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Steel: Reality check

Sep 10, 2003

The markets refuse to take a breather and continue to roll, achieving greater heights (the indices touched their 3-year highs yesterday). However, one sector continues to remain volatile, yet at the top of the mind of all investors, big and small. It is the steel sector.

As can be seen in the chart above, barring Tata Steel (Tisco), all other major steel stocks have 'grossly' underperformed the Sensex. Not to say here that Tisco hasn't underperformed. While the BSE-Sensex has gained 11% since August 18, 2003 till yesterday, steel stocks have taken their own course - this time downwards! While there has been no change in Tisco's stock price since August 18, 2003 (this is underperformance when compared to Sensex gains of 11%), Jindal Iron lost 7%, Essar Steel lost 28% and SAIL lost 30%. But then this was bound to happen, right? While the time period chosen here is very short term, we are trying to indicate that steel stocks have been very volatile off late and retail investors need to be very cautious while investing in these.

During the month of August, while the world was bullish on steel stocks, we at Equitymaster felt that steel stock valuations were highly stretched and a correction was imminent. In fact, in a series of articles (some of these included paragraphs on steel stocks), we had clearly warned about the euphoria being created around steel stocks and that the fundamentals did not justify the run up in steel stocks. The list of articles is as below:

Defying fundamentals
Optimism overplayed
Where are steel stocks headed?
Steel: Time to sell?

So, what now? At current valuations, steel stocks continue to remain pricey. Since steel is a core industry and its performance is linked to economic growth, P/E multiple of a 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 higher valuations. Moreover, some recent developments indicate that Indian steel companies are likely to face increasing pressure going forward.

To begin with, domestic steel companies are facing increasing resistance from steel consumers towards price increases. In fact, the recent postponement of hike in steel prices (due in the first week of September) seemed to have been an effect of the same. Moreover, if news reports are to be believed, the government (read steel ministry) has stated that it feels that domestic steel producers are reaping undue benefits of high import duties (currently 30%). This in effect could mean that import duties could come down, thus increasing the competition for domestic steel producers. Moreover, as if the US levies on Indian steel was not enough, China issued its first warning to the Indian government stating that India should either curb its steel exports to China or be ready to face safeguard measures. It must be noted that 30% of Indian steel exports enter the Chinese markets.

All these developments are not a good sign for the Indian steel industry, and this makes steel stocks seem more over valued. In the near term, since steel stocks have corrected at a pace similar to their upward movement, there could be some spike up in steel prices, which would continue to allure investors. However, we would like to re-iterate our stand that investing in steel stocks, at current valuations, is a high-risk proposition.

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Dec 6, 2021 02:57 PM