Results Update - Detailed)

    Jun 12, 2017

    The company registered a negative EBITDA of Rs 2.64 billion during the quarter. This is on the back of an increase in raw material prices.

    Tata Steel: Strong Quarterly Performance (Quarterly Results Update - Detailed)

    May 22, 2017

    Tata Steel reported a robust operating performance on the back of strong domestic and European operations.

    SAIL: Pressure Continues. Loss at Operating Levels... (Quarterly Results Update - Detailed)

    Feb 15, 2017

    SAIL has reported a 26.2% YoY increase in the topline while the bottomline reported a loss of Rs 7.94 billion.

    Tata Steel: Loss from Discontinued Business Mars Performance (Quarterly Results Update - Detailed)

    Sep 27, 2016

    Tata Steel has reported a 6.3% decline in the topline while the bottomline was in red in 1QFY17.

    More Views on News

    Most Popular

    Demonetisation Barely Made Any Difference to Tax Collections(Vivek Kaul's Diary)

    Aug 7, 2017

    The data tells us quite a different story from the one the government is trying to project.

    A 'Backdoor' to Multibaggers: It's Like Investing in Asian Paints Ten Years Ago(The 5 Minute Wrapup)

    Aug 10, 2017

    Don't miss these proxy bets on growing companies or in a few years you will be looking back with regret.

    Should You Invest In Bharat-22 ETF? Know Here...(Outside View)

    Aug 8, 2017

    Bharat-22 is one of the most diverse ETFs offered so far by the Government. Know here if you should invest...

    Signs of Life in the India VIX(Daily Profit Hunter)

    Aug 12, 2017

    The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.

    7 Financial Gifts For Your Sister This Raksha Bandhan(Outside View)

    Aug 7, 2017

    Raksha Bandhan signifies the brother-sister bond. Here are 7 thoughtful financial gifts for sisters...

    More
    Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
    Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement.

    LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

    SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

    Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
    Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407
     

    Become A Smarter Investor In
    Just 5 Minutes

    Multibagger Stocks Guide 2017
    Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
    We will never sell or rent your email id.
    Please read our Terms

    S&P BSE METAL


    Aug 18, 2017 (Close)

    S&P BSE METAL 5-YR ANALYSIS

    COMPARE COMPANY

    MARKET STATS