Steel firms set to shine in New Year

Analysts expect China's steel output cuts to result in stronger earnings for Indian manufacturers in the next 2-3 quarters

The onset of winter and consequent moves by China to cut its steel production signals good news for global steel producers, including the Indian ferrous industry. Already, domestic steel companies have seen a decent improvement in their operating performance in the September quarter (Q2) despite disruptions in the business climate. Their share prices, too, have clocked strong gains of 30-40 per cent in the past six months, led by improving prospects from the troughs. But, despite these gains, analysts believe there is more upside for many steel companies, given the further improvement in the business environment.

In order to improve the air quality in northern China, the Chinese authorities have started enforcing production cuts from November 15, which would continue until the middle of March next year. The reduced production would also mean lower export by the world’s largest producer. 

This should further improve steel realisations and capacity utilisations for manufacturers worldwide. Analysts say some signs are already visible. Inventories in China have started declining sharply, leading to Chinese domestic rebar and hot rolled coil (HRC) prices rallying 21 per cent and seven per cent, respectively over the past month. A large part of these gains have come after November 15, the day winter curbs started being implemented. This has raised hope that global steel prices will start improving in some time. 

For domestic players, they too have seen steel prices gaining since November 2017. Indian steel producers had seen domestic demand getting impacted by the implementation of the goods and services tax (GST) during the first half of FY18 (mainly the June quarter). They also had to bear the brunt of higher steel imports in Q2. Steel imports surged 48 per cent year-on-year to 2.6 million tonnes (mt) in Q2. The quarter, however, saw good operational gains, helped by higher steel prices and cost efficiencies. 

Domestic realisations have started improving further, after a brief lull. And this should rub off well on their performance. After some price hikes in the current quarter (Q3) and improving long-steel product prices over the past 15 days, analysts at IIFL expect companies to report an improvement in realisations on a sequential basis. They expect margins to increase for steel producers, on the back of higher blended realisations and strong volumes, as production cuts in China would also mean lower dumping in global markets. Consequently, they maintain a positive view of the sector. Among stocks, they prefer Tata Steel and JSW Steel.

The larger impact of Chinese production cuts will be visible from January. This will rub off positively on global steel prices, thereby benefitting Indian steel producers, say analysts at PhillipCapital. They see the trend helping Indian steel producers from the March 2018 quarter.

The recent surge in raw material prices, including those of coal and iron ore, will also support steel prices globally and in India. But, in such a scenario, domestic players which have secure access to these inputs will tend to benefit more (higher margins), as those which import/outsource raw materials will be pushed to pass on the increases to customers.

Domestic demand, too, is expected to improve. Q3 onwards is seasonally a strong period, as construction activities pick up. Also, the impact of the disruption due to GST is fading, say analysts.

Such are the expected gains that Kotak Institutional Equities expects strong earnings improvement (led by margin expansion) over the next two-three quarters for Indian steel players. This, according to the brokerage, could exceed their full-year estimates on the operating front. The brokerage remains positive on Tata Steel, JSW Steel and Jindal Steel & Power, while PhillipCapital has a buy rating on Tata Steel, JSW Steel and SAIL.

Capacity utilisations on the rise: