Favourable winds from the East signal more gains for steel players

Firms witnessing expansion-led volume growth and cost-efficient operations are preferred picks

The demand for steel has grown by over four per cent till August this financial year, but the full benefits to manufacturers would accrue now.

The June quarter performance was impacted by the goods and services tax (GST) -led destocking. A correction in international steel prices also weighed on domestic prices. Lower Chinese steel prices meant higher imports into India.

Edelweiss’ channel checks had suggested that while the demand surged 4.5 per cent year-on-year (y-o-y) in August, the imports surged 62 per cent at 955,000 tonnes on account of material booked during April-May 2017 when China’s export price dropped to $425-430 per tonne. However, its export prices are now up 36 per cent at more than $580 per tonne. Rising prices and expected steel capacity cuts in China will benefit domestic players. 

Deutsche Bank’s analysts say that the supply side reforms should reduce China’s total blast furnace capacity by 115 million tonnes (mt) by 2018. Moreover, healthy domestic demand should ensure improved capacity utilisation, resulting in a recovery of margins of the Indian steel sector.

The domestic per tonne steel prices in July-August have improved by Rs 1,500-2,000 and by some more in September. Edelweiss says domestic players are expanding their presence in exports market, too. These factors should help them to reap benefits of operating leverage in the ensuing months.

Deutsche Bank expects improving asset utilisation and rising margins to drive a 29 per cent compounded annual growth in EBITDA (earnings before interest, tax, depreciation and amortisation) and up to 536 basis point increase in return-on-equity for Tata Steel and JSW Steel over FY17-19.

Analysts’ expectation of demand growing five to six per cent in FY18 also indicates a higher run-rate during the second half. Nonetheless, a foreign brokerage pegs demand to improve by five per cent and six per cent, respectively, in FY18 and FY19. This coupled with improving realisations should drive profitability for domestic steel makers, but rising input costs (coal) need to be monitored.

Though most steel companies will benefit, analysts prefer players undergoing capacity expansions. Tata Steel, after the restructuring of its European business, is likely to concentrate on domestic operations. HDFC Securities says with the lowering of external debt, it can explore both organic and inorganic opportunities domestically. Further, expansions at Kalinganar are already driving its domestic volumes. Analysts, thus see more gains for the stock.

JSW Steel, too, having expanded capacities and undertaking further expansions, should benefit over time. Even as it is a low-cost steel producer, the company is working on enhancing cost efficiencies since it is dependent on external raw material supplies. Analysts at Motilal Oswal Securities have increased their FY19 EBITDA estimates for JSW by four per cent and target price to Rs 297.

The commissioning of its four-million-tonne blast furnace will double Jindal Steel’s production by the end of FY18, but the Street is watching its debt reduction moves. SAIL is also in the last leg of expansions, but reduction in per tonne cost of production is crucial.