Steel: Will the big bets pay off?

Likely capacity
additions
(mt)

Outlay
(Rs Cr)

SAIL

20

25,000

Tata Steel

6

23,000

Vedanta Resources

5

12,500

Rashtriya Ispat Nigam

3.5

8,500

Jindal Iron & Steel Company

1.5

2,000

Ispat

2

840

Essar Steel

4

700

 Several smaller private sector players like Bhushan Steel and Tata Metaliks are also eyeing bigger capacities. What was once thought to be the biggest investment of all - a Rs 55,000 crore project in Orissa by the international player Posco of South Korea - has hit a roadblock due to differences between the company and the Orissa government over the mining lease for iron ore.  Not that Indian companies are content sitting at home and expanding local capacities. As evidenced by Tata Steel's recent acquisition of Singapore-based Nat Steel, they, too, are harbouring global ambitions, though as of now acquisitions remain an exception, rather than a rule.  However, according to analysts, acquisitions are unlikely to be for the purpose of catering to global demand, but rather for producing downstream products and catering to local markets.  Also steel companies are taking the M&A (merger and acquisition) route for forward integration and for cheaper raw material supplies.  Recent examples are Ispat group's acquisition of iron mines in Nigeria and Essar group's plans to pay $500 million to buy out its UK-based partner Stemcor's 51 per cent stake in a pellet plant that feeds one of Essar's steel plants.  According to government estimates, domestic consumption of steel will go up to 60 mt by 2010 from the current 35 mt, and to 100 mt by 2020.  "The current expansions will lead to a capacity of 70 mt in the next 15 years. So if 100 mt is the estimated steel consumption in that period, we will still be short by 30 mt," says an analyst with Mumbai-based Refco Sify Securities.  "Assuming a CAGR growth of 6 per cent in steel demand, the domestic demand should be around 90 million tonnes by 2020. So these capacity expansions are justified. Also most steel companies have strong balance-sheets, which will help them carry on with their expansion plans. For example, companies like SAIL are almost debt free," he points out.  The story so far
The Indian steel industry has been on a recovery path for the past three years, after being burdened with low steel prices and rising interest rates previously.  However, the cycle has turned in the wake of an upsurge in global and domestic demand as well as a sharp fall in interest rates. Also, the steel companies who were caught in a debt trap took advantage of the lower interest rates to restructure their debt, which put their finances back on an even keel.  And with the steel cycle turning again, thanks mainly to the surging Chinese demand and rising prices, Indian steel companies are now confident enough to think big again, gearing up to meet the expected quantum jump in both global and domestic demand.  The impetus for the surge in investments has mostly been the result of the improving outlook on both global and domestic steel industry.  Global firms are also looking at consolidation which has resulted in the formation of large companies such as Arcelor, JFE and Nippon Steel, apart from Mittal Steel which became the largest steel maker in the world through a series of global acquisitions.  Coupled with strong demand growth, led by China, this has reduced the need to close down unviable capacities and led most steel manufacturers to look at capacity expansions.  Another factor has been the need for Indian companies to integrate backwards. India, which contributes nearly 3 per cent to overall global steel demand, is among the major suppliers of iron ore to the global steel industry.  Concerns over the availability or iron ore and coal, and the resultant volatility in prices, meant that most Indian steel producers had to integrate backwards in order to have greater access and pricing power over these commodities.  This explains the big investments in backward integration projects (Bhushan Steel & Stripes, Bhushan Steel and SAIL) announced in the recent past.  Apart from this, Indian companies are gearing up to meet the increased demand going forward. With the GDP growth projections for the next few years hovering around 7 per cent, and a huge influx of funds into infrastructure and housing segments, steel demand and consumption are set to grow rapidly, say analysts.  Also end-user industries like auto, consumer durables and infrastructure are expected to show an increasing appetite for the metal in the years to come. 

Improving profitability
	Nine months ended Dece 31, 2004		FY2004		FY2003		Trailing
(Rs crore)	Sales	Net profit	Sales	Net profit	Sales	Net profit	12-month P/E
SAIL	19744.08	4,139	24877.31	2512.08	19725.83	-304.31	4.25
Tata Steel	10634.3	2,566	11920.96	1746.22	9793.27	1012.31	6.21
Ispat	4382.40	530	4114.71	44.32	3370.62	82.83	11.90
Jindal Iron & Steel	4496.54	465.97	2265.84	242.70	1612.26	120.98	4.94
Jindal Steel & Power*	2271.03	515.7	1550.25	305.46	1101.3	145.08	6.10
* FYO5

 "The domestic demand continues to be strong, mainly driven by infrastructure spending, with construction, engineering, auto and auto ancillary sectors likely to be key growth drivers," notes Kanan Shah, analyst with Mumbai-based securities firm Networth Stock Broking.  What makes most analysts believe in a stronger demand and consumption growth in the future is the fact that average domestic consumption in India is abysmally low as compared to other countries.  India has a per capita consumption of steel of around 30 kgs against 180 kgs in China and an average of over 400 kgs in the developed countries.  Analysts point out that India's steel consumption has stagnated at around 30 kgs, despite increasing steel production, mainly because of an increasing population.  Heading for over capacity?
While growing demand and the need for ample capacity to service are is not in question, what has cast a shadow of doubt over the steel industry is the spectre of over capacity as well as the feeble outlook on prices.  According to a recent report by Organisation for Economic Co-operation and Development (OECD), world steel supply is likely to expand dramatically over the next two to four years.  According to the report, much of this unprecedented investment is occurring as a result of decisions by governments to support the expansion of domestic steel-making capability.  "These state-supported expansions will likely lead to growing steel trade disputes and a return of over-capacity conditions within the next few years," warns the report.  It also noted that the planned capacity expansions will represent a structural problem for the global steel industry to the extent that production exceeds the projected increase in demand for steel between now and 2008.  The OECD report projects Indian steel consumption to grow by only 3.5 per cent in 2005 from the levels a year ago.  It says the gap between demand and supply would mean that the vast majority of India's new production capacity will be for export.