4 reasons why Credit Suisse sees the tide turning for Indian steel sector

In a recent report, Credit Suisse has maintained a bullish view on the Indian steel sector and has initiated coverage with an outperform rating on Tata Steel, JSW Steel and JSPL. It, however, maintains an underperform rating on Steel Authority of India (SAIL).

Also Read: Efforts to cut overcapacity in steel sector fall through

Markets, too, seem to have taken a note of the changing dynamics in the metals sector, with the Nifty Metal index outperforming the markets with a rise of 24% in the past two months, as compared to nearly 10% rise in the benchmark index, Nifty 50.

On Wednesday, the Nifty Metal index surged over 3% in intra-day trade to hit an eight-month high, as compared to the Nifty 50 index that trimmed gains after reclaiming 7,900 levels earlier in the day. Among individual stocks, Vedanta surged 7% to Rs 105, followed by Jindal Steel & Power (up 6% at Rs 74), Hindustan Zinc (up 5% at Rs 177), Tata Steel (up 4.5% at Rs 351) and Hindalco (up 3.3% at Rs 100) on the National Stock Exchange (NSE).

Ravi Shankar, an analyst with Credit Suisse attributes the changing dynamics of the steel sector to four key developments. Firstly, Credit Suisse believes that the inventory cycle has bottomed out (globally, and not just in China). Given the extent of destocking and current inventory levels, the restock this time could last more than the usual six – nine months. Any uptick in demand (expected in 2H) would further elongate this, he says.

“Secondly, the weakness in dollar has helped stabilise cost curves. Thirdly, China has laid out plans for a higher fiscal deficit to stimulate the economy. On-the-ground checks by our China team indicate that projects indeed are ‘moving’, with the central government pushing for more project approvals and lower ‘preparation time’. And lastly, supply discipline in China would be a further positive. We believe that around 100 million tonnes of idling capacity looks unlikely to return from winter maintenance,” he says in the report.

Even though global economic growth continues to look weak, Credit Suisse suggests that chances of a hard landing in China or a US recession appear remote. It expects no further deterioration in global GDP growth (2016E at 2.4%).

 

“Commodity prices have rebounded from 25-year lows hit in January 2016 and prices are up for most large commodities. In some prior years, the rebound fizzled in April/May with seasonal demand weakness. But that seems unlikely this year,” he points out in a recent report co-authored with Neelkanth Mishra and Prateek Singh.

“Domestic prices have surged $50-60/tonne after the minimum import price (MIP) was imposed in February 2016. Even though Chinese prices have rallied too, we think protectionism is here to stay (NPAs a bigger issue). Thus, higher EBITDAs should aid interest cover,” it adds.

Among individual stocks, Credit Suisse likes Tata Steel the most given upside from UK drag going away and lowest bankruptcy risk.

"JSW Steel too looks well-placed to benefit from higher prices (capacity already live). Major risk to our thesis: a fall in steel prices, if demand in China fails in the second half of 2016," the report adds.