Falling iron ore prices a boost for steel producers

40% decline in iron ore prices will prop up steel players' profitability

Global iron ore prices have been on a continuous decline since the highs of $95 a tonne in February this year to about $56 now, primarily due to slowdown in Chinese demand. Analysts at IIFL highlight that iron ore inventory levels at Chinese ports have risen by 40 per cent over past one year and 15 per cent year-to-date in 2017. The Chinese government had directed steel producers to decrease the metal’s output in a bid to reduce pollution. Thus, while iron ore imports were 8.5 per cent higher during January-April, steel production was comparatively much lower at 4.8 per cent.

All this has led to iron ore prices tumbling, which analysts at IIFL estimate to hover between $50-65 in the near-term. Prices, however, could get some support if some of the iron ore production is cut. 

The decline in iron ore prices has not been good news for India’s largest iron ore producer NMDC, which has also seen its stock price correct by almost 32 per cent from the highs of Rs 152.50 in March to Rs 104 now. The limited downside in iron ore prices from here on, though, should cushion further decline for NMDC. Analysts say NMDC’s FY18 volumes and earning may see an impact, which, though, is now factored in the stock. In fact, analysts at Motilal Oswal, in their recent note, have maintained ‘buy’ rating on NMDC looking at its high-quality iron ore and low-cost operations, as they feel valuations, too, are attractive now.

Lower iron ore prices, however, will bode well for domestic steel producers, especially looking at the volatility in prices of other basic raw material such as coal. Players such as JSW Steel, which are dependent on external iron ore supplies, will benefit more from lower ore prices. Though profitability in the June quarter may still see an impact of high-priced coal as well as iron ore inventory (NMDC is yet to cut domestic prices), moving forward the benefits will accrue. Analysts at Kotak Institutional Equities say leaving the June quarter aside, earnings of steelmakers should gain from anti-dumping duties, falling raw material prices and improving demand-supply equation in India. They maintain ‘add’ ratings on Tata Steel, JSW Steel and ‘buy’ on Jindal Steel and Power.

Analysts at Motilal Oswal also see demand-supply equation for steel improving as they forecast steel demand to grow 7.3 per cent CAGR over the next 10 years. The recent investments in creating new capacities will only help meet demand for the next three years, they said. Looking at the stretched balance sheet of most private steel producers and poor execution track record of public sector players, analysts believe only JSW Steel and Tata Steel have balance sheets to support investments in new capacity and hence these stocks remain their top picks.